[Sarthika is a student at Damodaram Sanjivayya National Law University.]
In today’s age of instant communication and real-time financial data, investors in India have to wait a whole day to take ownership of the stocks they’ve purchased or to receive payments for the stocks they have sold. However, this issue is on the brink of a significant transformation. Through its latest proposal dated 21 March 2024, the Securities and Exchange Board of India (SEBI) has introduced same-day settlement of trades (T+0 settlement) on an optional basis alongside the existing T+1 cycle in the Indian stock market. The T+0 settlement cycle will be implemented in a phased manner, commencing on 28 March 2024, wherein a list of 25 stocks will be made available for same-day settlement through a limited number of brokers.
The transition has sparked debates among the market participants, and one important question needs consideration: will the benefits outweigh the risks? While there is no definitive answer to this at present, it is imperative to delve into the potential ramifications and risks linked with implementing a T+0 settlement system in the nation.
Beyond Paper: Evolution in Stock Settlement Cycles
Stock trades before the dematerialization age involved the physical exchange of share certificates, with settlement happening on a ‘fixed-day basis.’ To eliminate the problems of poor delivery and frequent defaults in the paper system, SEBI introduced the T+5 rolling settlement system, wherein shares and money were settled on the fifth day after a trade occurred. After successful adoption of the T+5 settlement cycle, SEBI gradually shortened the cycle to T+3 in April 2002, T+2 in April 2003, and finally to T+1 in January 2023.
To secure a further optimal and efficient system, SEBI is leading the Indian securities markets’ transition to a T+0 system. Under the T+0 beta version, the trading session for T+0 stocks will be from 9:15 a.m. to 1:30 p.m. with client code modifications allowed until 1:45 p.m. T+0 settlement will not apply to certain trading sessions, including pre-open, special pre-open, block window, auction, periodic call auction, and post-close. The specifications for T+0 securities, such as ISIN, symbol, tick size, and market lot, will be the same as those of the corresponding T+1 securities. Index computation and settlement price computation will be unaffected by T+0 pricing.
Globally, most equity transactions typically follow a T+2 settlement cycle. The US is transitioning to a T+1 system starting only on 28 May 2024. Presently, only some countries - China, Russia, and South Korea - offer same-day settlement for certain securities. Therefore, in the global context, India will be among the selected major countries to adopt a revolutionary same-day settlement system.
Implications of T+0 Settlement: Navigating the Risks and Rewards
While same-day settlement may indicate the appearance of maximum efficiency, it would also introduce new operational risks that require fundamental changes in the infrastructure and are likely to increase costs for investors.
Trading in the stock market requires margins, i.e., the money that needs to be blocked for buying shares. A shorter settlement cycle would free up margins’ funds faster since sellers will receive 100% of their funds on trade day as opposed to 80% in the T+1 system. This enhanced liquidity will enable investors to swiftly capitalize on reinvestment opportunities, react to market developments, and optimize investment strategies in real-time. For heavy volume traders and high-net-worth individuals, the freed-up margin amounts represent significant potential for maximizing interest income through bank deposits or alternate investment vehicles. However, on the other hand, this could deter small retail investors with limited access to capital from participating in the market since they rely on leverage or margin trading to finance their transactions.
A shorter cycle also means lower odds that the buyer or seller may default before the transaction is complete, furthering SEBI’s aim to boost investor confidence and protection. SEBI’s analysis highlighted that an annual INR 700 crore benefit accrued to investors with the shift from T+2 to T+1 settlement. Data from NSDL and CSDL also highlighted that the volumes of trades and the number of shares traded substantially increased with a shorter settlement cycle. On the basis of these previous figures, it is expected that a further optimized process would help in building investors’ trust and would ultimately enhance investor engagement and contribute to a more responsive market ecosystem.
Generally, brokers would stand to benefit from reduced working capital requirements, facilitating smoother cash flow management and reducing the overall cost of doing business. However, it may negatively impact the business model of stockbrokers, who heavily rely on interest income from client funds. Since T+0 settlement poses operational challenges, particularly in terms of crystallizing obligations and coordinating with clearing corporations for timely settlement, brokers would have to navigate these complexities to mitigate any associated risks. Brokers are also anticipated to face intensified competition as clients seek brokers capable of efficiently managing their finances and delivering enhanced benefits in the fast-paced market environment.
