A move to a T+1 settlement cycle is expected to benefit domestic investors by increasing market liquidity and trading turnover, while reducing settlement risk and broker defaults
The Securities and Exchange Board of India (Sebi) has introduced an optional T+1 settlement cycle for the Indian markets.
The regulator has put the onus on the stock exchanges to decide whether they want to opt for the shorter settlement cycle for any of the listed scrips — after giving a one-month prior notice to all stakeholders, including the public at large.
A move to a T+1 settlement cycle is expected to benefit domestic investors by increasing market liquidity and trading turnover, while reducing settlement risk and broker defaults. Foreign portfolio investors (FPIs), however, are expected to face considerable operational challenges in adjusting to the new regime because of the difference in time zones, especially for US and European investors.
“Sebi has been receiving requests from various stakeholders to further shorten the settlement cycle. Based on discussions with 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,” said a note from the regulator on Tuesday.
The provisions of the circular come into effect from January 1, 2022.
Currently, trades on Indian stock exchanges are settled within two days just like most major markets around the world such as Singapore, Hong Kong, Australia, Japan and South Korea. Taiwan, which had moved to a T+1 settlement, has moved back to a T+2 cycle.
“Domestic investors will be in favour of moving to a T+1 system since all the money today is coming on a realised basis. The offshore investors, however, will face an issue,” said a person familiar with the matter.
According to him, the exchanges may initially try to move 5, 10 or 15 scrips that are outside of the key benchmark indices such as Nifty 50 and Sensex to T+1 cycle. “FPIs are the biggest drivers of Indian equities and moving Sensex of Nifty stocks could prove too risky if liquidity dries up,” he said.
After opting for T+1 settlement cycle for a scrip, the stock exchange shall have to mandatorily continue with the same for a minimum period of six months. Post that, in case, the exchange intends to switch back to T+2 settlement cycle, it shall do so by giving one-month advance notice to the market. Any subsequent switch (from T+1 to T+2 or vice versa) shall be subject to minimum notice period. There shall be no netting between T+1 and T+2 settlements.
Two different settlement cycles on different exchanges for the same scrip could also result in flow of domestic liquidity from one exchange to another.
For example, if the RIL scrip is traded under T+1 on NSE but T+2 on BSE, a domestic institutional investor preferring a T+1 cycle may trade the scrip on the former.
“Most of the global banks and FPIs will find it difficult to fulfill the fund obligations and it may be an operational chaos,” said a foreign custodian, adding that neither FPIs nor custodians have been consulted on the issue.
“A market transition to T+1 would require significant, coordinated, and expensive structural changes to the settlement process, including technological enhancements and real-time/near real-time trade processing, all of which would limit and delay the realization of the expected risk-reducing benefits of shortening the settlement cycle. It is unrealistic to expect that global investors can streamline what would typically be a multi-year initiative to meet Sebi’s timeframe of 2022,” said Lyndon Chao, head of equities at ASIFMA, an industry association comprising top FPIs, in an interview to Business Standard this week.
The China equities market is the only market of significant size and scale which operates on a shortened settlement cycle (T0/T+1).
The Indian market had migrated to T+2 in 2003 under the then Sebi chairman GN Bajpai.