Sebi may move to T+1 trade settlement cycle

Proposes to encourage internet-based trading, explores new collateral system; feedback till a month more

The Securities and Exchange Board of India (Sebi) is looking at the possibility of shortening the trade settlement cycle for domestic stocks.

In a discussion paper on Thursday, the capital markets regulator invited suggestions for the proposal to cut the trading settlement to the first day after the trades, known as T+1, from the existing system of closing the transaction on the second day, popularly called T+2. Feedback has been invited till May 20.  

The move is aimed at reducing the risk involving lengthier settlement cycles. Also, to cut and free up the capital which is given as collateral. But, brokers warn the shift to T+1 could also pose a huge logistical challenge because the banking system is still not geared up for the system. To achieve a T+1 cycle, the existing trading, settlement and payment cycle will have to move from manual to automated.

“T+1 is a feasible idea, provided the fund clearing system compulsorily goes online. Even now, quite a lot of the fund clearing, especially retail, is done physically through the cheque system,” said Ambareesh Baliga, managing partner, Edelweiss Global Wealth.

In the discussion paper titled ‘Risk Management - Safer Markets for Investors’, Sebi has conducted a study which explains the feasibility of a shortened settlement cycle. The securities regulator has also proposed to have a new collateral client framework, whereby an investor will be able to place his collateral directly with a professional clearing member who doesn’t have a trading right. The move will keep the client collateral at ‘arm’s length’ from the broker, who currently takes the advantage of using it for purposes other than meeting the respective client’s margin requirements.

Another settlement model proposed is that the clearing corporation will be more pro-active, to ensure that collateral is not misused by the broker or trading member.

On the T+1 settlement cycle, the main issues for which the regulator has sought feedback from market participants are, one, since retail clients pay by cheques, will the implementation of T+1 be feasible, and, two, whether the cost of upgrading the existing systems will be less than the benefits envisaged.

The benefits of a T+1 cycle listed by Sebi include 30 per cent reduction in value at risk, fewer unsettled trades’ dues, less risk of counterpart insolvency and savings in operational costs as processes become automated.

Deena Mehta, managing director at Asit C Mehta Investments, said introduction of a T+1 settlement might affect activity in tier-2 and tier-3 cities. “Places where online banking is not available or have not seen too much penetration would be negatively impacted. Brokers in many places might have to ask customers to pay in advance before trading,” she said.

Incentivising internet-based trading models and mitigation of risk to client collateral are the two other critical proposals Sebi has made in the discussion paper.

The regulator has proposed incentives to retail clients who use internet-based trading, as such a framework poses zero risk, since it involves checking and blocking 100 per cent of the funds. “Since this trade model brings no additional risk to the system, there is a case to incentivise more and more investors to use this model, so as to reduce the overall risk in the system,” Sebi has said in the discussion paper. Some of the incentives proposed by Sebi include a waiver of margin requirements by the clearing corporation, release of any blocked margin as soon as the pay-is made and lower clearing charges. THE RISK-REWARD GAME

• The Securities and Exchange Board of India floats discussion paper 'Risk Management – Safer Markets for Investors'
• Shows intent to shortened settlement cycle to T+1
• Proposes  incentivising internet-based trading models as they pose minimal risk
• Proposes two new models for collateral management to mitigate client risk, curb misuse
• Invites public comments and suggestions latest by May 20