Decoded: Why Sebi wants to shorten trade settlement cycle to a day

The Securities and Exchange Board of India (Sebi), the country's capital markets regulator, has revived a plan of shortening the trade settlement cycle. Here is explanation of what the plan aims to achieve.

What is the current settlement cycle?

All cash segment trades are presently settled on the so-called T+2 basis. When you buy a security, it reflects in your demat account after two days. 

What is Sebi targeting?

The regulator wants to reduce the trading settlement cycle to the next day, or T+1. Sebi, in 2013, put out a discussion paper called ‘Risk Management--Safer Markets for Investors’ that discussed the feasibility of a shortened settlement cycle. The paper proposed to move to a T+1 settlement cycle, highlighting challenges in doing so. 

How a shorter trading cycle helps?

A shorter settlement cycle reduces the risk in financial markets volatility and frees up capital faster. It give investors greater flexibility when it comes to providing collaterals and margins. This issue gains more prominence as Sebi has tightened the rules pertaining to upfront margins. Investors can be nimbler in react to price-sensitive developments. A shorter cycle also reduces the risk of counterparty insolvency.

Overall, it would save operational costs. It would also help reduce systemic risk as it would automatically reduce number of outstanding trades at a given point and reduce the load on clearing corporations and depository firms.

What are the challenges in shortening the cycle?

Earlier, the biggest challenge used to be cheque payments by retail investors. The process of clearing cheques used to be the biggest impediment. However, now most investors have moved to online payments. Industry players say the major hurdle now is the foreign portfolio investor (FPI) trade settlement. Many FPIs operate from different time zones. Experts say the process of getting custodian approvals and settling trades of foreign investors is still a lengthy process. This issue needs to be handled delicately as FPIs are one of the most vital cogs of the stock market ecosystem.

Sebi will have to address this issue before it can announce a shorter trade settlement cycle, they said.