Reducing the trade settlement cycle

Market regulator Sebi has revived the plan of shortening the trade settlement cycle. We bring you an explainer:

What is the current settlement cycle?

Currently, all the cash segment trades are settled on socalled T+2 basis. In simple terms, when you buy a security, it reflects in your demat account after two days. Similarly, when you sell a security, the money gets reflected in your bank account after two days.

What is Sebi targeting? The regulator wants to cut the trading settlement cycle to the next day — known as T+1. In 2013, Sebi had floated a discussion paper titled ‘Risk Management - Safer Markets for Investors’, where it has dealt into the feasibility of a shortened settlement cycle.

The paper had proposed to move to a T+1 settlement cycle and also highlighted challenges in doing so. Since, then there hasn’t been much movement on the proposal.

How will this benefit?

A shorter settlement cycle reduces the risk emanating from volatility in the financial markets. It also helps free up capital faster. This give investors greater flexibility when it comes to providing collaterals and margins.

This issue gains more prominence as Sebi has tightened the rules pertaining to upfront margins.

Also, they can be nimbler when it comes to react to the price-sensitive developments. A narrower cycle also reduces the risk of counterparty insolvency.

Overall, it would result in operational costs savings, thereby reducing cost of trading. It would also help reduce systemic risk as it would automatically reduce number of outstanding trades at a given point and reduce the load on clearing corporations and depository firms.

What are the challenges when the cycle is reduced? Earlier, the biggest challenge used to be cheque payments by retail investors. The process of clearing cheques used to be the biggest impediment. However, now most investors have moved to online payments.

Industry players say the major hurdle now is the foreign portfolio investor (FPI) trade settlement.

Many FPIS operate from different time zones. Experts say the process of getting custodian approvals and settling trades of foreign investors is still a lengthy process. This issue needs to be handled delicately as FPIS are one of the most vital cogs of the stock market ecosystem.

The markets regulator will have to address this issue before it can announce a shorter trade settlement cycle, they add.