T+1 hour settlement — a challenging experiment
The Securities and Exchange Board of India (SEBI) Chairperson Madhabi Puri Buch recently said the regulator plans to move towards T+1 hour settlement cycle by March 2024 and instantaneous settlement by October 2024.
Settlement system in Indian stock market has witnessed remarkable changes over the years. Before the advent of demat or dematerialisation of electronic share bank, share certificates used to be physical. To accommodate the physical movement of shares, bourses implemented a fixed-day settlement cycle. Initially, BSE settled on Fridays, while the National Stock Exchange commenced with Wednesdays and later transitioned to Tuesdays.
Lack of trust between traders and brokers and among brokers were a hallmark of that opaque system, where almost all settlement days witnessed acrimonious fights over non-delivery of shares or funds. Besides, the fixed day settlement also triggered excessive volatility in stock prices, as shares need not be delivered on the first two-three days and the system was fraught with default risks.
Rolling settlement
In December 2001, a significant reform altered the trading system. Exchanges introduced a T+5 rolling settlement framework, requiring the delivery of shares or money on the fifth day after a trade occurred. This seamless trading system was welcomed by all, as it was transparent and removed confusion. After the successful launch, the exchanges shortened the cycle to T+3 in 2002, and to T+2 in 2003.
After almost 20 years, with the emergence of a robust banking system, SEBI nudged exchanges to adopt T+1 settlement cycle from this January. With exchanges and other intermediaries still grappling with T+1, SEBI now wants to shorten the cycle further.
However, this move is unwarranted as it will create a lot of confusion for not only market intermediaries but for investors and traders also.
Difficult for FPIs
First, it will put a lot of pressure on foreign portfolio investors, who are until now reluctant to participate in T+1 cycle, as they operate from different geographies with different time zones. So, settlement on hourly basis will put their custodians under heavy stress.
Mutual funds may also face some issues, with respect to calculation of the applicable NAV (the reference price for purchase and sale). The cut-off time for equity and debt funds is 3 pm. If an application is submitted before 3 pm, you are allotted units at NAV prevailing on the same day. If it’s after 3 pm, you get units at NAV of the next day. With six settlement cycles on a single day, computing NAV on hourly basis will be a Herculean task and that may lead to unnecessary disputes.
Another possible area of concern could be on corporate actions such as bonus, dividend, merger, demerger, etc where the record date is important and is based on settlement cycle. This would unnecessarily increase the trading in the last cycle of the day, creating overload on the whole system.
Apart from this, brokers will have to face heavy back-office workload that may exert pressure on their financials. Already small players are finding it difficult to run the business due to operational and financial challenges.
Day trading may rise
Besides, the move may also end in overtrading by retail investors who, according to a SEBI study, are losing heavily in F&O trades. A study by the market regulator revealed that for active traders (excluding outliers) in F&O, average loss stood at ₹50,000 in FY22 — 15 times higher than for those who made average profits. Some of them, who find it difficult to trade in F&O due to margin pressure and other reasons, may shift to cash segment and indulge in heavy day trading.
Currently India is the only country to have T+1 settlement cycle on a full scale. Most larger stock exchanges, including developed ones, still follow T+2 or T+3 settlements. Quick settlement is a laudable objective of SEBI. However, as the saying goes, any over-speeding can lead to severe accidents.
Given the possible procedural wrangles, SEBI can hit the brakes for now. However, this proposal will be optional only, said SEBI official.