FPIs raise a storm over T+1 settlement cycle, approach Sebi chief

Rattled by the Securities and Exchange Board of India’s (Sebi’s) decision to allow a shorter settlement cycle, foreign investors have written to the market regulator, warning of a reversal of gains by unforeseen consequences of moving to the new system.

A clutch of foreign portfolio investors (FPIs) also plan to reach out to global index providers MSCI and FTSE Russell with their concerns about India’s move towards the T+1 settlement cycle.

The switch to the T+1 cycle could make the domestic capital markets less attractive to global investors, who may view India as a pre-funding market where money needs to be in place before shares are received, market experts said.

“There have been significant and beneficial developments in the Indian markets since the markets moved to T+2, which have greatly increased their attractiveness to foreign investors. We do not want those gains to be possibly reversed by unforeseen consequences of moving the settlement regime to T+1 without key risk areas being fully understood and covered,” the Association of Global Custodians wrote to Sebi Chairman Ajay Tyagi on Tuesday. The association comprises 12 foreign banks, six of which cater to India.

Sebi on Tuesday introduced an optional T+1 settlement cycle for the markets, with effect from January 1. The regulator put the onus on the stock exchanges to decide whether they want to opt for the shorter settlement cycle for any of the listed scrips.

The settlement cycle represents the time period within which the stock exchanges have to settle security transactions. T+1 means settlements will have to be cleared within one day of the actual transactions taking place.

Deviating from international standards could increase the risk of settlement failure, given the compressed timelines. It may push some FPIs to have forex booked and funds ready on trade date or T-1 in advance of settlement.

“A change to T+1 can add unwelcome trading frictions for FPI investments into India’s capital markets and may register concerns with MSCI. Our members on the buy side are currently planning to reach out to MSCI and FTSE Russell. Ease of market access is a relative game between markets, and a primary driver for index companies to assess relative market weightings,” said Lyndon Chao, head of equities at ASIFMA, an industry association of FPIs.

Its prominent buy side members include BlackRock, Blackstone, Amundi Asset Management, Aberdeen Standard Investments, BNP Paribas Asset Management, Fidelity, Goldman Sachs Asset Management, JP Morgan Asset Management, Morgan Stanley Investment Management, Nomura, Schroders, and T Rowe Price, among others.

The shift to T+1 could potentially impact India’s weighting in key global indices if the move is viewed as a restrictive trade practice by the index providers.

“Meeting funding obligations for FPIs will be a difficult task, and there is a possibility of a reduction in India’s weighting in global indices, at least till such time the investors adjust to the new normal,” said a foreign custodian, on condition of anonymity.

Global index provider MSCI has warned India and four other emerging markets against restrictive policies in the past, and reiterated that any move that impedes overseas investment could lead to a downgrade.

An email sent to MSCI and FTSE Russell on whether India’s move warrants action on the part of the index providers remained unanswered.

Indices developed by these two providers are tracked by funds with trillions of dollars of investments, and any reduction in the weighting of a country could result in millions of dollars in outflows.

India, for instance, currently has a weighting of 11.66 per cent in the MSCI Emerging Markets Index, which captures large and midcap representation across 27 emerging markets. Its weighting in MSCI AC Asia Pacific ex Japan is at 11.38 per cent.

According to experts, global investors may be situated in different time zones and are often only able to allocate, affirm and fund trades after Asia trading hours when execution confirmations have been received from the broker.

Local custodians, before issuing settlement instructions on behalf of investors, need authorisation from global custodians, who await confirmation from the fund managers after they have affirmed trade confirmations from their brokers. Even under the current T+2 settlement cycle, timely and precise coordination across different time zones can be challenging, especially when there is a trade mismatch.

The move to T+1, however, could be facilitated by emerging technologies such as Distributed Ledger Technology or other smart contract technologies.