Securities and Exchange Board of India (SEBI), a statutory body established in 1992, recently authorised stock exchanges to implement the T+1 system optionally. This has been done in lieu of the traditional T+2 system for the completion of share transactions in a bid to improve liquidity.
Understanding the Settlement System
In the securities industry, a trade settlement period refers to the duration between when an order is executed in the market on the trade date and when the trade is finalized on the settlement date. At the end of this period, the buyer becomes the official holder of the security.
Key Points About the New System
If a stock exchange chooses to utilize the T+1 settlement cycle for a particular scrip – a substitute for legal currency that gives the bearer entitlement to a return – it must be used continuously for at least six months. After this period, if the stock exchange wishes to revert back to the T+2 system, a one month prior notice needs to be given to the market. Any further switches between T+1 and T+2 will be subject to a mandatory minimum period.
T+1 vs T+2 Settlement Explained
In a scenario where an investor sells shares in a T+2 settlement, the trade settles after two working days. The broker handling the trade receives payment on the third day but only credits the investor’s account by the fourth. As a result, the investor receives money only after three days. Conversely, in a T+1 settlement, the trade resolution occurs in a single working day, and the investor receives funds the following day. Transitioning to T+1 won’t require monumental operational or technical changes by market participants and won’t pose a risk of fragmentation to the core clearance and settlement ecosystem.
Advantages of T+1 Settlement
Several benefits come with implementing a T+1 settlement system. Reduction in settlement time is the foremost advantage, wherein capital required to collateralise the accompanying risk also diminishes. The new system also curbs the number of unsettled trades at any given moment, causing a 50% decrease in unsettled exposure to the Clearing Corporation. A slimmer settlement cycle decreases the chance of trade settlement issues due to insolvency or bankruptcy. Additionally, the capital blocked to cover trade risk decreases proportionately with the reduction in unsettled trades—resulting in lower systemic risks.
Potential Issues for Foreign Investors
Foreign investors have expressed concerns regarding operation difficulties they might encounter when functioning from different geographical zones, such as time zone disparities, information flow processes, and foreign exchange complications. They may also find it challenging to hedge their net India exposure in dollar terms by the end of the day under the T+1 system.
With time and exposure, it remains to be seen how smoothly the transition from T+2 to T+1 will occur and if it will indeed bolster market liquidity as intended.