By Snehal Bajpeyee
T+0 – The new settlement system
In the 1950s and 1960s, India’s productive sector faced significant challenges, predominantly due to restricted and limited access to the financial sector. Banks stood on the brink of failure. A strain on the overall economic vitality of the country characterized this era.
Today, India’s digital revolution and a full transition to the T+1 settlement system in January 2023 itself, when most developed countries, like the USA and Canada, will make this transition only in 2024, has been an inspirational journey. India’s robust financial system’s growth has been tremendous since 1991, and now, the Securities and Exchange Board of India (SEBI) strives to make more strides in this sector.
SEBI’s chief, Madhabi Puri Buch, announced the intention of the securities market regulator to make same-day settlements, commonly known as T+0 settlements, possible by the end of March 2024 and the option of instantaneous settlements available by the next year.
T+0 stands for transaction day plus zero, which refers to a system where the whole transaction is completed on the very same day it is executed, which includes payment, transfer, and settlement of ownership.
This bold initiative pursues the objective of transforming the settlement system outlook of India by exceptionally decreasing the time required for the buying, selling, and receiving of trades and proceeds. If implemented successfully, this terrific arrangement will make Indian share markets one of the most effective and efficient in the entire global financial world, being only second to China in having a short settlement cycle of just one day. This system aims to accelerate Indian financial markets’ attractiveness to foreign investors and make them less prone to fraud and risks.
This article delves into the intricacies of the proposed T+0 settlement system, exploring its benefits, distinctive features, and associated concerns, particularly those voiced by foreign investors. Understanding them is crucial in evaluating the system's potential success and its implications for India's standing in the global financial arena.
The advantages of T+0 and the instant settlement system –
The T+0 system represents the technological and managerial expertise of India. It is an upgrade of the previous T+1 system, following many benefits and advantages, some of which are enumerated below.
1. Reduced Counterparty Risk: Because trades are paid on the same day as they happen, the T+0 system lowers the risk of fraudulent activities. It makes it harder for people to cheat in a trade deal. This creates overall stability in the Indian financial system, making investors feel safer about investing.
2. Market Efficiency: With T+0 settlement, the market can work more efficiently. It shortens the time between doing trade and getting it settled by one day. This efficiency has the potential to bring more people to the Indian markets, as there are very few countries that follow this kind of system.
3. Increased investor confidence: A good market increases the prospects of investors doing more buying and selling. Investors will be able to realize profits or losses more easily and sooner than before. People who invest will feel safe knowing their trades are settled on the same day.
4. Enhanced Capital Utilization: Investors can use their money better now because they don't need to set their finances aside for a longer period of time. This may cause better use of money and assets and hence, better utilization of capital.
5. Attraction of Short-Term Traders: The T+0 payment system might bring in short-term traders, like day traders who enjoy fast market changes. These traders gain from quick payments after deals, letting them make money on small price changes and use the daytime chances.
Features of T+0 and the Instant settlement system –
The proposed mechanism is to be implemented in two phases, as per a consultation paper released by SEBI on 22nd December 2023, which is summarised in this section.
i. In Phase 1, an optional T+0 settlement cycle (for trades until 1:30 PM) is planned, with funds and securities settled on the same day by 4:30 PM.
ii. In Phase 2, an immediate trade-by-trade settlement (funds and securities) will be made optional. Trading will continue until 3.30 p.m. in the second phase.
The phase 1 mechanism of optional T+0 settlement will be phased out after the implementation of phase 2 (optional instant settlement).
Phase 1 settlement:
All clients will be considered eligible investors, except those clients settling through custodians. Custodians are clearing members but not trading members. They settle trades executed by other trading members on behalf of their clients. A trading member may delegate a specific trade to a custodian for settlement. The custodian must confirm whether or not he intends to settle the trade.
The T+0 settlement will be available in the top 500 listed equity shares by market capitalization. This will be done in three tranches of 200, 200, and 100, from the smallest to the largest market cap. The exchanges must work together to create a common list of securities and a calendar for migration under the T+0 settlement.
A separate series code shall be created for T+0 settlements.
There will be only one continuous session from 9:15 a.m. to 1:30 p.m. Other sessions like pre-open, block, auction, and post-close sessions will not be allowed. There will be no trading in the regular market on the settlement holiday/expiration date of corporate action (including the scheme of arrangement).
T+0 prices are not included in the index calculation/settlement price. There will be no separate close price for securities that are traded in the T+0 section.
Phase 2 settlement:
All clients will be considered eligible clients, including those clients settling through custodians.
All securities available under the Phase 1 settlement will be made available in the Phase 2 settlement as well.
Only limit orders shall be allowed in instant settlements. Trading hours will be from 09:15 a.m. to 03:30 p.m., identical to the T+1 segment.
Other rules of Phase 1 shall apply to Phase 2 settlements.
Concerns and potential mitigation with the proposed settlement system –
Some concerns and mitigation tactics were noted by SEBI itself in the consultation paper noted above. They have been summarised in this section.
