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SEBI's one-hour settlement plans

ICICIdirect 9 Mins 03 Nov 2023

Have you noticed that when you buy or sell a stock from your trading account, the actual credit or debit happens the following day? Earlier, the settlement process used to take even longer. SEBI has brought down the settlement time, and now it aims for an even faster settlement: a 1-hour settlement. Let us look at how it will change things for investors and the exchanges once implemented.

The History

Before we get into details of SEBI's plan for a one-hour settlement, let us look at stock settlement history. Before 2002, stock exchanges in India followed a T+3 settlement cycle, where trades executed on a trading day had to be settled within three business days. It means that if you buy stock on Monday, you receive it on Thursday. In 2002, SEBI mandated a move to a T+2 rolling settlement cycle. It reduced the settlement period, making it more efficient. Now, shares bought on Monday get credited on Wednesday.

For two decades, the Indian stock exchange followed the T + 2 settlement cycle. In January 2023, India became the second country after China to move to a one-day settlement cycle, which brings faster fund remittances, operational efficiency, and share delivery. SEBI is now targeting a T+0 settlement.

Settlement Process

It is crucial to understand the settlement process before we move on to one-hour settlement details. The process is complicated, but we will try to simplify it to the maximum possible extent. Many things happen behind the click of the sell/buy button. Let us look at a simplified version of it.

The process begins with the execution of a trade - you selling/buying a stock. On the trade date, buyers and sellers come together in the stock market, and the agreed-upon price and quantity are recorded. It marks the beginning of the settlement cycle.

After a trade is executed, the buyer and the seller receive trade confirmation statements from their brokers. These statements contain trade details, including the security's name, quantity, price, and settlement date. The trade details are matched by the clearinghouse or clearing corporation. They ensure that the buyer has the necessary funds or margin and that the seller has the required securities to complete the trade. Any discrepancies or trade failures are addressed at this stage.

In the case of a buyer, the required funds or margin are blocked in their trading account to cover the purchase cost. For the seller, the securities are frozen in their demat account to ensure they are available for delivery. The clearing corporation acts as an intermediary between the buyer's and seller's clearing members. It ensures the smooth flow of funds and securities.

The depositories, such as NSDL and CDSL, verify the details and ensure that the delivery request is valid. This step prevents unauthorized transfers.

On settlement day, both the buyer and the seller receive confirmation of the settlement, notifying them that the funds and securities have been transferred successfully.

One-hour settlement

As per the latest information, one-hour trade settlement technology has been developed. The regulators are confident that they will implement it soon. The regulators are also working on instantaneous settlement, but that will take time for development.

The plans are to make a one-hour settlement live by the end of the current financial year (March 2024). Add another 6 to 8 months, and regulators will be ready with instantaneous settlement.

By January, the application supported by a Blocked Amount (ASBA) )-like facility for the secondary market will go live. By March, we will move to a one-hour settlement.

There are concerns about the instantaneous or one-hour settlement process. The regulators have said that the early settlement facility will not be forced and will be optional for investors. A

Are you wondering who has concerns with the instantaneous settlement? The concern is coming from foreign investors. Why? Let us understand the reason. Foreign investors invest in India and other markets. Their buying decision is influenced by forex price fluctuation - since they are dealing in millions, even a minor forex change can impact the investment amount significantly.

The second point is that the trade for them happens through custodians - think of them as holders of securities for foreign investors before trade settlement. There are global custodians and local custodians. The local custodians will be banks in India. So once a foreign investor decides to buy, he deals with global custodians who work with local ones to settle the trade. As you would have guessed by now, the process takes time.

If the settlement happens instantaneously, foreign investors have to pre-fund their trading accounts with millions. If there are immediate buying opportunities, no one has any problem. However, if there are no buying opportunities, the funds will sit idle and won't earn any interest - no one wants to miss the opportunity.

How will an instant settlement benefit investors?

Let us look at how the instant or same-day settlement will benefit Indian investors:

  • Lower risks: With instant settlement, investors will not become victims of counterparty risk, which they face when the counterparty delays or defaults. Counterparty risk is the risk that one party in a financial transaction may default on their obligations, potentially leading to financial losses for the other party.
  • Increase in liquidity: With instant settlement, stocks will become highly liquid. You can sell them on the same day and get the cash in your bank account on the same day.
  • Higher efficiency of the system: Instant settlement will improve the transparency and efficiency of the Indian stock exchange.

Before you go

India will become the first country to implement the T + 0 settlement. Without a doubt, it will become a game-changer for the Indian stock market. Investors will surely benefit from the change. However, some market experts still see some challenges for the regulators in the implementation of the same. So, let us keep our fingers crossed and see how and when SEBI dreams become a reality.

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