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 27th, the stock markets in India completed their transition to the T+1 settlement system. It has become the second largest market after China to make the transition, ahead of the US, Europe and Japan, which adhere to the T+2 settlement cycle. The phased transition had begun on February 25 last year following the September 2021 circular issued by the Securities and Exchange Board of India (SEBI).
What is the T+1 settlement cycle?
A trade involves three important functions, trade execution, clearing and settlement, which are performed by separate entities. The clearing function involves the affected entity determining the obligation of what to deliver and what to receive from the parties involved. In this phase, a risk assessment of both parties is carried out. The process ensures that the parties have sufficient funds or transferable assets for the transaction to go ahead. On the settlement date, funds and securities are transferred to their new owners. All of this is preceded by a purchase or sale of a share. It is represented by “T”, ie trade executed on a specific day. Since clearing took place earlier the next day, followed by another day for settlement, the previous mechanism was defined as “T+2”. From now on, settlement will take place on the next day itself, i.e. T+1.
Regarding the infrastructural changes made for the transition, the Bombay Stock Exchange (BSE) told The Hindu: “On our end, we have kept our infrastructure ready to handle additional activities in the T+1 settlement cycle, including upgrading securities settlement data, real-time monitoring systems, margin calculation, settlement activities, etc. within the shortened time cycles.” The exchange said it had not encountered any gaps and all processes had been handled smoothly.
In the digital age, why isn’t billing done immediately?
The process is complex and many entities are involved. Founder and CEO of brokerage firm Zerodha, Nithin Kamath had stated in a post, “While instant settlement is impossible, even T+0 is extremely difficult considering the amount of time brokers need to clear the commitments and the then settle clearing companies.” It’s important to note that an investor cannot buy or sell shares directly on an exchange. Registered members of an exchange, called stockbrokers, act on behalf of an investor. Although individuals can open a Demat account themselves by contacting a Depository Participant (DP), in order to buy or sell shares they will need a trading account provided by a SEBI registered broker. The size and operational capability of the individual broker is another important factor.
What is the T+1 regime debate?
Global investment associations including the Asia Securities Industry & Financial Markets Association, the Asia Trader Forum and The Investment Association (IA) stated in a joint open letter (September 2021) that the transition would involve an “end-to-end process transformation and extensive technology” would require investment and enhancements to support near real-time processing capabilities, and which will require an extended migration schedule.” It added that this is due to time zone differences and the involvement of multiple parties (such as global and local custodians, foreign exchange banks and brokers) would apply especially to foreign investors (e.g. those based in the US and Europe) participating in the Indian market ) in different jurisdictions.
Milan Vaishnav, founder of Chartwizard FZE and Gemstone Equity Research, told The Hindu, “What has happened so far is that they would take some time to allocate the trade to the client, which must be faster now,” adding added: “The time zone differences would also bring some difficulties, but eventually they will converge.” The Securities and Exchange Commission (SEC) of the United States had also argued in its proposal (February 2022) that the more days between the execution of a trade and the default of a counterparty, the greater the variance of the price change would be. In other words, the asset’s price is likely to differ from the execution price. According to Mr. Vaishnav, from an investor’s perspective, “money rotation would accelerate. In addition, you would retain less margin with the broker, commitments would be a day shorter, and receipts would also come a day earlier than before. Overall, this would result in some reduction in the retail investor’s or trader’s overall margin requirements.” Regarding brokerages, Mr. Vaishnav explains that this would reduce the amount of margin they keep with clearing houses as settlements would be faster.
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