Explained | How will the T+1 settlement cycle impact markets?

A pedestrian walks past the Bombay Stock Exchange (BSE) building in Mumbai on January 27, 2023.
| Photo Credit: PTI

The story so far: On January 27, stock markets in India concluded its transition to the T+1 settlement regime. It has became the second largest market after China to have made the transition ahead of the U.S., Europe and Japan which adhere to the T+2 settlement cycle. The phased transition had begun on February 25 last year following markets regulator Securities and Exchange Board of India (SEBI)’s circular in September 2021.

What is the T+1 settlement cycle about?

A trade involves three important functions, execution of trade, clearing and settlement, carried out by separate entities. The clearing function entails the concerned entity determining the obligation of what is due to be delivered and what is to be received by the parties involved. Risk assessment of both parties is carried out at this stage. The process ensures that the parties have enough funds or transferrable assets for the transaction to go through. On the settlement date, funds and securities are transferred to their new owners. All of it is preceded by purchase or sale of a stock. It is represented using ‘T’, that is, trade executed on a particular day. Since clearing used to take place the next day followed by another day for settlement, the previous mechanism was defined as ‘T+2’. From now onwards, the settlement will be done the next day itself, thus, T+1.

About the infrastructural changes made for the transition, the Bombay Stock Exchange (BSE) told The Hindu, “At our end, we have kept our infrastructure ready to take care of additional activities in the T+1 settlement cycle, including updation of securities settlement data, real-time monitoring systems, margin computation, settlement activities etc, within the reduced time cycles.” The exchange said it did not observe any gaps, and all processes were managed smoothly.

In a digital age, why is a settlement not done instantly?

The process is complex and there are many entities involved. Founder & CEO of brokerage firm Zerodha, Nithin Kamath, had stated in a post, “While instant settlement is impossible, even T+0 is extremely tough considering the time required for brokers to crystalise the obligations and then clearing corporations to settle.” It is important to note that an investor cannot directly buy or sell shares on a stock exchange. Registered members of a stock exchange, called stock brokers, trade on an investor’s behalf. Even though individuals can open a demat account on their own by contacting a depository participant (DP), they would require a trading account, which is provisioned by a SEBI-registered broker, to purchase or sell shares. The size and operational capability of the individual broker is another important factor.

What is the debate around the T+1 regime?

Global investment associations, including Asia Securities Industry & Financial Markets Association, Asia Trader Forum and The Investment Association (IA) in a joint open letter (in September 2021) had observed the transition would require “end-to-end process redesign and substantial technology investments and enhancements to support near real-time processing capabilities and necessitating an extended migration timeline.” It added that this would be particularly true for overseas investors (such as those based in the U.S. and Europe) for participating in the Indian market owing to time zone differences and involvement of multiple parties (such as global and local custodians, FX banks and brokers) in different jurisdictions.

Milan Vaishnav, founder of Chartwizard FZE and Gemstone Equity Research, told The Hindu, “What happened till now is they would take some time in allocation of trade to the client, which will now have to be faster,” adding, “The time zone difference too would pose some difficulties but ultimately they will align themselves.” The United States’ Securities and Exchange Commission (SEC) had also argued in its proposal (February 2022) that the more days that elapse between the execution of a trade and a counterparty default, the greater would be the variance of price change. In other words, it is likely that the asset’s price would deviate from the execution price. According to Mr. Vaishnav, from an investor standpoint, “The rotation of money would become swifter. Further, you would be keeping less margins with the broker, obligations would be a day shorter and receipts would also come a day earlier than before. Overall, it would lead to some reduction in the overall margin obligations of the retail investor or the trader.” For brokerages, Mr. Vaishnav states that it would reduce the amount of margin they keep with clearing houses because the settlements would be faster.