Foreign portfolio investors (FPIs) are likely to be at the opposite end of the spectrum. According to reports, FPIs raise evident concerns about investing in India due to the same-day settlement plan. Unlike the practice in global markets, FPIs would have to necessarily pre-fund their trade, exposing them to foreign exchange risks. Due to time zone differences, foreign investors might have to arrange funds even one day in advance. The need to execute foreign exchange transactions and to coordinate with multiple market infrastructure institutions (including local and foreign custodians) before executing a trade adds extra layers of complexity and operational hurdles for FPIs. This could lead to market fragmentation and hinder efforts to have a more inclusive investor base.
Speeding up the settlement cycle would reduce the window available for market participants to address errors in the transaction process and for regulators to root out the potential proceeds from frauds, among other challenges. Consequently, T+0 would likely lead to more failed trades, especially during periods of heightened market volume and volatility. However, it is worth noting that according to SEBI’s chairman, the defect rate (delivery v/s payment ratio) halved to a range of 0.2%-0.3% upon a shift to T+1, suggesting that a similar improvement is anticipated with a shift to T+0, unlike the usual phenomenon of increased failed trades in a shortened cycle.
Recommendations and Collaborative Strategies for Efficient Same-Day Settlement
The regulators, brokers, and investors would have to work together to ensure a successful implementation and to realise the full potential of the innovative move. Market participants must be fully aligned and accurate in their transaction processing. This necessitates robust matching and credit upfront, along with the enhancement of back-office functions such as aggregation, netting, compliance, and risk checks. A collaborative effort among industry stakeholders is crucial to ensure smooth implementation and minimize operational risks.
SEBI should explore flexibility in funding trades for foreign investors and give consideration to China’s same-day settlement systems. Not all market participants may have the technological infrastructure or operational capabilities to seamlessly transition to a same-day settlement system. Therefore, providing flexibility would allow investors to adapt at their own pace, minimizing disruption to their operations and ensuring a smooth transition.
During the consultation phase, ASIFMA raised concerns and warned that an optional same-day settlement could fragment the market, SEBI did not respond to it immediately. Noting that FPIs and global asset and fund managers are increasingly getting interested in investing in the Indian market, SEBI should engage in consultation and collaboration with foreign investors, industry associations, and other foreign stakeholders to solicit feedback, promoting transparency and consensus-building.
To avoid failed trades in the system, India should develop and leverage distributed ledger technology (DLT). DLT offers a decentralized system where market participants work together to maintain and validate the ledger collectively. By having access to a central source of data, market participants would be able to track transactions throughout the entire securities lifecycle, facilitating settlement efficiencies. The European Securities and Market Authority is also in line to adopt such technology through its ‘unique transaction identifier’ technology.
Furthermore, India can take inspiration from DTCC (US Clearing Corporation) to add efficiency to the settlement cycle. Lately, it reengineered its night cycle processing, which produced greater operational and capital efficiencies, improved intraday settlement finality, and delivered substantial savings in the form of lower transaction costs. Similarly, India should leverage its technological infrastructure to streamline the process.
Conclusion and Way Forward
The transition to a T+0 marks India’s first step in achieving a ‘UPI moment’ in the settlement cycle. Being among the first major economies to adopt such a settlement cycle positions India as a significant player on the international stage. While an accelerated cycle underscores efficiency in the system, it is a complex undertaking that could actually result in more risk, fundamentally changing the investor-market experience.
Thus, the T+0 settlement would demand a learning curve from the investors, and regulators would need to guide this transition. Furthermore, as SEBI gears up for instantaneous settlement, it must take care of the downside, i.e., loss of benefit from netting and pre-funding requirements for investors, among other challenges. Overall, embracing the T+0 settlement demonstrates Indian exchanges’ commitment to innovation and to staying up-to-date with international financial trends.
The true litmus test lies ahead: Will the T+0 settlement stand the test of time and operate seamlessly in both normal and volatile market conditions? With SEBI’s present efforts to leverage technological advancements, it is undeniable that the vision of ‘one-click trading’ is not far away.
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