Exchange, Clearing Corporation, Depository: Who Does What

Four institutions stand behind one completed trade, and each does a single job. Kaveri Stock Exchange Limited matches the two orders and stops there. The clearing corporation becomes the counterparty to each side and works out who owes what. The depository keeps the entry that is itself the ownership. A custodian is appointed by one holder, to hold and settle for that holder alone.

Two orders met at a price. A match is a smaller moment than it sounds, and a match is information and nothing more. No security has moved. No money has moved. Nobody yet has the shares who did not have them a second ago. Everything that turns that information into a change of ownership happens afterwards, at institutions whose names are not on the screen where the match appeared.

One thing is worth carrying into everything that follows. Each of those jobs carries a different kind of risk, and that is the reason they sit in different places. Matching orders is a technology problem: it requires a system that is fast, fair and does not fall over. Standing between two sides is a credit problem: it requires resources for the day somebody does not pay. Keeping the register is a records problem: it requires one authoritative list and no arguments about it. Acting for one holder is an agency problem: it requires doing what was instructed and nothing else. Put two of those in one institution and a bad afternoon in one of them reaches the other.

Why do four institutions stand behind one trade rather than one?

Ask it the other way round and it answers itself. One trade needs four separate things done. Two orders have to meet at a price. Somebody has to make sure both sides actually perform. The change of ownership has to be recorded somewhere everybody accepts. And a holder who does not want to handle any of this has to be able to appoint somebody who will. Four jobs are not one job. Each of the four fails in a different way, and an institution doing two of them would let one failure walk straight into the other.

The everyday version is closer than it sounds. A household buys a scooter. The showroom sells it, a finance company stands behind the payment, and a government office records who the scooter belongs to. Three places, on purpose. No buyer would want the registration to depend on the showroom staying open next year, and no buyer would want the office that records ownership to also be the one carrying the credit risk on the instalments. Nobody designed that arrangement in one sitting either. The arrangement ended up that way for a plain reason. Each of those three failures is a different failure, and keeping them apart is cheaper than cleaning up after they mix.

What does Kaveri Stock Exchange Limited actually do, and what is it paid for?

Kaveri Stock Exchange Limited, an invented venue, runs the order bookThe list of buy and sell interest waiting at each price, held by the venue and matched according to its own published rules. How an order reaches that list is covered separately. where orders arrive, and it matches them. Matching is the job. Be strict about how little that is: the exchange does not become the buyer to the seller, it does not hold anybody's money against the trade, and it does not keep the record of who the shares belong to afterwards. It is a matching system that publishes prices, and a matching system that publishes prices is a genuinely hard thing to build, but it is not a promise about anybody paying.

Kaveri Stock Exchange Limited is paid a transaction fee for that matching, and the figure used here is its own. The fee is 0.00325 per cent of the value matched. On the year in question, turnoverThe total value of trades matched over a stated period. Turnover counts value, not profit and not the number of trades, and turnover is the base a transaction fee is struck on. matched came to Rs 48,00,000 crore, and 0.00325 per cent of turnover for that year is Rs 156 crore of transaction fee for the same year.

A percentage with three zeros after the point is not a number anybody has a feel for. The rate becomes easier to hold once it is attached to a single trade. Take one trade: 8,000 shares of Suvarna Commercial Bank Limited, an invented lender, at its own reported Rs 105.00/- a share. The value matched is Rs 8,40,000/-. The fee on it is Rs 8,40,000/- multiplied by 0.0000325, and the answer is Rs 27.30/-. Better still, the rate per lakh: Rs 3.25/- on every Rs 1,00,000/- of value matched. The per-lakh form is the one worth carrying away, and it can be done in the head on any trade at all. Rs 3.25/- multiplied by 8.4 comes back to Rs 27.30/-, and the same rate carried up to a year of turnover comes to Rs 156 crore. One rate, three readings, identical arithmetic.

What does the clearing corporation do that the exchange does not?

