Markets
Mint Explainer: Can instant shares settlements coexist with the T+1 cycle?
Summary
- Sebi has proposed allowing for the existing T+1 settlement cycle to continue, while traders will also have the option of instant settlement
The Securities and Exchange Board of India last week floated a much-awaited discussion paper on instant settlement of shares. No advanced or emerging market offers such low settlement time. India is already among a handful of global markets that offer T+1 settlements–requiring trade settlements to be completed within a day of a transaction–as against the global norm of T+2 or T+3 settlements. Mint takes a look into the mechanism, and potential risks.
What is instant settlement?
Currently in India, buyers and sellers of shares receive their respective proceeds a day after a transaction is completed–a transaction Day (T) + 1 settlement cycle. Sebi has proposed a mechanism in which a market entity can receive the proceeds instantly after an order is executed.
The process will be implemented in two phases. In phase 1 market participants will be offered T+0 settlement, which means investors will receive their payouts by the end of the same trading session. In phase 2, the settlement time will be instantaneous.
To be sure, the existing T+1 settlement cycle will continue, and instant settlement will be optional. Investors who are comfortable with the existing settlement system can continue to trade on the T+1 settlement cycle.
How will instant settlement help?
The proposed framework will benefit retail investors who make delivery-based trades because they will be able to receive proceeds instantaneously. For sellers of shares, it would be helpful since they would be able to receive payout of funds immediately, which will allow them to reinvest their funds in the market quicker. For buyers, receiving the shares immediately will allow them to pledge the shares for further trading.
The settlement also improves risk management in the market by clearing corporations since the trades in instant settlement are backed by upfront funds and securities.
Why is it optional, not mandatory?
While a shorter settlement system can be extremely beneficial for domestic investors, foreign funds face certain challenges in shifting completely to it. This is because offshore funds operate across different time zones and make investments through custodians. Also, for making a trade, foreign funds will need to book foreign exchange transactions to convert their dollars into rupee. Keeping in view these challenges, Sebi has proposed making instant settlements optional while keeping the existing T+1 cycle operational.
What are the potential risks of instant settlements?
Market participants have expressed concerns about price distortion and fragmentation of the market due to the proposed system of having two separate settlement cycles: T+1 and instant.
Trades done in both the cycles will be executed on two different platforms. For instance, an order placed by a buyer wanting to buy shares of a company via instant settlement cannot be matched with the order of a person willing to sell shares of the same company under T+1 settlement. Hence, it could lead to a situation where the scrips are trading at two different prices on both the platforms. Also, some trades will go with instant settlement and some with T+1, leading to fragmentation of volumes.
Sebi, however, is banking on arbitrage traders to close any price/volume gaps. Basically, if the shares of a company are of two different prices, arbitrage traders typically would buy the shares from the platform where it is available cheaper and sell it instantly on the platform where it is expensive, making a small spread. Due to such trades, the trading price on both the platforms would get adjusted towards uniformity.
