T+1 settlement system: how it works, and how it will help investors

If stock Markus exchanges agree to the proposal for the T+1 settlement system made by the Securities and Exchange Board of India (Sebi), investors will get money for shares they sold or bought in their accounts faster, and in a safer and risk-free environment.

What has Sebi allowed?

On September 7, Sebi allowed stock exchanges to start the T+1 system as an option in place of T+2. If it opts for the T+1 settlement cycle for a scrip, the stock exchange will have to mandatorily continue with it for a minimum 6 months. Thereafter, if it intends to switch back to T+2, it will do so by giving one month’s advance notice to the market. Any subsequent switch (from T+1 to T+2 or vice versa) will be subject to a minimum period. A stock exchange may choose to offer the T+1 settlement cycle on any of the scrips, after giving at least one month’s advance notice to all stakeholders, including the public at large.

Why T+1 settlement?

According to a Sebi paper, a shortened cycle not only reduces settlement time but also reduces and frees up the capital required to collateralise that risk. T+1 also reduces the number of outstanding unsettled trades at any instant, and thus decreases the unsettled exposure to Clearing Corporation by 50%. The narrower the settlement cycle, the narrower the time window for a counterparty insolvency/bankruptcy to impact the settlement of a trade. Further, the capital blocked in the system to cover the risk of trades will get proportionately reduced with the number of outstanding unsettled trades at any point of time. Systemic risk depends on the number of outstanding trades and concentration of risk at critical institutions such as clearing corporations, and becomes critical when the magnitude of outstanding transactions increases. Thus, a shortened settlement cycle will help in reducing systemic risk, SEBI says.

How does T+2 work?

If an investor sells shares on Tuesday, settlement of the trade takes place in two working days (T+2). The broker who handles the trade will get the money on Thursday, but will credit the amount in the investor’s account only by Friday. In effect, the investor will get the money only after three days.

In T+1, settlement of the trade takes place in one working day and the investor will get the money on the following day. The move to T+1 will not require large operational or technical changes by market participants, nor will it cause fragmentation and risk to the core clearance and settlement ecosystem.

In April 2002, stock exchanges had introduced a T+3 rolling settlement cycle. This was shortened to T+2 from April 1, 2003.

Why are foreign investors opposing it?

Foreign investors have written to SEBI and the Finance Ministry about operational issues they would face while operating from different geographies — time zones, information flow process, and foreign exchange problems. Foreign investors will also find it difficult to hedge their net India exposure in dollar terms at the end of the day under the T+1 system.

In 2020, SEBI had deferred the plan to halve the trade settlement cycle to one day (T+1) following opposition from foreign investors. According to an earlier schedule, the Sebi board was to decide on the issue at one of its board meetings in 2020. 📣 Express Explained is now on Telegram. Click here to join our channel (@ieexplained) and stay updated with the latest

What’s the global scenario?

In February 2021, the US Depository Trust & Clearing Corporation (DTCC), the premier market infrastructure for the global financial services industry, released a two-year industry roadmap for shortening the settlement cycle for US equities to one business day after the trade is executed (T+1). DTCC highlighted the immediate benefits of moving to T+1, including cost savings, reduced market risk and lower margin requirements as well as the firm’s plans for galvanising the necessary support for the project across a wide range of market participants. In order to move to T+1, industry participants must align and agree to shorten the settlement cycle by implementing the necessary operational and business changes, and regulators must be engaged, DTCC said.

Based on extensive industry engagement conducted by DTCC throughout 2020, early indications suggest market participants favour the move to T+1, especially during times of high volatility and stressed markets. “Based on simulations detailed in the paper, DTCC estimates that a move to T+1 could bring a 41 per cent reduction in the volatility component of NSCC’s margin,” DTCC said.

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