How the Stock Settlement Process Works
By SmartProInvesting.com Stock Investing Team.
February, 2008
There are many challenges which investors face when they deal with stockbrokers in the course of buying or selling stocks. Some of them may be attributed to the knowledge gap – the stockbroker knows the rules and dynamics of the business, while the investor, in many cases, is relatively a rookie. In some cases, the proclivity to taking advantage of other transaction parties, which is, to some extent, a systemic feature in the environment, is what is at play. After all, even if the investor is deficient in his understanding of the workings of the process, a protective counterparty would ensure that his interests are guarded in accordance with the rules. That may not always happen. That is also why it is good to keep learning and understanding the processes.
Understand the Stock Settlement Process
A key aspect of the transaction process is the settlement. When you request a stockbroker to sell a stock for you, it is not exactly like taking some bags of flour to the market which somebody buys and hands over the cash. When you ask to buy also, the stockbroker does not take the money to the stock market to pay for and collect the stocks. Yet, that is what ultimately happens, but because of the nature of the stock transaction process – the physical stocks and payments are not exchanged on the floor of the exchange – there is a settlement process that makes it possible for the selling investor to receive money and the buying investor to receive the stocks. Unfortunately, that process is not concluded on the spot or even in one day. That also leaves room, especially when the investors don’t understand the process, for the stockbroker(s) to stretch the process to the detriment of the investor(s). It is possible, for instance, not to receive your payment when you ought to. Knowing that money has a cost (even in forgone interest earning), that delay in remittance obviously creates a loss, the value of which depends on the size of the fund held up. That is one reason you should know the rules, so that when your interest is abridged, you can at least complain on an informed basis.
How Settlement Works
Simply put, settlement is the process whereby the intensions of the stock buying and selling parties are given effect and consummated, after the trading transaction by the stockbrokers. The Nigerian Stock Exchange currently runs an electronic, automated trading system (ATS), which captures the transactions concluded by the stockbrokers. That platform has helped to shorten the settlement process to what is technically referred to a “T + 3”. That phrase just says that settlement is concluded on the third day following the transaction (T) day. It translates to: “trading day plus three working days”. If my stockbroker executes my sell order today (transaction or “T” day), the proceeds will settle into the broker’s account on working day-4, counting in today. If the broker pays me on that fourth day, he has actually paid from my money. In any case, he should be willing to pay me on the fifth day at the worst. So, if the sale is made on Monday, my money is available by Thursday and, at the worst, they should be ready to disburse to me on Friday. That, too, is the case if I am buying. I should have the stock in my account on the third working day after the transaction day. Both parties (the buyer and seller) get value on the same date and this is captured in the settlement concept of “Delivery-Versus-Payment”, on which our market operates. In effect, money settlement and stock settlement converge, consummating the transaction on day-four.
Technical Details
Between Monday (in our example) and Thursday (day four), there are a lot of technical things that happen, which ought not to bother the investor. One, much of that settlement process is managed by the Central Securities Clearing System Limited (CSCS). It is also done through banks. The Nigerian Stock Exchange has appointed banks that are designated settlement banks for the purpose of stock market transactions and with whom stockbrokers must maintain stock trading accounts, each broker choosing the settlement banks to use. A series of advices and processing will take place between the CSCS and the settlement banks, all aimed at ensuring ‘delivery-versus-payment’ at due date. There is also a Trade Guarantee Fund, contributed by the dealing members, which provides a backup, should a default situation arise. If, for instance, the broker’s stock account is not good to fund the settlement, the stock seller is not left in the cold as the authorities would draw from the fund to make good the stock transaction, still ensuring settlement on “T + 3”.
Compliance for Your Benefit
Well, it’s for you to know if your stockbroker keeps to this timeframe, the objective of which is to ensure speedy conclusion of transactions and to make the market liquid. If they depart substantially from it, you may have cause to complain. But how do you know when your transaction is done (that is day-T)? Often, it’s the broker that says when. However, you have the opportunity for independent verification, should you have strong reason to want to crosscheck. The CSCS, for a token fee, will print various types of transaction reports for you which can help you specifically pinpoint how and when transactions are done. Such reports can be requested through your stockbroker, or if you have to, by directly asking at the CSCS (Stock Exchange building, Tinubu Square). It is possible for an investor to know on what exact date or at what actual price his transaction was done, just by requesting the relevant trade information. You probably know that prices will vary in the course of a trading day, though there is a final (widely reported) closing price, but that doesn’t say that all transactions for the day are done at that closing price. Checking will, of course, only be necessary if there is good reason to worry.
So, now you know what it takes for your transaction to settle and for you to have your stock or cash. It’s good to know too that the T + 3 settlement timeframe on the Nigerian Stock Exchange competes well internationally.
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