NISM Series VI Depository Operations – Part 5: Trading, Settlement, Pledge & Hypothecation

Quick Summary: Part 5 of our NISM Series VI short notes covers how securities are transferred in the depository system — off-market and market settlements, important trading terminologies, and the creation, closure, and invocation of pledge and hypothecation arrangements on demat securities.

Transfer of Securities in the Depository System

One of the most important functions of a depository is to facilitate the transfer of securities from one account to another at the instruction of the account holder.

In the depository system:

Both the transferor (seller) and the transferee (buyer) must give instructions to their respective DPs.
The transferor gives an instruction to deliver (transfer out) securities.
The transferee gives an instruction to receive securities.

Settlement of Off-Market Transactions

An off-market trade is any trade that is cleared and settled without the involvement of a Clearing Corporation or Clearing Member. Securities are transferred directly from one beneficiary account to another.

Off-market settlements are commonly used for:

Large deals between institutional investors
Trades between private parties
Transfer of securities between a client and a sub-broker
Large trades in debt instruments

Settlement of Market Transactions

A market trade is one settled through the participation of a Clearing Corporation / Clearing House (CC/CH).

How the process works:

Once a broker executes a trade on a stock exchange, the seller gives a delivery instruction to the DP to transfer securities to the broker's Clearing Member (CM) account.
In case of CDSL, the seller BO can deliver securities directly to the Clearing Corporation (BO Level pay-in).
The broker must ensure that the pay-in instruction is submitted using the CM ID and that sufficient balance exists in the CM account before the pay-in deadline set by the stock exchange.

Brokers of stock exchanges that settle through the depository must open a Clearing Member Account. These are also called 'Broker Settlement Account' or 'Broker Pool Account'.

In addition to brokers, custodians registered with SEBI and approved by stock exchanges can also open a Clearing Member Account.

Important Trading & Settlement Terminologies Market Type

Stock exchanges offer different market segments (e.g., equity, derivatives, debt). Each segment has a specific type of settlement. The contract note or trade confirmation slip indicates the settlement details.

Settlement Number

Each trading period in a market segment is identified by a settlement number. The Delivery Instruction Slip (DIS) must contain the correct settlement number for which securities are being transferred to the clearing member account.

Clearing Member (CM)

Every broker participating in the settlement process through a depository must open a Clearing Member account. These accounts are identified with BO IDs or CM BP IDs and are called 'CM accounts'.

Delivery Deadline

Stock exchanges set a deadline by which clearing members must deliver securities. CMs can only meet this deadline if they have already received securities from their clients.

Pay-in

The process of a broker/trading member submitting securities sold on behalf of clients to the CC/CH of a stock exchange is called pay-in.

Pay-out

The process of the CC/CH transferring securities to the broker's CM account for securities purchased on behalf of clients is called pay-out.

Inter-Settlement Transfer

Securities in a CM account are held in a specific market type and settlement number. A clearing member can instruct the movement of securities from one settlement bucket to another — this is called an inter-settlement transfer.

Automatic Delivery-out

Delivery-out instructions (moving securities from CM Pool Account to CM Delivery Account) can be generated automatically by the Clearing Corporation based on the net delivery obligations of its Clearing Members.

Early Pay-in

The early pay-in facility is used to avail margin exemptions and other benefits including Buy-back and Tender Offer transfers.

Normal Pay-in

Normal pay-in is applicable primarily for BSE Clearing Members. It allows a CM or seller BO to deliver securities to CC/CH by giving a normal pay-in instruction to the DP. Instructions from non-BSE CM accounts are not permitted under this facility.

Auto Pay-in

Available to BSE-CMs on written request to CC/CH (i.e., ICCL/NSCCL). By enabling this option, the CM is not required to give separate pay-in instructions — securities are automatically considered for pay-in.

Inter-Depository Transfer

Transfer of securities from an account in one depository (e.g., NSDL) to an account in another depository (e.g., CDSL) is called an inter-depository transfer.

Mutual Fund Units – Subscription and Redemption Through Depository Subscription (Purchase) Through Stock Exchange

MF units purchased through a CM are routed through the stock exchange's settlement cycle.
The eligible CM places the purchase order on the stock exchange's order entry platform on behalf of the investor.
After the order deadline, the order file is sent to the AMC / RT&A for validation.
The CM then transfers the MF units to the BO's demat account.

