“SEBI has been receiving requests from various stakeholders to further shorten the settlement cycle,” the regulator said in a statement posted on its website. (File Image: Reuters)
The Securities and Exchange Board of India (SEBI) said on Tuesday that stock exchanges would have the option of moving to a shorter stock settlement cycle – T+1 – starting on January 1.
“SEBI has been receiving requests from various stakeholders to further shorten the settlement cycle,” the regulator said in a statement posted on its website.
“Based on discussions with Market Infrastructure Institutions (Stock Exchanges, Clearing Corporations and Depositories), it has been decided to provide flexibility to Stock Exchanges to offer either T+1 or T+2 settlement cycle on any of the scrips (traded on the exchanges)."
Exchanges would have to give one month’s notice of the move to a T+1 settlement on any scrip to all stakeholders, including investors.
A stock exchange will have to mandatorily continue with the shorter trading cycle for at least six months after opting for it on a publicly traded stock. In case it were to revert to a T+2 cycle, it will again have to give a one-month notice to stakeholders.
What is a T +1 settlement cycle?
T+1 and T+2 indicate the settlement date for a securities transaction, with T standing for the date of transaction, and 1 and 2 denoting how many days later the transfer of stock ownership and payment to the buyer and the seller, respectively, takes place.
What is the logic of the move to a shorter investment cycle?
The move will offer greater flexibility to stock exchanges, make them more efficient, free up capital, boost liquidity and reduce default risks, goes the argument in favour of an optional T+1 settlement cycle. In 2003, Indian stock exchanges moved to a T+2 cycle from T+3 on the same grounds.
The Covid-19 pandemic had delayed the move, which has the backing of tech-based companies that offer contactless trading and settlement via mobile phone applications. T+1, they say, will hasten cash flows.
In August, SEBI formed a panel of experts to look into the concerns that could hinder the process of shifting the settlement to T+1.
What comes next?
Market players have less than four months to prepare for the optional switch to a shorter settlement cycle.
“Stock exchanges, clearing corporations and depositories are directed to take necessary steps to put in place proper systems and procedures for smooth introduction of the T+1 settlement cycle on optional basis, including the necessary amendments to the relevant bye-laws, rules and regulations,” SEBI said.
What are the reservations over the move to T+1?
Zerodha Broking’s co-founder Nithin Kamath, in a Twitter post, cited one potential complication.
“We are now among the first few countries to allow this. So when you buy, you can get stock to your Demat account or get funds for the stock sold on the next day (T+1) instead of two days (T+2). I guess what we will need to figure out is how settlements will work if one exchange adopts T+1 and the other is on T+2 when the same stock trades on both exchanges,” Kamath said in a Twitter post, referring to BSE and the National Stock Exchange of India.
A mismatch in the settlement cycle will be chaotic for investors, traders and arbitrageurs and has the potential of affecting market volumes. It would increase the capital allocation of players, especially short term traders and arbitrageurs.
What are the other concerns?
The Association of National Exchange Members of India, the Asia Securities Industry and Financial Markets Association (Asifma) and overseas traders have expressed concern over the operational and technical implications of the move.
Asifma has in the past cited operational difficulties it would cause to foreign portfolio investors (FPIs). Given that working hours in the US and Europe were not aligned to Asia Pacific markets, T+2 effectively functioned as T+1, it said in a letter to SEBI last year quoted by Business Standard newspaper.
Any discrepancies in a transaction are typically discovered on T+1 and shortening the settlement cycle would escalate costs and settlement risks for FPIs.
“...failures in trade matching may result in the settlement obligation being borne by domestic broking houses, raising the risk of default in scenarios where high value trades have failed to match,” the association warned.
It cited the example of China, which it said was the only big market that implemented a T0 or T1 settlement cycle.
“This has been a headache for global investors who need to pre-fund and pre-deliver shares on a free of payment basis. This is not a model to emulate or replicate,” the association had warned.
For FPIs, a T+1 cycle would mean a cash and carry business where they will have to keep money and shares ready with them on the day of the transaction. This could impact FPI flows, especially from short-term investors.