India is prepared to move to the T+1 settlement cycle as the country’s banks now offer online settlement for funds. It will substantially improve liquidity and remove the need for transactions like “Buy Today, Sell Tomorrow”
The stock market in India is one of the best in the world. This may come as a surprise to many. The reasons are obvious. India has rarely contributed to financial innovations in recent times. Also traditionally India has been one of the late starters in stock market and stock market continued to follow primitive practices till the time two major changes happened, which are: 1) starting of screen-based trading, and 2) dematerialization of securities.
We have often been accused of aping practices of the US and European securities market. Whatever be the fact, today India seems to have left behind some of the advanced economies in managing settlement cycle. If you do not believe it, you just need to look at the table below:
Source: CISI, London (India also has T+1 and T+0 settlement cycle for debt and Germany has T+ 2 for equity if both parties are German)
The table clearly shows that countries like USA, Australia, France and UK still continue to follow T+3 settlement cycle in stocks. These so-called advanced countries have not been able to move to T+2 settlement cycle as yet while a country like India with relatively less advanced banking system managed to move to T+2 settlement cycle in 2003. Benefits of shorter settlement cycle (SSC) have already been reaped by investors in India.
Longer settlement cycles have several negative aspects like higher capital required, increases in operational risks and liquidity issues, while it has some limited benefits as well. In order to overcome shortcoming of T+3 settlement cycles, The Depository Trust and Clearing Corporation (DTCC),USA, appointed Boston Consultancy Group (BCG) to study the cost benefit analysis of shortening of settlement cycle. BCG has submitted its report earlier this month to DTCC on the subject ( http://www.dtcc.com/downloads/leadership/whitepapers/BCG_2012.pdf). While India is already operating in T+2 settlement cycle, there are some interesting aspects in the study which can be used in India as well. Let us look at some of the interesting findings from the reports, which are as follows:
Shorter the settlement cycle, more the cost benefits
Analysis done by BCG shows that shorter the settlement cycle, more is the benefit in terms of costs and risk reduction. The summary of cost benefit analysis is as follows:
The data above shows that initial investments of $550 million will have to be done for moving to the T+2 settlement cycle, while $1770 million will be required to move to the T+1 settlement cycle. The costs are high but there is a substantial saving in annual recurring cost which can very well compensate the costs. The BCG study says, “T+2 would result in $170 million in annual operational savings and $25 million in annual return on reinvested capital from Clearing Fund reductions, whereas T+1 would result in $175 million in operational savings and $35 million in return on reinvested capital. The assumed cost of capital in the above numbers is 3.5% and assumes firms are investing the proceeds in Fed Funds. 3.5% was the average Fed Fund rate for the 10-year period prior to the 2008 financial crises. If these funds were invested in alternative ways to Fed Funds, that yielded a 5% or 10% return, annual returns would be $30 million and $60million for T+2, and $50 million and $100 million for T+1, respectively.” The study also shows that there is a substantial reduction in risk exposure on unguaranteed buy-side trades which is $200 million and $410 million. Since this is unique to US market, drawing a parallel in India won’t be fair.
The study has also calculated payback period of the investments. On payback period the report says, “The payback period range is still quite favorable for most segments, considering only operations cost savings for the T+2 model. The longest payback period is 5.2 years for the buy side and other constituent groups have comparatively short payback periods ranging from 2.1 to 2.6 years. The segment-level payback periods for the T+1 operating model have a somewhat higher range. Excluding the buy side, these payback periods range from three to 3.7 years, assuming adherence to a “trade date” environment. The buy side payback period is 10.9 years, but this is based on relatively low operations savings only and does not take into account the significant additional upside due to risk reduction, which would shorten the payback period for the buy side to less than one year for either operating model.”
Challenges in moving to shorter settlement cycle (SSC)
A shorter settlement cycle has its own challenges. BCG has identified some of such challenges in the US context and has list the following as main challenges:
These challenges are more or less the same in India. However, like in the past we should be able to smoothly overcome these challenges.
Lessons for India
The study has brought out the details of cost benefit analysis of a shorter settlement cycle in USA. Is there any lesson for India in this? Can we move to the T+1 settlement cycle now? India moved to T+2 settlement cycle in 2003. At that time it was thought that since banking system does not have RTGS (Real Time Gross Settlement) it would have been challenging to move to settlement cycle of T+1. But now things have changed significantly. Today banks have online settlement systems for funds. Money movement is very smooth and RTGS is working fine.
Moving to T+1 settlement will have many benefits for stock exchanges. It will substantially improve liquidity and remove the need for transactions like BTST (Buy today, sell tomorrow). Also mark to market margin requirement will get reduced. More than anything else, it will help bring more funds from outside to India. It is high to analyse cost benefit of moving to T+1 settlement cycle in India.
As suggested yesterday, the intraday rallies today were met with selling. Only a close above any previous day’s high would mean a trend reversal
Warning of a downgrade of India’s sovereign rating in the next years by S&P and European concerns led the market lower today. Today the Nifty moved in a narrow range of 5,647 and 5,687 and closed near the days low. Yesterday we had mentioned that the index will move with a negative bias, we continue with this stance. The National Stock Exchange (NSE) saw a volume of 69.04 crore shares and an advance decline ratio of 477:1291.
