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Why Sebi’s optional T+1 settlement cycle has raised concerns

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Two different settlement cycles for the same scrip on BSE and NSE can cause liquidity to fragment, hamper price discovery and create arbitrage opportunities.

Why Sebi’s optional T+1 settlement cycle has raised concerns
The Securities and Exchange Board of India (SEBI) has recently introduced the optional T+1 (trade plus 1 day) rolling settlement cycle for stocks, which means that settlements will have to be cleared within one day of the actual transactions taking place. The T+1 will come into effect from January 1, 2022.
While Sebi is confident of moving into the T+1 settlement cycle from 2022, market experts feel the way ahead will not be smooth unless all market participants, including exchanges, depositories, and clearing corporations make a concerted and collaborative effort.
Initially, exchanges will be allowed to choose the stocks that they wish to offer with a one-day settlement option. However, they will have to provide a month’s advance notice to all stakeholders of the same.
What is T+1 rolling settlement cycle?
A rolling settlement is a process of settling the security trade on successive dates. Under the T+1 settlement cycle, the trade gets settled a day after the trade. This means the buyer would get the shares in the Demat account and the seller would receive the payment for the same the day after the trade has been conducted.
Similarly, a T+2 rolling settlement would mean the trade transactions get settled on the second working day after the trade has been executed.
Sebi had brought down the settlement cycles from T+3 to T+2 in 2003. Since then, trade in the Indian stock exchanges is settled in two working days. Exchanges in the US, EU countries, Singapore, Australia, Hong Kong, Japan, and South Korea also follow the T+2 settlement cycle. Taiwan returned to the T+2 cycle after testing T+1 settlement for some time.
What are the concerns?
Sebi’s move to shift to T+1 comes on the back of requests from various stakeholders to shorten the trade settlement cycle. Yet, experts are leery as two different settlement cycles for the same scrip on the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) can cause liquidity to fragment, hamper price discovery and create arbitrage opportunities.
For example, some scrips like Reliance Industries are listed on both the BSE and NSE. If the NSE offers T+1 settlement cycle on one such scrip, while BSE offers T+2 for the same, an arbitrage opportunity is created as investors may choose different platforms to trade the scrip. This will also impact the price of the stock.
“The confusing bit is if one exchange opts for T+1 and the other for T+2, how will the settlements happen? Today, the same stocks trade on both exchanges and there is interoperability, wherein stocks bought on one exchange can be sold on another, and vice versa. We will have to wait and see how this works out,” Nithin Kamath, founder and CEO of Zerodha told Business Standard.
For a smooth transition, all market infrastructure institutions will have to be well coordinated. It is unlikely for once exchange to offer T+1 and the other not to, the newspaper quoted KK Maheshwari, president, Association of National Exchanges Members of India (Anmi) as saying.
Other challenges
Bank holidays and days when the clearing corporations or market infrastructure institutions (MIIs) are not working could also create difficulties. In such as case, clearing corporations would have to clear settlements of the previous day and the current day at the same time to meet the T+1 deadline.
“One cannot particularly foresee the exchanges going gung-ho over implementing this pruned settlement process, as this will require planning, coordination, pre-emption, and management of various technical and procedural aspects, generally, which will also involve alignment with various stakeholders. This will also require parity and interoperability in its implementation between exchanges, failing which it may lead to significant confusion and potentially cause some chaos, too,” Gaurav Mistry, associate partner at DSK Legal, told Business Standard.
“Though the actual impact of the change in settlement period will only be seen from January 2022, it can be plausibly construed that concerns around the reduction in the settlement period currently outweigh its benefits,” he added.