The clearing corporation is the institution the whole arrangement turns on. The clearing corporation that settles trades matched on Kaveri Stock Exchange Limited is a separate company from the exchange, and it does the job the exchange refuses. Stepping into the middle of the matched trade, it becomes the counterparty to each side. After it has done so, the buyer's counterparty is no longer the seller, and the seller's counterparty is no longer the buyer. Both of them now face the same institution. The substitution has a name of its own, novationThe replacement of an existing obligation between two parties with new obligations to a third, so that the original two no longer face each other. The conditions that make novation binding are covered separately., and what has to be true for it to bind is covered separately.

From there the clearing corporation does three more things. The corporation works out who owes what, netting one side's purchases against its sales so that a member ends the exercise with one obligation rather than hundreds. The clearing corporation collects marginMoney or securities placed with the institution that will be left facing a failure, held against an obligation that has not settled yet. How much, and in what form, is set by the Securities and Exchange Board of India (SEBI). from its members against obligations that have not settled. And it maintains a settlement guarantee fund: a pool held so that one member's failure is not paid for by members who did nothing wrong. A clearing memberA firm admitted by a clearing corporation to settle trades through it, and answerable to that institution for what it owes. is the firm through which all of that flows.

Here is the structural fact readers almost never hear: the money that stands behind a settlement sits at a different institution from the one that earned the fee for matching the trade, and that separation is deliberate rather than historical. The Rs 27.30/- from the trade above went to the exchange. Not one paisa of it is standing behind whether the buyer pays. The separation is why the two are always spoken of in the same breath and yet are always two companies.

What does a depository hold, and why is the entry the ownership?

A depository holds securities in dematerialisedHeld as an entry in an electronic account rather than as a printed certificate. The form of the holding, not a statement about who it belongs to. form, which means the holding exists as an entry in an account rather than as a printed certificate in a cupboard. Most readers arrive with a picture in which the entry describes something: a certificate exists somewhere, and the account is a convenient index to it. The picture is wrong: there is no certificate behind the entry, and the entry is the ownership itself rather than a description of it.

A land register works the same way, and the comparison is exact enough to be worth keeping. Whether the land belongs to a particular person is settled by what the register says. A photocopy of an old deed in a cupboard is evidence about the register and nothing more. A photocopy does not make the land anybody's. If the two disagree, nobody thinks the cupboard wins. The same applies to a share held in dematerialised form: the statement a broker sends the holder and the screen shown in an application are both copies of a fact recorded somewhere else, and the somewhere else is the depository.

A holder does not deal with the depository directly. The account sits with a depository participantThe firm through which a holder's account with a depository is opened and operated, and where instructions on that account are given. A broker is a different job, and one company may do both., which is the firm where the account is opened and where instructions on it are given. The participant layer exists for the same reason most access layers exist: a register that serves everybody cannot also run a counter for everybody. A participant decides nothing. The firm operates an account whose entries live at the depository, and the entries are what count.

What does a custodian do that a depository does not?

How depositories and custodians support market ownership

A depository and a custodian are worth taking as a pair. The two are merged more often than any other pair here, and the difference between them is the cleanest idea in this guide. A depository is a register. A register serves everybody in the market, and no particular holder engaged it. A custodian is an agent. One holder appoints it to hold that holder's securities, give the instructions, settle the trades and keep that holder's own records straight. The test that separates them for good is a single question: ask who appointed it. Nobody appointed the depository. A specific holder appointed the custodian, and can appoint a different one tomorrow.

The second difference follows from the first and is worth stating on its own. The depository's entry decides who the security belongs to, and the custodian's records decide nothing at all. That is exactly why a holder can change custodian without the ownership moving anywhere. The new custodian starts keeping records and giving instructions; the entry at the depository has not been touched, so nothing about the holding has changed. The same move against the depository describes a different thing entirely. There is no other register for the holding to move to.