The market opened lower on weak global cues following the International Monetary Fund’s caution about the pace of global economic growth. Concerns about Spain and Greece also weighed on the sentiments.
The Nifty opened 34 points lower at 5,671 and the Sensex started the day at 18,699, down 94 points from its previous close. Select buying amid sharp volatility saw the indices hitting their intraday highs in early trade itself. At this point the Nifty rose to 5,687 and the Sensex went up to 18,741.
The market remain subdued in morning trade after global rating agency Standard & Poor’s stated that there is “one in three” chance of India facing a downgrade in its sovereign rating to junk status in the next two years. The agency added that the outlook can be revised upwards to stable if the government succeeds in reducing fiscal deficit, improve the investment climate and revives growth.
The announcement resulted in banking, capital goods and technology stocks coming under selling pressure. Selling intensified in the second half of trade as the European markets opened in the negative following comments from the IMF that the region’s debt crisis was seen as the main reason for the slowdown in global growth.
Lacklustre trade continued in the last hour, which dragged the benchmarks to their lows around 2.30pm. The Nifty went down to 5,648 and the Sensex retracted to 18,622 at the lows.
The market closed near the lows following the downgrade threat by S&P which resulted in the realty, power and banking sectors emerging as the top losers. The Nifty closed 49 points (0.85%) down at 5,656 and the Sensex dropped 162 points (0.86%) to settle at 18,631.
The broader markets suffered a bigger blow today as the BSE Mid-cap index dropped 1.29% and the BSE Small-cap tanked 1.53%.
BSE Fast Moving Consumer Goods (up 0.04%) was the only sectoral gauge to settle higher. The top losers were BSE Realty (down 4.61%); BSE Power (down 2.17%); BSE Bankex (down 1.31%); BSE PSU (down 1.31%) and BSE Capital Goods (down 1.30%).
Only three of the 30 stocks on the Sensex closed in the positive. The gainers were ITC (up 0.36%); Hero MotoCorp (up 0.33%) and Reliance Industries (up 0.09%). The key losers were State Bank of India (down 2.32%); Tata Power (down 2.25%); Hindalco Industries (down 2.11%); BHEL (down 2.04%) and NTPC (down 1.82%).
The top two A Group gainers on the BSE were—Container Corporation of India (up 3.29%) and Jaiprakash Associates (up 2.58%).
The top two A Group losers on the BSE were—GMR Infrastructure (down 9%) and Lanco Infratech (down 8.54%).
The top two B Group gainers on the BSE were—Karuturi Global (up 19.39%) and Burnpur Cement (up 17.35%).
The top two B Group losers on the BSE were—Som Distilleries & Breweries (down 12.26%) and Raj Oil Mills (down 12.02%).
Out of the 50 stocks listed on the Nifty, seven stocks settled in the positive. The key gainers were Jaiprakash Associates (up 2.87%); HCL Technologies (up 1.11%); Punjab National Bank (up 0.86%); Hero MotoCorp (up 0.64%) and ITC (up 0.48%). The major losers were DLF (down 5.40%); Siemens (down 3.98%); IDFC (down 3.43%); Reliance Infrastructure (down 2.94%) and SBI (down 2.70%).
Markets in Asia settled lower on worries that the tardy global growth would impact corporate earnings. The ongoing territorial dispute between China and Japan also weighed on investors.
The Hang Seng dipped 0.08%; the Jakarta Composite shed 01.01%; the KLSE Composite fell 0.24%; the Nikkei 225 tanked 1.98%; the Straits Times declined 1.05% and the Seoul Composite dropped 1.56%. Bucking the trend, the Shanghai Composite gained 0.22%. The Taiwan market was closed for trade today.
At the time of writing, markets in Europe were down between 0.22% and 0.41% and the US stock futures were in the negative.
Back home, foreign institutional investors were net buyers of shares totalling Rs613.98 crore on Tuesday whereas domestic institutional investors were net sellers of stocks amounting to Rs430.60 crore.
Reliance Power has raised external commercial borrowings of around Rs1,588 crore ($302 million) to fund its 100 MW solar power project in Rajasthan. The 100MW plant is being built adjacent to India’s largest thin film PV Project, the 40 MW photovoltaic project, commissioned by the company in March. The stock tanked 4.05% to settle at Rs99.60 on the NSE.
L&T Finance Holdings, the NBFC arm of the engineering giant Larsen & Toubro, today said it has successfully completed the acquisition of Indo Pacific Housing Finance (IPHF) for Rs110 crore. The acquisition is likely to help L&T Finance enter the housing finance business by expanding the network of IPHF. The stock closed 1.44% lower at Rs51.50 on the NSE.
Off-the-road tyre manufacturer Balkrishna Industries has commissioned the first phase of its plant at Bhuj in Gujarat. The greenfield plant is a part of the company’s Rs1,800-crore expansion programme that would be completed in 2015. The stock dropped 1.55% to close at Rs285 on the NSE.