1. Concern – T+0 and instant settlements may lead to liquidity fragmentation, affecting price discovery. Liquidity fragmentation refers to a situation when participants are unable to complete transactions with others due to a lack of clearing arrangements in a trading venue.
Mitigation – As per SEBI, some participants will have access to both T+0 (and the instant settlement system) and T+1 settlement systems, which would bridge the gap between price and liquidity gaps in the market.
2. Concern – The two settlement systems may have different prices for the same security.
Mitigation – Arbitrageurs will play a significant role in the mitigation of divergence of prices. Arbitrageurs are the people who take advantage of price inefficiencies in the market to gain profits. Their participation will bridge the gap in case divergence emerges between the two settlement systems.
3. Concern – The introduction of T+0 will increase the cost of trade as funds and securities will have to be made available before placing orders.
Mitigation – SEBI says that its client base is already ready for this change as investors do early pay-in for trades worth of INR 1,00,000, which is 94% of delivery-based trades.
Other major concerns –
Foreign investors have raised voices regarding some concerns with the proposed mechanism of the T+0 system and the instant settlement system, which have not been answered by SEBI. Though the mechanism seems aspirational, its implementation and regulation will be demanding and burdensome. Some foreign investors believe the instant settlement system will lead to a fragmented market, adding to the cost of trading.
An article by the Securities Industry and Financial Markets Association (SIFMA) discussed how the T+1 system has the highest optimal benefits for investors and how transitioning to a T+0 settlement system, with the assumption that it will make the markets efficient and will help in risk mitigation, actually does not work due to the law of diminishing returns. Basically, the disadvantages outweigh the advantages.
Some analysts are of the opinion that the new settlement system will require heightened investors’ education. This system will introduce different prices for the same security, which will need time for adaptation. Due to reduced float periods, business models relying on interest from client funds may have to reevaluate their strategies.
Zerodha founder and CEO Nitin Kamath explained why a T+0 system will not work for Indian financial markets in 2021, mainly due to the presence of intraday trading, which makes up a huge bulk of trading volumes in Indian stock markets. He even claimed an instant settlement system is impossible for India.
Many such concerns were not discussed or recognised by SEBI in the consultation paper. Such major concerns have been outlined below –
Increased pressure - Clearing corporations are essential to the efficient and seamless settlement of trades. They will be under more pressure to process and settle trades in a shorter amount of time with T+0.
Similarly, depositories like NSDL and CDSL will also face increased pressure to perform more efficiently. T+0 will increase their workload by requiring that settlement instructions be processed more quickly and that securities balances be reconciled effectively. Depositories will need to modernize their infrastructure, expedite procedures, and increase operational capacity to meet these demands.
Operational Hurdles - The instant settlement plan would present serious operational challenges, especially for those based in different time zones, like foreign investors. The absence of a global settlement system and the requirement to conform to various market timings may lead to operational inefficiencies.
The challenges for foreign investors don’t end here. Regulations may also present challenges because foreign investors are governed by different laws in their home nations. It might prove to be difficult and time-consuming to comply with these rules and SEBI's instant settlement requirements at the same time.
Discouragement to participate - Implementing a T+0 settlement cycle poses challenges for industry participants due to their reliance on existing business processes and infrastructure. This framework could create a competitive imbalance, favouring larger players with the resources to adapt while putting smaller participants at a disadvantage. Smaller entities, lacking sufficient resources, may struggle to make the required investments, impacting their ability to compete effectively and potentially leading to discouragement for smaller players from participating.
Failed trades - Settlement failures happen when there are mistakes in settlement instructions or trade details, often due to human errors. If the settlement time is reduced to T+0, there's a risk of more failures because there's limited time to fix these errors before the settlement date. In a T+0 setup, there's little or no time available to correct these mistakes, leading to an increase in the number of failed trades.
Conclusion –
It can’t be denied that SEBI’s proposed mechanism is inspirational and futuristic. T+0 and the instant settlement system demands efficiency from many financial sectors and regulators of India. SEBI is pursuing a future with reduced counterplay risk, efficient markets, and better capital utilization in Indian financial markets. SEBI aims to be one of the finest markets globally, but the reality is that the T+0 system is an uncharted territory. This kind of settlement system has not been explored by the majority of developed countries, and what benefits and disadvantages the system will bring is unexpected. The concerns of domestic and foreign investors are justified which are essential to address. However, SEBI should not be discouraged from implementing this system. If implemented successfully, Indian financial markets’ calibre will be shown to the world. India is well-positioned to not only revolutionize its financial markets but also become a global leader in inclusive, progressive, and robust economic growth.
The author of this article is Snehal Bajpeyee, a first-year BALLB student at National Law University and Judicial Academy, Assam.
This article contains the view of the author and the publisher in no way associates with the views or ideologies of the author. All the moral rights vests with the Author(s).
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