Explainer- Towards quicker settlement with T+1

Explainer: Towards quicker settlement with T+1

The stock exchanges are set to move to a shorter ‘trade-plus-one’ (T+1) settlement cycle from January 27. Future and options (F&O) stocks were to be transitioned to this regime in two phases, in December 2022 and January 2023. T+1 comes with its own benefits and issues. Ashley Coutinho takes a look at what this move entails  

What the T+1 cycle means 

The large cap and blue-chip companies will be switching to the T+1 system on January 27. This shift comes almost 20 years after the Securities and  Exchange Board of India (Sebi) brought down the settlement period to T+2 from T+3 in April 2003. 

The benefits and challenges that come with the new regime

The T+1 settlement system will shorten the settlement cycle, which will reduce the risk of default and increase market liquidity with availability of funds. This may result in an increase in trading volume as the funds will be free within a day. It may also lower margin requirements.

FPIs may face operational challenges in adjusting to the regime because of the difference in time zones, especially in the case of US and EU investors. Once theT+1 cycle kicks in, forex will have to be necessarily booked either late in the evening of trade day or early morning the next day. This may pose some challenges as well. Pre-funding will mean the cost of doing transactions in India will go up. Costs will also rise for those catering to FPIs such as custodians, brokerages and tax consultants, as they will have to engage larger teams for longer hours.

Other T+1 jurisdictions

China is the only market of significant size which follows short settlement cycles (T0, T+1). The US, Canada, and Japan follow T+2 settlement, and plan to shift to T+1 in 2024. Very few comparator economies still follow the T+3 regime. Many developed economies — South Korea, Australia, and Switzerland follow T+2, and haven’t reported T+1 plans.

Phased rollout

In 2021, the National Stock Exchange and the Bombay Stock Exchange announced T+1, in a phased manner from February 25, 2022. This was rolled out with the bottom 100 stocks by market value. There has been a serious backlash from the FPIs since they operate from a different time-zone and factoring that in meant larger costs of transacting for them, given all the manpower needed. Even domestic brokers wanted more time. Hence, there was a phased rollout.

Why are markets globally moving to T+1 settlement? Will volumes get impacted?

Global appetite for shorter settlement cycles has grown as market participants look to mitigate settlement risk, which was reinforced by the volatility seen during Covid-19 and its meme stock trading episode (recall l’affaire Game Stop). Meme stocks are stocks that become popular among individual investors, thanks to social media. Margin demands and collateral requirements from broker-dealers can be pared by reducing the settlement cycle. The move will also help limit systemic risk by reducing counterparties’ exposures to each other. As a risk mitigation solution, shorter settlement cycles are very compelling.

Trading volumes by FPIs in top stocks may get impacted, especially in the near term. Transactions may reduce as investors do not want to risk penalty or franchise risk. The impact on buy-and-hold type of FPIs will largely be confined to the time of placing the orders or bringing in funds, according to experts. These include the likes of sovereign wealth funds, pension funds and even asset managers. The impact on

FPIs such as hedge funds, which resort to daily or more frequent transactions, may be much higher.