How a Position Moves Through Clearing and Settlement

Every day a position stays open, the same six things happen to it in the same order. Collateral is already standing against it, the day trades, a settlement price is determined at the close, obligations in both directions are set against each other, one figure is called or credited, and the balance is put back where the arrangement requires. The next morning it all runs again.

None of that is one event, and the tense matters more than any single step in it. A position is not something that was clearedThe arrangement by which a position that is still open is carried, revalued and collateralised each day, rather than left alone until it ends. back on the day somebody entered it. A position is something that is being cleared, this evening and tomorrow evening, by a sequence of small operations that runs from end to end every single day it stays alive.

The timing of the money holds the sequence together. The collateral is called while the position is still open and while nothing has yet gone wrong, so nothing is allowed to pile up into an amount that somebody would rather argue about than pay. Calling early is the whole design, and every operation that follows is machinery in service of it.

Before any of it, the figures need fixing. Every number that follows is built on them. There is a reference asset, invented for this illustration, standing in for whatever a contract might reference. Its spot price is Rs 2,000.00/-, a PRICE, and one unit of it carries an exposureThe value of the referenced thing that a position stands on. The exposure is the base a collateral percentage is struck on, and it is not an amount that changes hands. of Rs 2,000.00/-. The reference asset pays nothing at all while it is held. A payout during the holding period would change the carried figure, and nothing is paid out. Financing costs 6.50 per cent a year. Carrying one unit for a year gives an agreed price of Rs 2,000.00/- multiplied by 1.065, or Rs 2,130.00/-. The multiplication is worth doing rather than taking on trust, and the same Rs 2,000.00/- is doing two jobs at once: it is the spot price of the reference asset and it is the exposure on one unit. The arithmetic is worked on exactly one unit, so the two figures agree. Neither has been copied into the other.

What shape does one day take for a position that is already open?

Six things happen, and they happen in the same relation to each other every day. Collateral is already standing before the day begins. The day trades. The close comes, and a settlement priceThe price determined at the close of a day that every open position in a contract is revalued against. The settlement price is arrived at by a stated method rather than picked up off the last trade. is determined for the contract. Obligations running in both directions are set against each other so that one figure is left rather than many. The single netted figure is called from the position holder or credited to the position holder. And the collateral balanceWhat is being held for the position holder at any given moment. The balance falls when the day's movement is taken out of it and rises when the position holder puts more in. is put back where the arrangement requires it to be.

Read that list once more and notice what it does not contain. The list carries no hour, no cut off, no period allowed for anything, and no minimum anybody has to hold. Each piece of the day is worked in full separately, under its own subject. The ordering is what none of them gives on its own.

There is an ordinary version of this shape that most households already run without calling it anything. A milk supplier who leaves two crates at a shop every morning does not settle up once at the end of the year. He reconciles what went in and what came back at the end of each day, keeps a running figure in a notebook, and asks for money while the relationship is still warm. A year of it demanded in one go finds a shop that cannot pay, and nobody who wants to be the one who let it get that far. Clearing is that instinct, written down and made compulsory.

What is already standing against the position before the day starts?

Collateral. The money was put up before the position was carried, and it is sitting there before anything at all happens on the day being described. On the invented figures, the amount is Rs 160.00/- against an exposure of Rs 2,000.00/-, and the 8.0 per cent behind that Rs 160.00/- is a teaching figure rather than a requirement anybody has set. What is actually asked for is set by clearing corporations under the framework of the Securities and Exchange Board of India (SEBI) at sebi.gov.in, and it differs by contract and by day.

The invented figure earns its place by exposing a pair of ratios. Either one alone misleads, so the two have to be read together. Rs 2,000.00/- of exposure standing on Rs 160.00/- of posted collateral is 12.50 times. Read it the other way and Rs 160.00/- divided by Rs 2,000.00/- is that same invented 8.0 per cent, the same fact written upside down. Now put a movement against it: a gap of Rs 80.00/- is 4.0 per cent of the Rs 2,000.00/- exposure and 50.0 per cent of the Rs 160.00/- posted. Every one of those ratios names the base it is struck on, and that is not pedantry. Swap the two bases and 4.0 per cent turns into 50.0 per cent, the difference between a quiet evening and a callThe demand that follows a revaluation, asking the position holder to put the collateral balance back where the arrangement requires it..

The ordering itself is worth stopping on. The money was standing there before the risk was. Collateral before risk is the opposite of nearly every arrangement an ordinary household deals with, where the electricity is used first and paid for afterwards, the meal is eaten before the bill arrives, and the loan is drawn before the first instalment. Here the collateral goes first, before there is anything to collect on, and that reversal is the reason the promise is collectable at all.

