Under the system introduced eight years ago to protect investors, investors still bear the risk of non-payment and non-delivery of shares due to inefficiency of stock exchanges and intermediaries. It is time SEBI penalises those who have benefited from this and compensate investors who have suffered silently
The Securities and Exchange Board of India (SEBI) introduced the T+5 rolling settlement in the equity market in July 2001 and subsequently shortened the settlement cycle to T+3 in April 2002. After having gained experience from the T+3 rolling settlement and taking other steps such as introduction of straight through processing (STP), SEBI further reduced the settlement cycle to T+2, hoping to reduce the risk in the market and protect the interest of investors.
Accordingly, the T+2 rolling settlement was introduced from 1 April 2003. The calendar of events / activities for T+2 rolling settlement as proposed by SEBI at the time, were as follows.
* Confirmation of trades by custodians latest by 11am on T+1. A provision of an exception window would be available for late confirmations. The time limit and the additional charges for the exception window would be decided by the exchanges.
* The exchanges / clearing house / clearing corporation would process and download the obligation files to the brokers' terminals latest by 1.30pm on T+1.
* DPs shall accept instructions for pay-in of securities by investors in physical form at least up to 4pm and in electronic form up to 6pm on T+1.
* The depositories would accept requests from depository participants (DPs) till 8pm for 'same day processing'.
* The depository would permit the downloading of the pay-in files of securities and funds till 10.30am on T+2 from the broker pool accounts.
* The depository would process the pay-in requests and transfer the consolidated pay-in files to the clearing house / clearing corporation by 11am on T+2.
* The exchanges / clearing house / clearing corporation would execute the pay-out of securities and funds latest by 1.30pm on T+2 to the depositories and clearing banks and the depositories and the clearing banks would in turn complete the process by 2pm on T+2.
In actual practice, there is a considerable variance between what was proposed and what is implemented today, as detailed here below.
This is how the trades are conducted today by one of the leading broking intermediaries in a computerised environment and in respect of on-line transactions conducted by thousands of investors.
"I enter into a buy transaction on Monday through an on-line trading window provided by a broker, without any manual intervention, on earmarking necessary funds in my bank account. The broker issues a contract note on the same day for the purchase done on that day.
My bank account in respect of this deal gets debited with the deal value including brokerage, taxes, etc on Tuesday, that is T+1.
My DMAT account gets credited with the shares purchased on Thursday, that is T+3."
"I enter into a sale transaction on Monday through on-line trading after ensuring that the requisite shares are earmarked for sale in my DMAT account. The broker issues the contract note on the same day for the sale of shares done on that day.
My DMAT account in respect of this deal gets debited with shares sold on Tuesday, that is T+1.
My bank account gets the credit for the sale proceeds after deducting brokerage, taxes, etc, on Thursday, that is T+3."
The above cycle takes place during the week, when both the banks and the stock exchanges work without any holidays. The practice followed by other broking intermediaries may marginally vary from what is stated above, but in all cases, there is marked variation from the laid down guidelines.
It is clear from the above that what was intended by SEBI while introducing the T+2 trading cycle has not been implemented either in letter or in spirit, and the Stock Exchanges and the intermediaries have devised their own settlement cycle to the detriment of the investors. It is not known, whether this cycle has the blessings of SEBI.
The investors have the right to seek answers to the following questions:
1. Who bears the risk of non-payment for two days in respect of shares already withdrawn from the investor's DMAT account?
2. Who bears the risk of non-delivery of shares for two days, for which the investor has already made the payment?
3. Even a day's delay in delivery of shares purchased by the investor can result in his facing the risk of a fall in prices due to volatility in the market. Why should he bear this risk for no fault of his/hers.
4. Who enjoys the float funds for two days at the cost of investors?
5. Who has allowed this variation from the intended settlement system, where the risk was much less to the investors?
If the investor has to bear the risk of non-payment or non-delivery of shares for the inefficiency of the stock exchanges or the intermediaries, it is incumbent on the part of SEBI to take immediate steps to rewrite the rules of the game and ensure that the interests of the investors are protected. SEBI should also investigate to find out as to who has benefited by this changed settlement cycle followed since April 2003, and based on the principle of "undue enrichment of those not entitled", should ask those intermediaries who have benefited, to compensate the investors by working out an appropriate formula, thereby serving the cause of investors who have suffered silently so far.
It is worthwhile to mention here that in the wake of the security scam involving Harshad Mehta, revealed by journalist Ms Sucheta Dalal, in April 1992, the Reserve Bank of India (RBI) had completely overhauled the payments procedure in the government securities market and devised a full-proof payment and delivery mechanism called 'Delivery versus Payment' (DvP) system, which is worthy of emulation by the stock exchanges.
DvP is the mode of settlement of securities wherein the transfer of securities and funds happen simultaneously, on the same day. This ensures that unless the funds are paid, the securities are not delivered and vice versa. The DvP system completely eliminates the settlement risk in transactions. The banks and other players in the gilt-edged securities market have immensely benefited from this arrangement and it has been working very well for more than 15 years.
In the present context of all stock exchanges and the depositories being run on sophisticated computerised platforms, and the banks in our country being better equipped now to transfer funds on a real-time basis under the Real Time Gross Settlement System (RTGS), there is no reason why the capital markets cannot follow in the footsteps of the RBI to give investors in the capital market the same level of safety, security and comfort enjoyed by the participants in the gilt-edged securities market.
If this improved settlement system is followed, SEBI could even consider bringing forward the settlement cycle to T+1, which will greatly enhance the credibility of the capital market in our country, benefitting all the players and the economy of our country as well.
Is it not better to upgrade the settlement system now than to wait for another scam to happen and then think of improvement as normally happens in our country?
(The author is former managing director and CEO of a mutual fund. He writes for Moneylife under the pen name 'Gurpur'.)