[Arnav and Yashasvi are students at Symbiosis Law School, Nagpur.]
The clearing and settlement process is a critical component of the securities market infrastructure, ensuring that trading operations run smoothly and efficiently. In this regard, the Securities and Exchange Board of India (SEBI), through a consultation paper dated 22 December 2023 has proposed a transformative and reformative change by introducing clearing and settlement facilities of funds and securities on T+0 and instant settlement cycle, both on optional basis. The proposals in the present consultation paper are said to increase operational efficiency, reliability, low cost and high speed of transactions and to attract more and more investors to invest in Indian securities market. The said consultation paper and the proposals therein, in their pith and substance, are in conformity with SEBI’s aims to maintain the efficiency and integrity of settlement cycles in Indian securities market by keeping pace with the changing times.
This post explores the rational and purpose behind the proposal and offer an outline of the SEBI’s proposal on introducing T+0 and instant settlement cycle. The post outlines the background and implications of the aforementioned consultation paper.
Background
The Indian securities markets have experienced remarkable expansion in terms of volume, value, and number of participants and retail investors who provide assets and cash up-front before making an order. According to the data stated by SEBI in the present consultation paper, investors made early pay-ins of money and securities for around 94% of delivery-based deals during the June 2023 period, with a maximum transaction value of INR 1,00,000 which is strongly indicative of increase in participation of investors in the Indian securities market. The ever-increasing participation of new investors in the securities market places a greater duty on SEBI to make markets more efficient and safer for its participants, with a particular emphasis on the increasing retail participants.
It is pertinent to note that the clearing and settlement process in India has developed and evolved through years as a result of numerous reforms and developments. At the very outset, it needs to be noted that the process of transferring cash and securities between buyers and sellers following the execution of a transaction is known as trade settlement. SEBI had, vide its circular dated 30 January 2002 (effective from 26 March 2002), shortened the settlement cycle from T+5 to T+3 and subsequently, vide another circular dated 6 February 2003 had further reduced the settlement cycle from T+3 to T+2. In its transformative move, T+1 settlement was introduced in a phased manner by SEBI through a circular dated 7 September 2021 which was fully implemented from January 2023. Through the present consultation paper, SEBI has proposed to further shorten the settlement process from T-+1 to T+0 which means that the settlement should be completed on the same day on which the transaction takes place.
SEBI has stated that the instant proposals come in the light of significant development of payment systems in the India such as Unified Payments Interface (UPI) which are increasingly embraced and accepted by Indian populace along with other sophisticated and robust technologies which are used by markets infrastructure institutions. Further, SEBI has stated that the Indian banking system is capable of transferring the funds in real time owing to the technological developments, and the depository system has visibility into client-level holdings.
Implications
The shorter settlement cycle proposed by SEBI and other regulatory organizations has far-reaching ramifications for market dynamics. Risk mitigation is one of the primary implications in the proposals given by SEBI in present consultation paper. The risk factor has always acted as a deterrence for investors to participate in Indian securities market and shortening of the settlement period shall encourage and even increase the investors participation in the securities market. Shortening and expediting the settlement cycle in financial markets reduces market risk by accelerating the completion of securities transactions, reducing the period between trade execution and settlement during which price variations might occur. The shorter period between transaction start and settlement from T+1 to T+0 shall reduce exposure to market fluctuations, improving the entire risk management framework and limiting the possible negative effects of market volatility on the value of assets. It needs to be noted that longer settlement cycles allow for a wider range of operational errors to occur and by shortening the settlement period, faults have less time to go unnoticed and potential issues have less time to proliferate, lowering operating risk.
SEBI’s proposals in the present consultation paper shall also ensure liquidity enhancement in the Indian securities market. Shortening and expediting the settlement cycle in securities markets helps to improve liquidity by accelerating the conversion of financial assets into cash, allowing for more efficient capital deployment, reducing counterparty risk, and aligning market transactions more closely with prevailing market conditions, fostering enhanced liquidity management capabilities for market participants. The accelerated settlement process reduces the amount of time funds are tied up in trades, allowing for faster capital turnover and providing market participants with more timely access to liquid assets, ultimately improving their ability to respond quickly to investment opportunities or meet financial obligations. Furthermore, aligning settlement cycles with current market circumstances guarantees that asset prices are more indicative of real-time values, fostering a more accurate picture of market liquidity and allowing participants to make more informed and timely investment decisions.
SEBI’s proposals in the present consultation paper also have nexus with technological development and digital payment mechanisms. Shortening and expediting the settlement cycle in financial markets creates a compelling motivation for wider technology adoption by mandating increased efficiency and automation throughout the entire deal lifecycle, igniting a profound paradigm change. As settlement cycles shorten, market participants are compelled to adopt cutting-edge technological solutions, to streamline operational workflows, reduce manual intervention, and accelerate trade settlement. Additionally, it needs to be noted that the present consultation paper SEBI has observed that UPI is increasingly embraced by the Indian populace, and hence the necessary implication of introduction of T+0 and instant settlement cycle is that efficiency and flexibility of these payment methods and technologies are extended to equity and securities dealing as well.
SEBI’s proposal also implies market integrity and transparency. A shorter expedited settlement cycle improves transparency greatly by giving investors and regulatory bodies with more immediate and accurate information about market operations and trades. The accelerated settlement procedure guarantees that trade information, including as transaction prices and volumes, are reflected in public records and market data feeds as soon as possible. This increased openness not only allows investors to make better informed decisions, but it also allows regulators to monitor market dynamics in real time, allowing them to discover and handle any abnormalities or manipulative tactics more efficiently. Hence, SEBI deems it fit to introduce a shorter settlement cycle to extend the efficiency and flexibility of these payment methods and technologies to equity and securities dealing as well.
However, while the regulator’s strategy may increase market liquidity and free up margins, but it will have an impact on the business models of stock brokers that rely on interest income from client money. The entire business model of such brokers shall have to be changed. The proposed change will necessitate extensive investor education and will have an impact on broker business because to the shorter float time. Furthermore, there are potential concerns that the new mechanism will cause liquidity fragmentation and impair efficient price discovery; enhance the cost of trading because funds and securities must be made available upfront before placing orders; and result in price divergence between the T+0 or instant settlement cycle and the T+1 settlement cycle for the same security.
Conclusion
The clearing and settlement process is a critical component of the securities market infrastructure, ensuring that trading operations run smoothly and efficiently. The proposals in the consultation paper for introduction of T+0 and instant settlement cycle are a step forward in improving the efficiency and agility of the Indian securities market. Shortening and expediting the settlement cycle in the securities market has several potential benefits and positive implications. Through the proposals in the present consultation paper, SEBI has taken a step to introduce not just expediated settlement cycle, but also dependability, low cost, and rapid speed of transactions are crucial characteristics that attract investors to certain asset classes.
It is critical to recognize that the realization of an expediated settlement cycle necessitates concerted and synchronized efforts from various market constituents, including stock exchanges, clearing firms, and intermediary entities, necessitating the strengthening of technological infrastructure and risk management systems to seamlessly facilitate the anticipated transition while maintaining the market’s integrity and operational efficacy. Further, there are few potential concerns such as change in business model of brokers relying on interest income on client money and investor education which need to be addressed.