Between them, the two support market ownership in different halves. The register makes ownership a settled fact that everybody can rely on and nobody has to negotiate. The agent makes that ownership operable by somebody who does not want to operate it themselves: a large holder with thousands of lines and daily instructions does not personally send each one. Both halves are needed. A register with no agents leaves every holder doing their own operations, and agents with no register leaves everybody arguing about whose shares they were.

Where does one security sit at each moment between the match and the settlement?

One holding is traced through below, with the same question answered at every stop: who holds what right now. Asking that question at every stop is the discipline the whole subject runs on, and it is more useful than any list of institutions. Asking it brings out the moments where somebody has performed and the other side has not.

At the match, nothing has moved. Kaveri Stock Exchange Limited has recorded that two orders met at a price of Rs 105.00/- for 8,000 shares. The seller still holds the shares. The buyer still holds the money. After the clearing corporation has stepped in, still nothing physical has moved, but the shape of the risk has changed completely: the buyer owes the clearing corporation and the seller is owed by the clearing corporation, and the two of them no longer face each other at all. Before the settlement, the shares are sitting in the seller's account at the depository, exactly where they were, and the money is still the buyer's. At the settlement, the entry at the depository moves and the money moves, and the ownership changed at the instant the entry did.

The reading rule to keep is this: at every moment somebody definite holds the security and somebody definite holds the money, and the question worth asking is always which of them is exposed if the other stops. That question is what the margin at the clearing corporation exists to answer, and it is the question the whole of the rest of this subject picks apart.

Why is the separation between these institutions the protection?

Put the three facts next to each other and the structure states itself. The institution that earns more when volume rises is not the institution that carries the loss when a member fails, and neither of them is the institution that holds the record of ownership. Three jobs, three balance sheets, three different things that would have to go wrong.

So a reader asking whether a trade is safe and a reader asking whether a business is growing are asking about two different institutions, and they get different answers because they are looking at different companies. The first question is about margin and a settlement guarantee fund at the clearing corporation. The second is about a fee on turnover at the exchange. Merging the two institutions muddles the answer to both, and the error described below does exactly that.

Whether the separation is sufficient, whether any fund is large enough, and whether any arrangement is safe are judgements about levels, and every level in sight is set by an authority and moves. The shape is the part that holds still: which failures are kept apart from which, and why the arrangement was built with the joins where they are.

Whose money is sitting where, and which of it is revenue?

Readers are loosest about whose money is sitting where, and three numbers sort it out. The transaction fee of Rs 156 crore for the year is Kaveri Stock Exchange Limited's own revenue: it earned it for matching, and it is free to spend it. Margins held of Rs 11,000 crore at the clearing corporation are not revenue and are not the clearing corporation's money. Margins are members' money placed against obligations that have not settled, and they go back when the obligation goes. The settlement guarantee fund of Rs 2,750 crore is a third thing again: resources held so that one member's failure is not paid for by the members who did nothing wrong.

Only one of those three numbers is anybody's income, and the other two are somebody else's money sitting somewhere for a stated reason. A wedding hall works the same way. The hall's fee for the evening is its revenue. The deposit left against damage is the customer's money, held by the hall, and returned when the evening ends without a scratch. The emergency float the hall's association keeps for the day a member hall lets somebody down is a third pot again, belonging to none of them individually. Nobody sensible adds those three together and calls the result the hall's earnings.

One relationship between them is worth stating with its base named. Margins against a fund and margins against turnover are different sentences that look identical in writing. Margins held of Rs 11,000 crore are 4.00 times the settlement guarantee fund of Rs 2,750 crore. The multiple is a ratio of one pool to another pool at the same institution, and it says nothing at all about turnover, about the fee, or about whether either pool is the right size.

Who sets the conditions these institutions work under?

Four conditions touch every institution described here. Each of the four is set by an authority and each of them moves, so the rows below carry their label and their authority, and the column that would hold the value is left blank. The sheet is filled in at the source.