T+1 settlement system: Capital markets regulator Securities and Exchange Board of India (Sebi) recently introduced the ‘T+1′ (trade day plus one) cycle of settlements for equities.
- This system has been introduced for completion of share transactions on optional basis in a move to enhance market liquidity.
What is T+1 Settlement System?
- In the new system, due to come into force from January 1, 2022, once a trade is executed, the settlement will be carried out within one day as against the current system of T+2, wherein it takes two days.
- Presently, trades on the Indian stock exchanges are settled in two working days after the transaction is done (T+2).
- If stock Markus exchanges agree to the proposal for the T+1 settlement system made by the Sebi, investors will get money for shares they sold or bought in their accounts faster, and in a safer and risk-free environment.
- In April 2002, stock exchanges had introduced a T+3 rolling settlement cycle.
- This was shortened to T+2 from April 1, 2003.
What has Sebi allowed?
- Sebi has allowed stock exchanges to start the T+1 system as an option in place of T+2.
- If it opts for the T+1 settlement cycle for a scrip, the stock exchange will have to mandatorily continue with it for a minimum 6 months.
- Thereafter, if it intends to switch back to T+2, it will do so by giving one month’s advance notice to the market.
- Any subsequent switch (from T+1 to T+2 or vice versa) will be subject to a minimum period.
- A stock exchange may choose to offer the T+1 settlement cycle on any of the scrips, after giving at least one month’s advance notice to all stakeholders, including the public at large.
Why T+1 settlement?
- According to a Sebi paper, a shortened cycle not only reduces settlement time but also reduces and frees up the capital required to collateralize that risk.
- T+1 also reduces the number of outstanding unsettled trades at any instant, and thus decreases the unsettled exposure to Clearing Corporation by 50%.
- The narrower the settlement cycle, the narrower the time window for a counterparty insolvency/bankruptcy to impact the settlement of a trade.
- Systemic risk depends on the number of outstanding trades and concentration of risk at critical institutions such as clearing corporations, and becomes critical when the magnitude of outstanding transactions increases.
How does it work?
- If an investor sells shares, say on Wednesday then settlement of the trade takes place in two working days (T+2).
- The broker who handles the trade will get the money on Friday, but will credit the amount in the investor’s account only by Saturday. In effect, the investor will get the money only after three days.
- However, in T+1, settlement of the trade takes place in one working day and the investor will get the money on the following day.
- The move to T+1 will not require large operational or technical changes by market participants, nor will it cause fragmentation and risk to the core clearance and settlement ecosystem.