Chapter 7: Clearing, Settlement & Risk Management
NISM Series VIII — Equity Derivatives | 10% weightage | ~10 exam questions
What this chapter is about
This is the most under-estimated chapter in the exam and the biggest surprise for most students. The bank has 69 questions on CH7 — more than any other chapter except CH4. Students assume "clearing and settlement" is boring admin stuff and skip it. Don't. This chapter has everything: who clears trades, how margin works, what MTM means, how much capital you need to be a clearing member, what liquid assets are, position limits. Get comfortable here and you'll pick up marks others leave on the table.
Key concepts
The Clearing Corporation — the central nervous system of the derivatives market:
- Acts as the central counterparty to EVERY trade (principle of novation)
- Guarantees settlement — no trade fails even if one party defaults
- Collects margins from all participants
- Runs the risk management framework
- Can disable trading members who fail to pay dues
Types of members:
| Member Type | Can Trade? | Can Clear? | Who they clear for |
|---|---|---|---|
| Trading Member (TM) | Yes | No | Cannot clear — must use a CM |
| Self-Clearing Member | Yes | Yes | Own trades only |
| Trading-cum-Clearing Member | Yes | Yes | Own trades + other TMs + institutional clients |
| Professional Clearing Member (PCM) | NO | Yes | Other TMs + institutional clients only |
PCM critical fact: Professional Clearing Member does NOT trade. They ONLY clear and settle. Typically banks and custodians become PCMs. They have NO trading rights — this is heavily tested.
Margin system — the most tested section
Initial Margin — deposited BEFORE you take a position. Both buyer and seller in futures pay initial margin. Based on VAR (Value at Risk) at 99% confidence level — as per L.C. Gupta Committee recommendations. Higher volatility = higher initial margin. Dynamic — recalculated continuously as volatility changes.
Mark to Market (MTM) Margin — daily settlement of profits and losses.
- Every open position is revalued at day's closing price
- If you made a loss → your margin account is DEBITED
- If you made a profit → your margin account is CREDITED
- This happens DAILY for futures (both debits AND credits are daily)
- MTM margin ≠ Initial margin (completely different)
In options: Only the SELLER pays initial margin. The BUYER pays the premium — no separate initial margin.
Liquid Assets — what clearing members deposit with the clearing corporation to back their positions:
- Cash
- Government Securities
- Fixed Deposits (FDs) ✅
- Treasury Bills
- Bank Guarantees ✅
- Investment Grade Debt Securities
- Equity Securities
- Foreign Exchange = NOT allowed ❌
- Cash component must be ≥ 50% of liquid assets
Net Worth requirements:
- Self-Clearing Member who clears only own trades: minimum ₹100 lakhs
- Trading-cum-Clearing Member (clears for others too): minimum ₹300 lakhs
- Security deposit with clearing corporation: ₹50 lakhs (+ ₹10 lakhs per additional TM)
- Derivative broker net worth > cash market broker net worth (derivatives carry higher risk)
Net Worth calculation = Capital + Free Reserves − Non-allowable assets Non-allowable assets include: fixed assets, pledged securities, membership card, unlisted securities, doubtful debts, intangible assets, 30% of marketable securities.
Exposure limits — linked DIRECTLY to liquid assets deposited. More deposits = more exposure allowed. NOT based on education, number of TMs, or anything else.
Position Limits:
- Market-wide position limit in a stock: at least ₹1,500 crores (for F&O eligibility)
- FII/MF position limit: ₹500 crores OR 15% of total open interest (whichever is higher)
- Client positions CANNOT be netted against each other for margin calculation
- Trading member on reaching position limit → can ONLY reverse existing positions, cannot open NEW positions
Calendar Spread margins — lower than two naked positions because the two legs largely offset each other's market risk. Only basis risk remains.
Trade Guarantee Fund (TGF) — fund maintained to guarantee settlement of bonafide exchange transactions. Purpose: protect investor interests, inculcate market confidence, guarantee settlement. All active exchange members contribute.
Settlement Guarantee Fund (SGF) / Core SGF — maintained by clearing corporation to cover defaults.
Broker-Members on Clearing Council — NOT allowed (conflict of interest).
Running account settlement — client funds must be settled on first Friday of the month (monthly) or first Friday of the quarter (quarterly). Cannot be delayed.
