T+1 Cycle: Understanding Benefits; Resistance from Foreign Investors

What is T1 holding? What is T+2 cycle in stock market parlance?

T+2 in stock markets refers to trading day + two additional days in which the stocks will be credited in an investor's demat account and the money will be processed in the same period too. Till 2003, the cycle was three days and an investor usually got their shares credited in trading + three additional days. 

However, after considering appeals from investors and other market participants, the capital markets regulator Sebi (Securities and Exchange Board of India) is planning to further reduce the settlement cycle to T+1 from T+2 to execute more smooth and fast processing of shares and money of an investor in their accounts. 

What is T+2 and how it works?

The current settlement cycle of Indian capital markets requires a trading day + two days to execute the trade settlement in the demat account and the investor will get money only after three days of their trade. To understand better, if you sell your shares on Monday, the broker handling the process will get the trade on Wednesday, and later the amount will be credited only on Thursday. Hence, the investor will get his/her money only after three days. 

Till 2003, the Indian capital markets followed the T+3 rolling settlement cycle which was brought to an end on April 1, 2003.

"The settlement cycle is all about determining the risk of clearance and blockage of the capital of an investor in the process," said experts speaking to BW Businessworld. 

Why T+1? 

If introduced, settlement of the trade will take place in one working day and the investor will get the money on the following day unlike the T+2 cycle wherein the investor gets the money post three days. The move comes in amid a boom in retail participation and keeping in mind that the individual investor's margin shouldn't be used for proprietary trading by brokers and their margin money should be used for their trades. 

Commenting on the matter, Ajay Tyagi, Chairman, Sebi, during an industry event, said, “The transition from T+3 to T+2 took place in 2003. There is a need to reduce it further now as there have been significant reforms in the payments and banking system. Investors have the right to receive what they purchase as quickly as possible."

The new framework will also reduce the unsettled exposure to Clearing Corporation by 50 per cent as the T+1 cycle will bring down the number of outstanding unsettled trades. Overall, the framework will enhance the trade execution, capital and margin, and will reduce the systemic risk. 

Amit Pamnani, Chief Investment Officer & DGM, Investment Banking, Swastika Investmart, said, "SEBI has taken this move in consultation with market infrastructure institutions such as stock exchanges, clearing corporations, and depositors."

The move will further create greater efficiencies in the market and simultaneously protect investors' interests. "Accelerating the settlement cycle will help reduce operational risk, liquidity needs, counterparty risk which would also reduce margin requirements and collateral requirements for broker-dealers," Pamnani added. 

Sharing similar views, Rahul Sharma, Co-founder, Equity99, said, "The process will be faster and will be benefited to retail investors."

Can exchanges switch back to T+2?

Post implementation of the T+1 settlement cycle, the stock exchange will have to mandatorily continue with the same for a minimum period of six months. Thereafter, in case, the exchange intends to switch back to the T+2 settlement cycle, it shall do so by giving one-month prior notice to the market regulator, said Sebi in a note. 

The regulator has also clarified that there will be no netting between T+1 and T+2 settlements. Furthermore, the framework will be effective for all regular as well as block deals in the market. 

Why are foreign investors unhappy and what will possibly change for them?

The foreign institutional investors have raised red flags on the proposal as there are a few hurdles with the same that foreign investors may face, considering different time zones and exchange problems, complained Foreign Institutional Investors, writing to Sebi and the Finance Ministry. 

However, Tyagi clarified on the matter, saying, the market regulator has kept in mind the concerns of FPIs. FPIs are investing in derivatives where upfront payments are required and even in IPOs wherein their money is locked for nine days. Furthermore, the US clearing corporation has also initiated a paper to implement the T+1 settlement cycle, he said.

Experts also pointed out that foreign investors will also find it difficult to hedge their net India exposure in dollar terms at the end of the day. "Most of the FPIs also have to hedge their net India exposure in dollar terms at the end of the day, which could be tough in T+1," Sharma explained. 

The change in the settlement cycle is expected to be brought into markets in 2022 and will be in everyone's interest, said experts.