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SEBI Permits T+1 Settlement Cycle from January 1st on Optional Basis

Editor, TRANSFIN.
Sep 14, 2021 7:41 AM 6 min read
Editorial

Last Tuesday, SEBI announced that Indian stock exchanges would be able to offer a T+1 settlement cycle for listed equities from January 1st 2022

What Does “T+1” Mean?

In financial markets, "T" is basically the transaction date or trade date i.e., the date on which you place an order for a stock, bond, ETF, mutual fund etc.

The settlement date is when the actual ownership of the asset is transferred to you. This can happen 48 hours after the transaction takes place (i.e. T+2) or even within 24 hours (ergo, "T+1").

 

The Current System

Presently, Indian bourses follow a T+2 settlement system. Basically, the trade cycle begins when an order is placed for an asset. This is followed by the execution of the order, which is cleared by a stock exchange's clearing house. Finally comes the settlement stage, which is when the payment for the securities involved changes hands.

Now, in a T+2 system, let’s say you buy 100 shares of a stock on a Monday. Then, provided the next two days are working days, you would get ownership of these shares by Wednesday, by when you would also pay for the shares and get your transaction cleared by the respective bourse.

 

A Peek into History

Settlement periods have naturally evolved over time. In the 18th century, the London and Amsterdam stock exchanges often listed the same scrips. To ensure uniformity while clearing such trades, a time gap was necessary so that the physical stock certificate could move between the two cities, on horseback and by ship. Back then, this period was T+14.

In the 19th century, under the influence of Napoleonic France, many European markets adopted a fixed settlement date i.e. They picked a particular day of the month to settle all trades, instead of the erstwhile (and current) rolling regime.

SEBI Permits T+1 Settlement Cycle from January 1st on Optional BasisBy the end of the 20th century, most countries had embraced a T+7 system and moved to further reduce settlement periods to ensure quicker transactions. With the declining need for physical trade certificates, most trades are now settled electronically. Consequently, most major economies now follow a T+2 system.

India adopted T+2 for equity spot markets in 2003. Incidentally, the EU and US were late to the party in this matter (2013 and 2017 respectively). Bourses in Singapore, Australia, Hong Kong, South Korea and Japan also follow the T+2 cycle. Taiwan has returned to the T+2 after testing T+1 settlements for some time. As of today, China is the only major economy to offer a shorter cycle (T+0).

 

SEBI’s Recent Announcement

Citing "requests from various stakeholders" and "discussions with stock exchanges, clearing corporations and depositories", SEBI said that, come 2022, bourses would be given the option of a T+1 settlement cycle.

Exchanges will be free to decide if they want to offer the same for any listed scrips and, if they went with the affirmative, they would have to provide a one-month prior notice to all stakeholders. Moreover, if an exchange begins to offer T+1 for an asset, it would have to continue doing so for at least six months. Any decision to revert back to a T+2 system after this period would also require a one-month notice.

This switch has been in the offing for over a year. The regulator was egged on by discount brokers and online trading platforms to shorten the settlement cycle, given that these firms typically have fewer employees and most of their trades are anyway settled via apps and largely done independently by their clients. But time and again, the pandemic played a spoiler. Until now.

 

How Might this Shift Impact Market Players?

A transition from T+2 to T+1 is not an overnight affair. It involves "significant, coordinated and expensive structural changes to the settlement process, including technological enhancements and real-time/near real-time trade processing", to quote the head of equities at an association of FPIs.

SEBI Permits T+1 Settlement Cycle from January 1st on Optional BasisThere are many moving parts involved in such a shift, which would require the efforts of and seamless coordination between depositors, exchanges, brokers, clearing corporations, banks, and many other stakeholders. Such a metamorphosis could "limit and delay the realisation of the expected risk-reducing benefits of shortening the settlement cycle".

Which is why some investors - especially the foreign ones - are more than a little nervous about SEBI's tight timeframe for what would "typically be a multi-year initiative".

 

Why are FIIs Jittery?

For domestic investors, the move is likely to be largely beneficial, providing for reduced settlement risk and working capital and margin requirements for brokers. Markets may also enjoy increased liquidity, besides the fact that sellers will get funds sooner and investors will be less susceptible to price-fluctuations.

For foreign investors, the dynamics are different. Let’s look at the current arrangement. Say a fund house in Singapore wants to buy some shares of RIL. It alerts its global custodians (i.e. The intermediaries) about the same, and they execute the trade the same day (“T”). The Singaporean FII now has time till 12pm the next day (“T+1”) to make the requisite foreign exchange transaction in INR and send the money to the custodians, following which the trade is settled.

But from next year, if the stock exchanges pick RIL for a T+1 regime, the Singaporean fund house would have to ensure that the money is transferred on “T” itself i.e. Before the transaction is done so that the settlement is done duly within 24 hours. This is called “pre-funding”, which is when an investor pays for the shares even before getting delivery of them.

The Asia Securities Industry and Financial Markets Association (ASIFMA) had written to SEBI warning that a T+1 system could make India a pre-funding market for FPIs. It highlighted how securities settlements for foreign investors is a complicated process involving inputs from multiple parties. So much so that for American and European investors, India's T+2 cycle is practically a T+1 one already. A further shortening of this timeframe might make matters very inconvenient for FIIs. Differences in time zones and regional holidays could further complicate the transition.

ASIFMA argues that China's short settlement cycle "has been a headache for global investors who need to pre-fund and to pre-deliver shares on a free of payment basis” and as such it “is not a model to emulate or replicate". Moreover, it points to Taiwan, whose own T+1 experiment was short-lived due to problems faced by foreign investors.

FYI: Another worry involves inter-exchange uniformity. Many scrips are listed on both the NSE and BSE. If one offers T+1 for a dual-listed stock while the other retains the old system, this might create an arbitrage opportunity, which could hurt the share price. (However, the President of the Association of National Exchanges Members of India has said that it is "unlikely for one exchange to offer T+1 and the other not to".)

 

FPIs Assume a “War Footing”

Some FPIs are planning to reach out to global index providers FTSE Russell and MSIC (which had earlier warned India that restrictive policies could result in a downgrade) with their concerns about this move. Many have written to SEBI, decrying the alleged lack of consultation and warning that this transition could increase their trading costs and make India a less attractive destination for global investments. Yesterday, it was reported that the Union Finance Ministry is in talks with SEBI regarding foreign investors' worries, and general concerns over whether stock markets are ready for such a shift.

SEBI, however, has refused to budge. It said FPIs need only tweak their existing systems and that the move is to the benefit of domestic investors. Eventually, the regulator opines, the market can decide what’s best:

If indeed T+1 settlement is so detrimental to the investors, there will be no volumes in the T+1 scrips. If market thinks T+1 is more effective, all the investors including FPIs will adopt the shorter settlement.”

FIN.
 

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