Redemption (Repurchase) Through Stock Exchange

The investor places a redemption order through an eligible CM on the stock exchange order entry platform.
After order entry, the investor / BO transfers the units for pay-in by submitting DIS to the DP with the Settlement ID and other details.
MF units are debited from the BO's account and credited to the Clearing House account.

Redemption Directly Through DP (Without Stock Exchange)

The BO can also redeem or offer for repurchase MF units held in demat form directly through the DP, without going through the stock exchange.
Modification is not allowed once a Repurchase / Redemption instruction is submitted.

Pledge and Hypothecation of Securities

Securities held in demat form can be used as collateral for loans and other credit facilities. The creation of pledge and hypothecation against demat securities is permitted under Section 12 of the Depositories Act, 1996.

Key conditions:

Both the pledgor (borrower) and pledgee (lender) must have a beneficial account with the same depository — inter-depository pledge is currently not permitted.
Both free balances and lock-in balances can be pledged or hypothecated.
If the lender needs the borrower's concurrence to appropriate securities, the transaction is called hypothecation.

Creation of Pledge / Hypothecation

The pledgor initiates the pledge creation through its DP.
The pledgee confirms the creation through its DP.
Each pledge transaction is identified by a unique system-generated pledge sequence number.
The pledgor submits the Pledge Request Form (PRF) with details of:
- Securities to be pledged
- Agreement number
- Closure date (indicative duration of pledge)
- Pledgee's details
The DP verifies the form and ensures the securities exist in the pledgor's account.

Confirmation by Pledgee

After creation, the pledgor submits the duly stamped and signed PRF to the pledgee along with the pledge confirmation letter.
The pledge details are electronically communicated to the pledgee's DP for confirmation.
Acceptance appears as a status change in the DP systems of both parties.

Closure (Unpledge) of Pledge / Hypothecation

After the pledgor repays the loan:

The pledgor initiates closure / unpledge through its DP.
The pledgee confirms the closure through its DP.
If the pledgee rejects the closure, the securities remain as pledged balances in the pledgor's account.

Unilateral Closure by Pledgee

The depository also allows the pledgee to close the pledge unilaterally. In this case:

The pledgee submits the closure instruction to its DP.
No action is required from the pledgor or the pledgor's DP.

Invocation of Pledge

If the pledgor fails to discharge obligations under the pledge agreement, the pledgee may invoke the pledge. This allows the pledgee to claim beneficial ownership of the securities.

Steps for invocation:

The pledgee fills up the Invocation Request Form (IRF) and submits it to their DP.
The DP accepts it for processing and issues an acknowledgement to the pledgee.

Invocation of Hypothecation

If the borrower fails to meet obligations under the hypothecation agreement, the lender may invoke the hypothecation to claim beneficial ownership of the securities.

The lender submits a request in the prescribed form to their DP for invoking the hypothecation.

Corporate Benefits on Pledged / Hypothecated Securities

The ownership of pledged or hypothecated securities remains with the pledgor (borrower) until the pledge is invoked. Therefore:

All corporate benefits — dividends, bonus shares, rights issues, etc. — accrue to the borrower.
Dividends are paid to the borrower directly.
Bonus shares are credited to the borrower's account as pledged balances.

Non-Disposal Undertaking (NDU)

Some shareholders (primarily promoters) enter into Non-Disposal Undertakings (NDUs) when borrowing funds. An NDU is an undertaking not to transfer or alienate the securities. It functions as a negative lien in favour of the lender.

Quick Revision Points for NISM Series VI Exam

Off-market trade: No CC/CM involvement; direct BO-to-BO transfer
Market trade: Settled through CC/CH; broker uses CM account
Pay-in: Broker submits sold securities to CC/CH
Pay-out: CC/CH delivers purchased securities to broker's CM account
Inter-depository transfer: Transfer between NSDL and CDSL accounts
Early pay-in: Used for margin exemption, buyback, tender offer
Auto pay-in: Only for BSE-CMs; no separate pay-in instruction needed
Pledge: Both pledgor and pledgee must have accounts with the same depository
Inter-depository pledge is NOT permitted
Corporate benefits (dividends, bonus) go to pledgor (borrower), not the pledgee
Pledgee can close pledge unilaterally — pledgor's confirmation not required
Invocation allows pledgee to claim ownership of securities
NDU = undertaking not to transfer securities (negative lien)

Up Next: Part 6 – Corporate Actions, Public Issues, Tender Offers & Debt Instruments

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