Volatility estimation — transparent and publicly disclosed by the exchange. Not a secret.
Real market example — MTM calculation
You buy 2 lots of Nifty futures at 24,000. Lot size 75. End of day, Nifty closes at 23,800.
MTM loss = (24,000 − 23,800) × 75 × 2 = 200 × 150 = ₹30,000
This ₹30,000 is debited from your margin account that evening. If your margin falls below maintenance margin, you get a margin call.
Next day Nifty closes at 24,100: MTM profit = (24,100 − 23,800) × 150 = 300 × 150 = ₹45,000 credited.
Both debits AND credits happen daily. Not just debits.
Trap Alert
Trap 1: "MTM margin debits are daily but credits are weekly" → FALSE Both debits AND credits are daily. No differential treatment.
Trap 2: "Fixed deposits and bank guarantees are NOT liquid assets" → FALSE Both FDs and Bank Guarantees ARE valid liquid assets. Foreign Exchange is the one that's NOT allowed.
Trap 3: "Clearing Corporation gives exposure based on number of TMs using the CM" → FALSE Exposure is based on LIQUID ASSETS DEPOSITED — full stop. Not number of TMs, not education, not experience.
Trap 4: "A Professional Clearing Member provides trading facility to clients" → FALSE PCM has NO trading rights whatsoever. They only clear and settle — they don't trade.
Trap 5: "Initial margin = MTM margin" → FALSE Completely different. Initial margin = upfront deposit to take a position (VAR-based). MTM margin = daily P&L settlement.
Trap 6: "Client positions can be netted for margin calculation" → FALSE Each client's position is calculated separately. If Client A is long 10 Nifty and Client B is short 10 Nifty, the broker must pay margin on ALL 20 contracts — not net zero.
Trap 7: "Institutional investors pay lower margins than retail" → FALSE Margin requirements are SAME for all — institutional or individual.
Trap 8: "Broker-members can sit on the Clearing Council" → FALSE Not allowed — conflict of interest. Clearing Council must be independent of trading members.
Numericals — key formulas
Initial Margin = Contract Value × Margin %
Contract Value = Price × Lot Size × No. of Contracts
MTM P&L = (Today's close − Yesterday's close) × Lot Size × Contracts
Net Worth = Capital + Free Reserves − Non-allowable assets
Security deposit = ₹50L base + ₹10L per additional TM
Calendar Spread open position = net of same underlying across months
(Long 8 near + Short 6 far = net 2 regular open positions)Must-remember rules
- Clearing Corporation = central counterparty to ALL trades, guarantees settlement
- PCM = clears and settles ONLY, NO trading rights
- TM = trades only, NO clearing rights
- Initial margin = VAR-based, 99% confidence, L.C. Gupta Committee
- Both buyer AND seller pay initial margin (futures)
- Options seller pays initial margin | Options buyer pays premium only
- MTM = daily, BOTH credits and debits
- Liquid assets: FDs ✅ Bank Guarantees ✅ Foreign Exchange ❌
- Exposure linked to liquid assets, NOT number of TMs
- Net worth requirement: ₹300L (clears for others), ₹100L (own trades only)
- Security deposit: ₹50L base + ₹10L per additional TM
- Client positions = NOT nettable for margin
- TGF = Trade Guarantee Fund = protects market confidence + guarantees settlement
- Running account = settled first Friday of month/quarter
- Institutional = same margin as retail (no special treatment)
Weightage note
10% of exam = ~10 questions. But 69 questions in the question bank — the highest hidden concentration. Expect 3-4 questions on margin mechanics, 2-3 on member types (especially PCM), 2 on liquid assets, 1-2 on position limits. This chapter rewards time investment heavily.
Quick revision — 60 second scan
- Clearing Corp = central counterparty, guarantees all trades
- PCM = NO trading, only clears | TM = NO clearing, only trades
- Initial margin = VAR 99% confidence, dynamic, both futures buyer and seller pay
- MTM = daily P&L settlement, both credits and debits daily
- Liquid assets: cash, FDs, T-bills, Govt secs, bank guarantees, equity (NOT forex)
- Exposure = linked to liquid assets deposited
- Net worth: ₹300L for clearing others, ₹100L for self-only
- Security deposit: ₹50L + ₹10L per TM
- Client margins = cannot be netted
- TGF = trade guarantee fund, all members contribute