One thing that Rs 160.00/- is emphatically not: it is not a part payment of the price. Nothing has been bought yet and nothing has been paid for. The agreed price is Rs 2,130.00/-, the collateral is Rs 160.00/-, and subtracting one from the other gives Rs 1,970.00/-. A price and a piece of collateral are two different kinds of object, so the answer means nothing whatsoever. Think of the deposit a wholesaler asks a new retailer to leave before releasing stock on credit. The deposit is not a payment towards the invoice. The deposit sits to one side, it belongs to the retailer, and the invoice is still due in full.

Who is actually facing whom once a position is being carried?

Not the two parties who struck the bargain. A clearing corporation stands between them, and each side faces a clearing memberThe party that faces the clearing corporation on behalf of a participant. A position holder deals with the member, and the member deals with the clearing corporation. which in turn faces the clearing corporation. Say it once and move on. The chain of members is set out in full separately. Only one thing about that chain matters for the ordering: the position holder sees the call and the balance, and everything behind them happens between the member and the clearing corporation.

What happens at the close, and in what order do the pieces fire?

The day stops trading. A settlement price is determined for the contract by a method that was fixed in advance. Every open positionA position that has not been closed and is therefore still being carried, so it is still being revalued and still being collateralised every day. in that contract is then revalued against it. The revaluation is neither selective nor negotiated: every position in the contract meets the same number at the same moment, whichever way it happens to point.

The method itself, and how long anything afterwards takes to move, is set under the framework of SEBI at sebi.gov.in, and both change.

Here is the day, end to end, on the invented figures. The position was struck at an agreed price of Rs 2,130.00/-, a PRICE. The settlement price determined at the close is Rs 2,050.00/-, also a PRICE. The gap between the two prices is Rs 2,130.00/- less Rs 2,050.00/-, being Rs 80.00/-, and that Rs 80.00/- is the only thing on the row that is money moving anywhere.

A gap between two contract prices and a gap between two spot prices are not the same object, even when they read the same. So the moment a movement is written down from has to be named each time. The Rs 80.00/- above is the gap between two contract prices, the agreed Rs 2,130.00/- and the settlement price of Rs 2,050.00/-, both determined for the same contract. Suppose the spot price of the reference asset had instead fallen Rs 80.00/-, from Rs 2,000.00/- to Rs 1,920.00/-, with a year of financing still to run. The contract price would have moved to Rs 1,920.00/- multiplied by 1.065, or Rs 2,044.80/-. The carry applies to the new spot price as well, so against the agreed Rs 2,130.00/- the gap is Rs 85.20/-, not Rs 80.00/-. Same underlying move, two different figures, and the only way to tell them apart is to name the moment and the base each time.

What is left once obligations in both directions are set against each other?

One figure, in place of several. Where a party is carrying more than one position, the day produces more than one obligation, and some of them point outwards while others point inwards. NettingSetting obligations that run in opposite directions against each other, so that one figure is left to move instead of many. is the step that sets them against each other and leaves one payment.

The invented book of positions has four obligations falling on one day: Rs 80.00/- out, Rs 40.00/- in, Rs 20.00/- in and Rs 10.00/- out. Added without any regard to direction they give a grossThe whole amount that would move if nothing were set against anything, counting every obligation at its full size and ignoring which way it points. movement of Rs 150.00/-. Added with regard to direction they give a netWhat is left once obligations running in both directions have been set against each other. The net actually moves. payment of Rs 30.00/- out. The net of Rs 30.00/- is 20.0 per cent of the Rs 150.00/- gross. Rs 120.00/-, being 80.0 per cent of what would otherwise have moved, does not move at all.

The arithmetic lands as shown, and setting many obligations against each other is covered separately and in full. Which obligations may be set against which is not an arithmetic question either. The permission is set under the framework of SEBI at sebi.gov.in.

Where in the day does the call actually go out?

The call is the single piece of the day that readers most reliably put in the wrong place.

The call goes out after the close, struck on the day's own movement, with the position still open and the price still where it is. A call is not a demand at the end of the contract, and it is not a consequence of anything having gone wrong. The call comes before the loss does, and that is not a figure of speech: at the moment the call is made nothing has been realised by anybody, the position is still alive, and the position holder may still be right about where the price is going.

There is also a further call that can be made during the day rather than after it, when the day has moved enough to warrant one. The existence of that intraday call is worth knowing. When it happens, on what trigger and against what, is set under the framework of SEBI at sebi.gov.in, and so is the period a party has to answer any call once it has been made.

What comes back to the position holder, and what has gone for good?

