Have you noticed that after buying or selling a stock, bond, or mutual funds, you have to wait for two days for that stock to reflect in your Demat account or the fund to come in your account? Well, the period to do so, i.e., T + Day Settlement – will reduce to just one Day, i.e., T + 1 from T+2. Cheers to this, as the Security Exchange Board of India (SEBI) has put out a circular providing flexibility to stock exchanges to offer T+1 cycles for stocks. The circular means that the credit of shares can be done the next Day itself (T+1). Are you still confused about what T+1 Settlement means, or do you want to know the history of Settlement? Well, we’ll cover this shortly.
History of Trade Settlement in India –
Initially, all the trading settlements (i.,e delivery and payment of shares and stocks) on BSE i.e, the Bombay Stock Exchange, used to happen between Monday and Thursday. And final Settlement used to occur on Fridays.
This Settlement was through the physical movement of paper. The exchanges are used to settle the trade by delivering the shares to the purchaser and payment to the seller. And later, physically moving the securities from the seller (involving the company) to the ultimate buyer.
The NSE – National Stock Exchange entering into the game – with tech-backed – screen-based trading brought various changes to the trading world, especially in India. The NSE also started the settlement cycle on fixed days only, i.,e Wednesdays as settlement days. Later, they shifted this to Tuesdays.
This weekly settlement system infused liquidity in the market because traders and others could buy and sell without having to pay immediately, which ultimately led to speculative activities in the cash market. The wildly infamous Harshad Mehta scam was a result of this.
This speculative nature of trading showcased the loopholes in the system, like default risks, and often extended the settlement cycle either for want of cash or scrip.
As a case study from the Harshad Mehta scam came the first revolution and resolution to the loopholes in the securities markets on the settlement side. To reduce the risk associated with the so-called fixed-day settlement system, the SEBI introduced rolling Settlement in July 2001. The settlement process for a trade contract begins at the end of the trading day, now famously termed as “T”.
Initially, it was introduced for limited scrips on a T+5 basis (in 5 days from the date of trade) and then expanded to other scrips in a very planned manner.
All scrips moved to rolling Settlement from December 2001 onwards. T+5 was replaced with T+3 in April 2002, and later it was replaced by T+2 in April 2003.
What is T + Day Settlement – T+1, T+2, T+3?
When you buy or sell a stock/bond/ or any other security, there are two critical aspects to it: one is the transaction date i.,e T, and the second is the settlement date. Therefore the abbreviations T+1, T+2, and T+3 refer to the settlement dates of security transactions that happen on a transaction date plus one Day, two days, and three days, respectively.
As the term suggests, the transaction date represents the exact date on which the actual transaction was carried out. For example, if you buy 50 shares today, then today’s date becomes the transaction date which is T. This date doesn’t change, as it will always be the date on which you made the transaction.
Why Delay Actual Settlement?
In earlier days, security transactions were done manually as compared to today’s electronic and now we are also moving towards blockchain. Coming back to the topic, investors had to wait for the delivery of their stock/bond/securities, which was in an actual certificate form, and the payment happened only after receiving the hard copy of the certificate. Since delivery times vary and prices tend to fluctuate, market regulators had to set a cutoff period in which the overall trading transaction needs to be settled.
Initially, the settlement date for stocks was T+5 i.,e five business days after the transaction date was initiated. Until recently, when the overall Settlement was set to T+3. Today, it’s T+2 or two business days after the transaction date, thanks to technological advancements and electronic trading.
India is the second largest market after China to implement the T+1 settlement cycle of stocks. Most international markets like the US, Europe, etc are still in the T+2 settlement cycle. Well, this means when you buy a stock or a bond, it will start reflecting into your demat account after a period of 2 days. And when you sell it, again, it will take two days to reflect into your system.
Here is the press release 2 from the exchanges. It says that starting Feb 25th, 2022, 100 stocks (starting with the lowest market cap) will move to the T+1 settlement cycle on both exchanges simultaneously. From March 2022, 500 stocks ranked from the bottom will move to the T+1 settlement cycle.
The Bombay Stock Exchange being an older exchange has almost 5000 active companies listed and being transacted, and National Stock Exchange has virtually 1800 active companies. The ~3000 additional on BSE are lower market cap companies (mostly penny stocks). So this means that in around ten months from Feb, or by Oct 2022, all the stocks in Indian markets will be on the T+1 settlement cycle.
Why not T+0 or Instant settlement?
This question of why we can’t have an instant settlement in today’s world where UPI is powering almost 4+ billion bank transfers a month, all settled instantly, keeps coming up. This is very different from a typical banking transaction, where money is immediately transferred from one account to another. Here the cash and stocks (with stocks comes with respective rights as a shareholder) both are involved and usually stocks cant be settled due to intraday trading.
If you observe the majority of trading volumes on the stock markets across the world is seen from intraday traders who are constantly buying and selling stocks without actually taking or giving delivery. Typically these intraday trader exits their position before the end of the Day, and that obligation to deliver the stock will eventually land with someone who holds the stock. Zerodha’s Founder Mr. Nithin Kamath commented on T+1 Settlement – “While instant settlement is impossible, even T+0 is extremely tough considering the time required for brokers to crystallize the obligations and then clearing corporations to settle.”
Why did SEBI opt for a phased roll-out of the new Settlement?
There was a great resistance seen from Foreign Portfolio Investors (FPIs) against the implementation of the T+1 Settlement. Since FPIs invest in India from different countries and time zones, this can be a bit of a challenge for them to get the necessary approvals for the stock transfers and complete procedures from their respective custodians or head offices. For them, this could become a real-time process of stock and money transfers. Domestic brokers argued against it as the new T+1 Settlement involves the high cost of changing their back and front office operations. Both of them wanted more time; hence SEBI and exchanges opted for a phased manner.
What is the settlement system followed in other developed markets?
Most large stock markets, like in the US (progressing towards the T+1 Settlement), Europe, and Japan, still follow the T+2 settlement cycle of trade settlement.
As NSEIT is the Technology consultant for the Capital market player stay tuned with us to learn more information about this development, we’ll be writing more about this in our next blogs. You may also want to understand and check out our other solutions – XpressSTP on capital market offering which is really benefitting the entire capital market industry.
Authored by: Swati Rai