Investors appreciate bonds and debentures and decide to invest. When they are asked to transfer the amount to a clearinghouse, they get a little confused. They know NSE/ BSE where bonds are listed, and they know GoldenPi as an online marketplace but are unaware of the clearinghouse.
This blog is about “Clearing and Settlement in Corporate Bonds.” Firstly, we shall understand what does clearinghouse means and its role. To understand clearinghouse, we will take an example from our day to day life.
You are at a restaurant for dinner. You order the waiter to get your preferred dishes. After that, you sit back in your chair and relax. The waiter goes to the restaurant kitchen and passes on your order to the cook. Your order is in a queue; you need to wait for your turn. After a few minutes, your food is served. Before leaving the restaurant, you pay the bill.
In this scene, you see a time gap between placing the order and the order getting fulfilled. Also, there is a time gap between the restaurant fulfilling your order and receiving the amount. But both of you, i.e., you and the restaurant, are ok with this because you are in close proximity to one another, and the amount involved is in hundreds of Rupees.
Imagine a scenario where you have to pay lakhs of Rupees to an unknown and unseen person on another side to buy goods. The mode of operation is: you transfer the money to the person’s account. The other person sends over the goods to you. All this is done in good faith that each party will keep its promise. Now, in the real world, there is a chance of default by either party.
Case 1: The other party can take the money and not deliver the goods.
Case 2: The person, i.e., you, can take the delivery of goods and renege on payment. This is called the default risk in a transaction. Clearing Houses are built to eliminate exactly this risk.
Say a buyer wants to buy Rs 10 Lac worth of Bond papers of State Bank of India (from the secondary market). A seller is willing to sell the Bond papers to him. They sign a contract for this called the ‘Deal Sheet.’ The buyer then transfers the exact fund amount to the Clearing House. The seller transfers the exact Bond papers to Clearing House. Once it has received both the exact amount of money and Bond papers (as per the details in the Deal Sheet), it will swap the assets. It will transfer the Bonds to the buyer’s Demat Account and remit the funds to the Seller’s Bank Account. In case any party fails to fulfill its promise, the funds/ bond papers are returned to the respective party.
We believe that you are now convinced with the role a clearinghouse plays. Now let’s look into the specifics of how clearing and settlement happen in reality.
A new bond investor may get confused by some of the jargon associated with the bond investment. We bring you a brief list of the most important bond jargon that you should understand and evaluate while making your investment decision.
Clearing and Settlement
The Role of Clearinghouse starts after the trade (buy and sell of a bond) is placed in its system.
Here seller agrees to sell, and the buyer agrees to buy bonds in a legally enforceable transaction. The transaction is confirmed by signing a ‘Deal Sheet’ that bears the details of the transaction and that of the buyer and seller. This order is then entered into the online system of the Clearing House.
The clearing is the process of keeping the accounts of buyers and sellers’ accounts ready for the exchange of money and bond units. A clearinghouse is an entity that takes the responsibility of clearing and settlement of trades of the securities that are traded on the recognized stock exchanges.
Depositories: who maintains the bond inventory in dematerialized form. In India, some of the more popular depositories are CDSL and NSDL.
Clearing banks: Clearing banks act between clearing house and clearing member
Clearing Members: They have rights in recognized clearinghouses.
Custodians: These members hold the documentary proofs of the bonds.
The clearing member owes financial responsibility in the bond clearing and settlement, but the clearinghouse is held responsible for the clearing of member defaults.
The two most popular clearinghouses in India are:
- Indian Clearing Corporation Ltd. (ICCL)
- National Securities Clearing Corporation Ltd. (NSCCL)
Some of the other lesser-known clearinghouses are :
- India International Clearing Corporation (IFSC) Limited
- Metropolitan Clearing Corporation of India Ltd.
- Multi Commodity Exchange Clearing Corporation Ltd.
- National Commodity Clearing Ltd.
- NSE IFSC Clearing Corporation Limited
Settlement begins after the clearing is over. The settlement body receives the money from the buyer and bond units from the seller, and then the settlement body transfers the money to the seller and bonds to the buyer.
Note: If you are investing in bonds that are NOT Corporate Bonds, such as Sovereign Bonds or Foreign Bonds, then Clearing and Settlement will be different.
In the case of Corporate Bonds, ICCL and NSCCL play the
role of ‘Counter Party Settlement Authority’. The Reserve Bank of India strictly
manages clearinghouses. These clearinghouses take payments via RTGS,
and settlement happens on T+ 0 day, i.e., the same trading day.
GoldenPi is an online aggregator of bonds and debentures: it is a market place. When you purchase bonds on our platform; your payment reaches the sellers of bonds through clearinghouses (ICCL/ NSCCL). Hence your RTGS should be made to ICCL or NSCCL. Both ICCL and NSCCL have Bank Accounts held with the Reserve Bank of India. You receive the bond units in your Demat on the same day, i.e. T + 0 day.