Let’s explore the T+1 settlement cycle
We know the first question that arises in your mind while you start reading this article. What is the T+1 settlement cycle?
The exact time when a trader buys a share in the market is not the time when that share gets delivered to the trader’s demat account. It currently usually takes place 2 days later. For example, if you buy a share on Monday, it will be delivered to your demat account on Wednesday. This system of equity settlement is known as T+2 settlement as the delivery of shares (i.e. stock settlement) is taking place 2 days after ‘T’ day i.e. the day the transaction takes place (or the trade date). It is a type of rolling settlement i.e. the entire trading process (from initiation to settlement) takes place over two successive days (or more, in case of T+2).
Note: If a rolling settlement is taking place over T+n days then the number n does not include trading holidays.
However, under the latest instructions of the Securities and Exchange Board of India (or SEBI), the time gap between transaction and delivery will be reduced to T+1. Therefore, if you order a security on Monday, it will be delivered to your demat account on Tuesday itself, instead of Wednesday.
The process of switching to the T+1 settlement cycle from T+2 was being rolled out in phases already. However, the entire process will be complete on 27th January, 2023, after which, all trades in the Equity Cash segment (including Futures and Options on stocks) will be conducted on T+1 basis.
Here’s what happened next
As a result of the SEBI guidelines, both NSE and BSE introduced the T+1 settlement cycle in their equity cash segment.
Moreover, for MTF (Margin Trading Facility) funding, the MTF pledge request must be authorised by 9:00 PM on the T day itself. Also, auction settlements (if any) will take place on T+2 days.
Reasons for choosing the T+1 settlement cycle
From the point of view of SEBI, the T+1 settlement will be solve the following issues –
- The number of demat accounts of individual investors in India has been growing rapidly – from 4 crore in March 2020 to over 10 crore in August 2022. This number is expected to grow further in the coming months. In such a scenario, quicker settlement could reduce the default risk as well as systemic risk of pay-in/pay-out of a large volume of transactions.
- Larger the settlement cycle, larger is the number of unsettled trades that need to be settled at any given point of time – hence larger the risk. On the other hand, narrower the settlement cycle, lower are the chances of large quantities of default at a single point of time.
- The risk associated with the value of an open position is proportional to the time to settlement. A 2-day Value at Risk(VaR) is 1.414 times of day 1 VaR.
- Lower risk immediately means a lower quantity of capital that is blocked in order to cover the counterparty risk in the market overall. It will increase the total quantity of liquidity available in the market, thus lowering risks further.
From the point of view of the traders/investors, the following are the benefits of T+1 settlement –
- Counterparty risk or risk of non-payment of funds or non-delivery of shares gets reduced.
- Traders are required to pay lesser margin and collateral – therefore they can utilise their funds more efficiently within the same period of time.
Hence SEBI reduced the period of rolling settlement from T+5 to T+3 in 2002 and to T+2 in 2003 already. Then in 2021, the T+1 settlement was introduced but was to be implemented in phases, starting with stocks with the lowest market capitalisation.
In simpler terms, it is always good for businesses or traders if the execution of the orders they place happens at a faster rate – it reduces risks and delays and the costs related to those risks and delays.
Reactions to the T+1 settlement from different interest groups
Traders welcome the move as their transactions will be executed earlier. It will increase the level of liquidity at which the market operates i.e. allowing assets to be exchanged at a higher rate than before.
There was a slight issue with T+1 for brokers and intermediaries who had to significantly alter their front and back office operations to accommodate the new delivery cycle. However, the phased rollout of the T+1 settlement cycle allowed the entire transition to go through smoothly and successfully.
The biggest issue arose in the case of FPIs who have multinational investments and therefore, they have to adjust their systems specifically for the Indian trading timeline. Problem areas include adjusting trading algorithms, risk calculations and getting necessary asset transfers and approvals from their foreign head offices. However, the SEBI decision has been eventually accepted by them.
Given that SEBI has been largely accommodative of the concerns of the major interest groups, it is unlikely that the execution of the T+1 settlement will cause any major dip in the total turnover volume in the markets during or immediately after its implementation.
Angel’s remark on the T+1 Settlement
The Indian economy has come a long way since the liberalisation of the economy in the early 1990s. Back then, the IMF and western nations had nudged us into accepting a more open financial market. But today we are about to show the world our own innovations in designing financial markets to meet the requirements of modern trading and investment.
If the above innovation in BSE and NSE settlement makes you interested in the stock market, but you do not have a demat account yet, try to open a demat account with Angel One, India’s trusted stockbroker.