SEBI recently published a circular allowing stock exchanges to use a T+1 settlement cycle for trading in listed company shares on an optional basis. One day passes from the time sellers and buyers meet on the exchange platform to decide on a deal to the time money and securities change hands. A buy/sell order that is executed on an exchange platform in India is now settled two business days after the deal is conducted. This may seem weird, since when we go to the store to purchase tomatoes, we pay for them and have them delivered in seconds.
For a variety of reasons, including the ability to net-off buy and sell orders, financial markets use a distinct method. When you purchase two kilos of tomatoes, you are unlikely to try to sell them back to the store later that afternoon, but it is conceivable in the financial markets, in which case you only pay for what you bought on the net. While the lengthier cycle has its advantages, it also has its drawbacks. In contrast to the tomato market, the opposite party may go bankrupt before its commitments are met. Furthermore, unlike the tomato market, the securities market insures deals and consequently assumes the risk of either side defaulting.
SEBI decreased the settlement schedule for trading from T+5 to T+3 in 2002, and then to T+2 in 2003. From January 1, 2022, the implications of the current circular, which provide a wide criteria for stock exchanges to transition from a settlement period to another, will take effect. This was done to allow all securities market participants, such as exchanges and brokers, time to modify their technological infrastructure and other operational processes in order to adjust to a trading environment with a shorter settlement cycle.
With the exception of specific market players, such as overseas investors, switching from a T+2 to a T+1 system would have far-reaching implications for the entire securities market. Shortening the settlement cycle should provide various advantages to the investor community at large. One should aware of understanding of invest in mutual funds online.
In a discussion paper published in 2013, SEBI looked at the possibility of using the T+1 settlement mechanism to reduce the risk of one of the trading parties being insolvent and unable to meet its commitments. A T+1 settlement method will maintain the above-mentioned netting of transactions, improve market efficiency, and reduce operational and systematic risks. Shortening the settlement cycle by one day reduces the risk of counterparty pay-in/pay-out failures, lowers margin requirements, and provides additional liquidity to investors by allowing them to access their cash and securities one day sooner.
Simultaneously, reducing the settlement period will introduce new problems. A T+1 settlement cycle, for example, will compel all stakeholders to enhance their systems and procedures in order to adapt to a shorter trading cycle. Funds and securities must be transferred promptly from one account to the next, and netting computations and bank transfers must also keep up. Furthermore, FIIs, who have a favorable impact on the expansion of the Indian securities market, have expressed worry about specific operational challenges they may experience under a T+1 settlement cycle. Some overseas investors may be put off by issues such as additional operational complications due to working in various time zones and the necessity to pre-fund their transactions.
The advantages of establishing a shorter timescale for trade settlement, on the other hand, may exceed the challenges that certain market players may confront. Sebi has not required exchanges to use the T+1 system across the board, and stock exchanges have been granted the choice to implement the quickest settlement period for any number of scrips that they think acceptable, taking into account the concerns of all stakeholders. Rather than dismissing the new rule entirely, it would be sensible to adopt the T+1 settlement cycle for a small number of scrips and see how investors, especially international investors, react.
To date, stock exchanges in major markets have continued to use the T+2 settlement cycle, with the exception of the Chinese markets. However, in certain jurisdictions, discussions about switching to a T+1 settlement period are gaining traction. Moving to a shorter settlement cycle would, in general, benefit the majority of investors, particularly retail investors, while also reducing system risks. Furthermore, all exchanges should speak with one another and adopt the T+1 settlement cycle for chosen scrips in a staged and coordinated way.
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