Settlement flexibility

Sebi should go ahead with a twin-track system

The Securities and Exchange Board of India (Sebi) is reportedly planning a twin-track trade settlement regime, after its earlier proposal to shorten the cycle met with stiff opposition from foreign portfolio investors. Under the twin-track system, traders can either opt to settle trades by the next trading session (T+1), or can stick to the current settlement time period of T+2 sessions. While a twin-track system may seem strange, it would be a pragmatic decision, if at all the settlement cycle is tightened. Overseas investors have practical problems complying with a T+1 system. Foreign portfolio investors (FPIs) hold an estimated 20 per cent or more of India’s market cap, and also generate a much larger share of the daily trading volumes.

The Asia Securities Industry and Financial Markets Association (Asifma) has made the point that FPIs need to reconcile operations across multiple time zones. Indian Standard Time is many hours ahead of Europe and America, and many hours behind the eastern financial centres in Japan, South Korea, Mainland China, Singapore, and Hong Kong. By the time a trading session ends in Mumbai, it is late at night of the same day in Tokyo (or very early in the morning in New York). The paperwork can, therefore, only be sorted out the next day by an East Asia-based FPI. Hence, a T+2 settlement becomes T+1 in effect, so far as institutions based in East Asia are concerned.

As Asifma has pointed out in a letter to Sebi, enforcing a T+1 settlement could create new systemic risks because such an FPI would have little time to arrange payment, or deal with any potential problems. Apart from any issues that may arise with the equity or derivatives trade in itself, a further complication is caused by the fact that an FPI may need to arrange forex conversion. Such a forex transaction would need to be pre-booked to adhere to a shorter settlement period of T+1. This is an unwieldy process. It would obstruct FPIs from trading at will if there is any news-based trigger affecting Indian markets, and this may also introduce new systemic risks for the exchanges.

Another point traders have made is that T+2 is the global norm across most major international exchanges, with the exception of Mainland China. This is precisely due to the complications of reconciling paperwork across time zones even in hard-currency trades where there are no conversion issues. In addition, the extra time allows for tax complications to be sorted out.

There has never been a meaningful default by an FPI. Hence, the regulator and the financial exchanges should not really be concerned about continuing to give an extra 24 hours of grace. So, moving to a twin-track system where traders have an option to stick to the T+2 settlement cycle would be a reasonable decision. At the same time, traders who may wish to enjoy a faster settlement would be able to avail of the new T+1 cycle. Of course, it remains to be seen how exactly Sebi will design and notify a twin-track settlement cycle if it decides to proceed along these lines. Tightening settlements has been on the cards for many years, but the regulator will need to consider all the variables carefully.