The proposal to shorten the settlement cycle to T+1 is the most ideal one to mitigate the overall risks in the trading system. With the banking system having taken giant strides in technology, this should help in introducing much faster settlement system in the capital market without any hassles whatsoever

The Securities and Exchange Board of India (SEBI) has put up a discussion paper on the subject of “Risk Management—Safer Markets for Investors” and has invited comments and suggestions from stakeholders on the following three proposals arising out of the need to improve the functioning of the capital markets in our country.

1. Incentivising internet based trading models posing minimal risk.
2. Mitigation of risk to client collateral.
3. T+1 settlement cycle as a measure to reduce overall risk in the system.

Almost two years back it was in Moneylife that I had suggested the need for introduction of T+1 settlement cycle in the place of the present T+2 settlement system with a view to give a boost to the capital market in our country.    
 

Read: How the T+2 rolling settlement in the equity market is subverted to benefit the intermediaries?
 

The fact that SEBI has now proposed to consider implementation of T+1 settlement system augurs well not only for the investors, but for all the players in the market, and to the economy of the country as well.  For the benefit of those who are not abreast with the settlement system followed at present, here is a brief account of the time-frame for settlement of trades followed by the stock exchanges.
 

What is the present settlement system?
 

At present stock exchanges follow T+2 rolling settlement systems for completion of the trades done on a day-to-day basis. For example, if you place an order through your broker to buy a share from BSE or NSE on Monday, and if your order is executed on the same day, the settlement of the trade takes place in two working days thereafter. That is, trading day plus two working days, or T+2.  In the instant case, trade executed on Monday gets settled on Wednesday which means the broker who handles your transaction receives payment for the shares sold on your behalf or gets shares which are bought for you on Wednesday and the broker in turn passes on the money or the shares, as the case may be, to your account latest by Thursday, the next working day. In effect, the Trade+2 days are followed up to the broker, and the investors normally get the payment or shares, as the case may be, within Trade+3 days under the present system. 
 

This system is followed in the case of automated trading done in the Internet based trading platform under the 3-in-1 account model, i.e. a bank account, a Dmat account and a broking account linked to each other for trading purposes.
 

Even when you are dealing with a broker on a manual basis, this time-frame of T+2 is followed up to the broker. Thereafter, how fast you will get your money depends on whether the broker pays you by means of a cheque or through NEFT as per the system followed by each broker and the arrangement you have agreed with him.  
 

What is the T+1 settlement system and how will it benefit you?
 

SEBI now proposes to go one step further and intends to complete the settlement on Trade +1 day (T+1), which means, trades executed on Monday gets settled on Tuesday, the next working day, This will help in saving a day for every investor as he gets his money credited to his account a day earlier or he gets his shares in his Dmat account a day earlier than at present. This shortening of the settlement cycle is expected to benefit a large number of people in different ways as under:
 

1. The most important benefit of this shortening of the settlement cycle is that it reduces the risk of non-payment or non-delivery of shares by the broker by one day, which is an improvement over the present system. In a world full of uncertainties, and where the total amount transacted is huge, even a day counts, and speeding up the settlement process will certainly reduce the risk of default in the stock market.
 

2. This will provide liquidity to the investors as they get their funds for the shares sold/ credited to their account a day earlier. The investors will have the benefit of profitably deploying their cash for a day more, either to buy shares or otherwise. The real advantage of such an early settlement can be experienced in a volatile market, as it can help in efficient use of capital and resultant benefits to the investors.
 

3. Under the new system the investors will get the shares purchased by them credited to their Dmat account also a day earlier. This will enable them to sell the shares purchased, if they wish, immediately on the next day, which may help them to protect their profits on the transactions.
 

4. With the additional liquidity provided by the improved system, there is every possibility of investors undertaking more transactions in the stock market, which will benefit the brokers as well, as they too will earn more through higher turnover.
 

5. With increased turnover possible through quicker settlements, all the participants in the market—stock exchanges, depositories, depository participants, and even the government—will stand to benefit by increased fees and taxes, etc.
 

In short, this proposal of T+1 settlement cycle will be a boon to the investors, brokers and all those involved in the stock market, as it should help in improving the overall sentiment for the benefit of all the stakeholders in the capital market.
 

