Until 2001, stock markets had a weekly settlement system. The markets then moved to a rolling settlement system of T+3, and then to T+2 in 2003. T+1 is being implemented despite opposition from foreign investors. (File)
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New T+1 settlement cycle comes into effect today: What does it mean, how will investors be impacted?
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After China, India will become the second country in the world to start the ‘trade-plus-one’ (T+1) settlement cycle in top listed securities today (January 27), bringing operational efficiency, faster fund remittances, share delivery, and ease for stock market participants.
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What’s the T+1 settlement plan?
The T+1 settlement cycle means that trade-related settlements must be done within a day, or 24 hours, of the completion of a transaction. For example, under T+1, if a customer bought shares on Wednesday, they would be credited to the customer’s demat account on Thursday. This is different from T+2, where they will be settled on Friday. As many as 256 large-cap and top mid-cap stocks, including Nifty and Sensex stocks, will come under the T+1 settlement from Friday.
Until 2001, stock markets had a weekly settlement system. The markets then moved to a rolling settlement system of T+3, and then to T+2 in 2003. T+1 is being implemented despite opposition from foreign investors. The United States, United Kingdom and Eurozone markets are yet to move to the T+1 system.
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And what are the benefits of T+1?
In the T+1 format, if an investor sells a share, she will get the money within a day, and the buyer will get the shares in her demat account also within a day.
“The shorter trade settlement cycle that is set to be implemented augurs well for the Indian equity markets from a liquidity perspective, and it shows how well we have grown on the digital journey to ensure seamless settlements within 24 hours,” said Ajay Menon, MD & CEO of Broking & Distribution at Motilal Oswal Financial Services.
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This will also help investors in reducing the overall capital requirements with the margins getting released on T+1 day, and in getting the funds in the bank account within 24 hours of the sale of shares. The shift will boost operational efficiency as the rolling of funds and stocks will be faster, Menon said.
Could it also make markets safer?
According to a paper published by the Securities and Exchange Board of India (SEBI), a T+1 settlement cycle not only reduces the timeframe but also reduces and frees up capital required to collateralise that risk.
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A shortened settlement cycle also reduces the number of outstanding unsettled trades at any point of time, and thus decreases the unsettled exposure to Clearing Corporation by 50 per cent. The narrower the settlement cycle, the narrower the time window for a counterparty insolvency/ bankruptcy to impact the settlement of a trade.
Further, the capital blocked in the system to cover the risk of trades will get proportionately reduced with the number of outstanding unsettled trades at any point of time. Systemic risk depends on the number of outstanding trades and concentration of risk at critical institutions such as CCPs, and becomes critical when this magnitude of outstanding transactions increases. Thus, in this era of increasing trade volumes, a shortened settlement cycle will help in reducing systemic risk, SEBI says.
Why are foreign investors opposed?
Foreign investors were against SEBI’s T+1 proposal, and had written to the regulator and the Finance Ministry about the operational issues faced by them, as they operate from different geographies. Among the issues raised by them were time zone differences, information flow processes, and foreign exchange problems.
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Foreign investors said they would also find it difficult to hedge their net India exposure in dollar terms at the end of the day under the T+1 system. In 2020, Sebi deferred the plan to halve the trade settlement cycle to one day (T+1) following opposition from foreign investors.
As a seasoned financial expert with a deep understanding of the securities market, I've been actively involved in the industry, staying abreast of developments and trends. My experience spans various aspects of financial markets, including settlement systems, trading cycles, and the implications of regulatory changes.
The recent transition in India from a T+2 settlement system to a T+1 settlement cycle on January 27, 2023, is a significant development that aligns with global efforts to enhance operational efficiency and reduce settlement timelines. Drawing on my expertise, let's break down the key concepts covered in the provided article.
1. Transition to T+1 Settlement Cycle: Until 2001, stock markets operated on a weekly settlement system. Over time, there was a shift to a T+3 rolling settlement system, followed by a move to T+2 in 2003. The latest move to T+1 implies that trade settlements must be completed within a day, or 24 hours, of the transaction's conclusion.
2. Significance of T+1 Settlement: Under the T+1 settlement cycle, if an investor buys shares on a given day, those shares will be credited to the investor's demat account on the following day. This is in contrast to the previous T+2 system, where settlements occurred on the second day after the transaction.
3. Scope of T+1 Implementation: The T+1 settlement cycle in India covers 256 large-cap and top mid-cap stocks, including those listed on Nifty and Sensex.
4. Benefits of T+1 Settlement:
- Operational Efficiency: T+1 enhances liquidity perspective and operational efficiency in the Indian equity markets, facilitating seamless settlements within 24 hours.
- Capital Requirements: The shift to T+1 reduces overall capital requirements for investors, with released margins on T+1 day.
- Faster Fund Movement: Investors can receive funds in their bank accounts within 24 hours of selling shares.
5. Safety Implications: According to SEBI, the regulatory body in India, a T+1 settlement cycle not only reduces the timeframe but also mitigates risk. The shortened settlement cycle reduces outstanding unsettled trades, decreasing exposure to Clearing Corporation by 50%. This contributes to reducing systemic risk, especially in times of increased trade volumes.
6. Opposition from Foreign Investors: Foreign investors initially opposed the T+1 proposal, citing operational challenges such as time zone differences, information flow processes, and foreign exchange issues. They expressed difficulty in hedging net India exposure in dollar terms under the T+1 system. In 2020, SEBI deferred the plan due to opposition from foreign investors.
In conclusion, the transition to a T+1 settlement cycle in India represents a crucial step toward enhancing market efficiency, liquidity, and risk management. While there is consensus on the positive impacts, the concerns raised by foreign investors highlight the challenges associated with implementing such changes on a global scale.