Two figures sat in the same balance this evening and only one of them was ever the position holder's property. The distinction between the two decides who has to find money in the morning, so it is worth being slow about.

The Rs 80.00/- collected as the day's movement is a PAYMENT. Money collected from one side of a contract is paid to the other, so the Rs 80.00/- has left the balance and been credited to whoever stood on the other side of the same revaluation. The payment does not come back. The Rs 160.00/- put up as collateral is a different animal altogether. The collateral remains the position holder's property throughout, it is held apart from the collateral of the member acting for the position holder, and it comes back when the position is closed. The collected movement has gone, the posted collateral has not, and the two live in the same account statement looking exactly alike.

After the call, the balance stands at Rs 160.00/- less Rs 80.00/-, or Rs 80.00/-, being 50.0 per cent of what was posted. The balance then has to be put back where the arrangement requires. The required level, how long the position holder has to get there, what may be put up and what it is valued at, and how the holding apart is actually done are each set under the framework of SEBI at sebi.gov.in.

What follows if what was called does not arrive?

The arrangement does not negotiate at this point, and that is the entire reason it can carry a promise at all. A call that goes unanswered leads to the position being closed outEnding a position without the position holder choosing to end it, which is what follows when a call is not met., and to a sequence of consequences that was settled long before anybody needed it.

Two things are worth holding on to about that sequence, and neither of them is a detail inside it. The first is that it exists at all. The second is that it was fixed in advance rather than decided at the time, and the reason is the same reason the settlement price method is fixed in advance: any rule chosen after the event is a rule that somebody can argue with, and the argument would arrive on exactly the evening when there is no time for one. The contents of the sequence, the order it runs in, and every threshold inside it are set by SEBI at sebi.gov.in, and they move.

What is running alongside this path all day?

Three arrangements sit beside the path without being steps in it, and a reader who has only ever seen the path is genuinely surprised by each of them. Positions are watched for patterns while they are being carried. There are caps on how large a position may be, and those bite before any of this fires rather than at any point during it. A change in the thing being referenced can force every contract written on it to be adjusted overnight, keeping the arithmetic meaning afterwards what it meant before.

Each of those three is covered separately and in full. Knowing that something runs in parallel is a different kind of knowledge from knowing how it works, and where ordering is the subject it is the useful kind.

What distinguishes a figure that moves from one that only gets quoted?

Every figure in this arithmetic is one of three things, and saying which inside the sentence rather than in a note underneath stops the commonest error in this machinery. A PRICE is what is agreed, quoted or determined: Rs 2,000.00/- spot, Rs 2,130.00/- agreed, Rs 2,050.00/- as the settlement price for the day. A PAYMENT is what actually leaves or reaches an account: the Rs 80.00/- called this evening. A NET is what is left after obligations in both directions have been set against each other: Rs 30.00/- against Rs 150.00/- of gross movement.

Mixing them is easy because a settlement price of Rs 2,050.00/- and a payment of Rs 80.00/- can sit in the same sentence while only one of them moves. Prices get quoted and payments get paid, and a reader who cannot tell which is which will either think the whole exposure changed hands or think nothing did. Quantities work the same way. The exposure the collateral is struck on is Rs 2,000.00/- a unit. A notional is the face amount a contract is written on, of which not one rupee changes hands, and the Rs 2,000.00/- exposure above is not one.

What in the day is not fixed by arithmetic?

No timetable is fixed by arithmetic. How long money and the thing itself take to move is set by an authority, and it changes. So is every level, every threshold and every percentage that anybody actually posts. So is what a member has to satisfy before it may act as one, and what is reported, to whom and by when. All of those go to SEBI at sebi.gov.in, and each of them changes.

One further question a reader is most likely to be carrying by now is a different kind of gap altogether.

What cannot be known about being on the receiving end of a call?

The arithmetic raises a perfectly reasonable question: given that Rs 2,000.00/- of exposure stands on Rs 160.00/- of posted collateral, and that a Rs 80.00/- gap takes 50.0 per cent of it, should anybody hold a position that can be called on like this at all?

The arithmetic alone cannot answer that question. An answer would need an outcome, a track record, a probability and a distribution, and none of those follows from the shape of the day. Understanding how a call works is not a reason to be on the receiving end of one, and a description of an obligation is not the same as a decision to take it on.

The inputs that would have to be known first are short enough to list: what the position exists to do, what is already held against it, what has been put up, what else could be put up at short notice, and what reaches the account on the worst day rather than the average one. Anyone who cannot answer those five is not being cautious by waiting, but missing the inputs.

The reference asset, the clearing corporation, the clearing member, the position holder and every price, payment and obligation in this walkthrough are invented.
Educational material. Not advice on any investment, tax, budget or market position.