Now that SEBI has invited suggestions before its implementation, here are a few suggestions on all the three proposals for consideration of SEBI in the interest of all the stake holders and for its successful implementation as early as possible.  

1. Incentivising internet based trading model (IBT):

The IBT model is the safest mode of dealing in the stock market as the funds and securities of investors are clearly earmarked in their respective bank accounts or in their Dmat accounts, with virtually zero risk to the broker. And this zero risk requires to be carried forward to the Clearing Corporation (CC), as well through a well-knit tripartite agreement between the bank, broker and the Clearing Corporation, which should be able to access the earmarked funds or the securities, as the case may be, in the event of the failure of the broker for whatever reasons to deliver. When this fool-proof system is put in place, the entire capital market operations carried through the IBT model will be risk-free for all the market intermediaries involved in the transaction.  
 

As of now, the IBT model of dealing in stock market is a bit expensive system for the investors, as most of the institutions, which maintain three-in-one account, charge much higher level of brokerage than the ordinary brokers who operate manually with the investors. This is because of the early mover advantage they enjoyed and most of the investors are stuck with them and pay a higher brokerage not out of choice but because of the procedural hassles involved in shifting from one bank to another. In view of the risk-free nature of the IBT based model; SEBI has rightly thought of incentivizing the investors, which should encourage more investors to join this system, which is investor friendly, market friendly and eco-friendly too.
 

To bring down the cost to the investor, it is necessary to offer all the proposed incentives suggested in the discussion paper, namely, waiver of margin requirement by CC and levying lower clearing charges by the CC for every trade executed through the system. However, to pass on this benefit to the investors, it is desirable that SEBI stipulates a cap on brokerage and other charges levied by these banks which offer the IBT model of service. If their charges are the lowest, particularly lower than that levied by the non-institutional brokers, it will be one of the biggest incentives for retail investors to move over to this model of dealing in the stock market. 

2. Mitigation of risk to client collateral:

In all fairness to the investors as well as the brokers, the client collateral should vest directly with the Clearing Corporation, which should be the focal point for safety of the client collateral in the event of the clearing member/trading member’s failure to honour his obligations to the Clearing Corporation.  There is no point in bringing in an additional intermediary of a professional clearing member to hold the baby of collateral provided by the clients, as too many cooks can spoil the broth. The Model B suggested in the discussion paper should be adopted as it is not only cost effective but also most suitable under the circumstances.

3. T+1 settlement cycle as a measure to reduce overall risk in the system:

The proposal to shorten the settlement cycle to T+1 is the most ideal one to mitigate the overall risks in the trading system. With the banking system having taken giant strides in successfully introducing core banking solutions in all their outlets and putting in place real time gross settlement system (RTGS) for transfer of funds, it is much simpler and feasible to transfer funds from one place to another in a matter of few minutes, and this should help in introducing much faster settlement system in the capital market without any hassles whatsoever.
 

What SEBI should ensure is that the T+ 1 settlement system reaches the ultimate investor, which unfortunately is not happening in today’s settlement system. At present the settlement system stops at the broker, who takes another day to settle the payments to the investor, thereby extending the settlement risk by one more day even in the automated Internet based trading model. SEBI should guard against subverting the system by delaying the actual settlement beyond T+1 so that the real benefit of the capital market reform reaches the well deserved beneficiary, the common investor.
 

The pay-out of sale proceeds to the credit of the investor should be done on the day of settlement itself. Similarly, the shares purchased should also be credited to the Dmat account of the buyer on the settlement day itself, even at late hours, so that the investor is put in funds and or securities on the settlement day itself. If SEBI can ensure that this is achieved in the proposed T+1 system, it will veritably serve the objective of mitigating the overall risk to a large extent. The real benefits of the proposed move will certainly be much more than the cost of modifications to the existing trading and settlement systems and it should undoubtedly help in deepening the capital market.
 

 Let us therefore, give big thumbs up to the proposal and hope that it will be implemented early. It is time for SEBI to say “on your mark, get set, go. Your time starts now” to all the stock exchanges in the country for an early start of the T+1 settlement system which should usher in a new era of security, liquidity and convenience for all the players in the capital market of our country.
 

(The author is financial analyst and writes for Moneylife under the pen-name ‘Gurpur’)