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

Syllabus: General Studies Paper 3

Context:

If stock Market 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.

About T+1 Settlement

• 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.

SEBI’s intention behind

• According to a Sebi, 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.

Working of T+2 settlement and how it is different from T+1.

• 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.

Reason behind the opposition of the foreign investors

• Foreign investors might face operational issues 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. 

The Indian Express Link:

https://indianexpress.com/article/explained/t1-settlement-system-how-it-works-and-how-it-will-help-investors-7506987/

Question: Write a short note On T+1 settlement system proposed by SEBI.