The September 2021 flow article Accelerated settlement – the move towards T+0, noted that “a market that chooses to adopt T+1 risks causing huge logistical problems, especially for investors operating across different time zones”.

A proposal by India’s regulators to introduce T+1 drew criticism from The Asia Securities Industry and Financial Markets Association [ASIFMA], which warned that the different time zones between Europe/US and Asia-Pacific would create operational complexities for investors, particularly around FX management – the two-day settlement window helps global investors manage their FX. Other industry bodies such as the Association of Global Custodians (AGC) and the Investment Company Institute (ICI) have also expressed concerns about potential difficulties for regulators.

The implications of the move were summarised in November 2021 by the newswire FixGlobal, which reported on the phased T+1 settlement implementation: “India’s two stock exchanges have decided to simultaneously introduce T+1 settlement in phases starting 25 February, starting with the bottom 100 stocks by daily market capitalisation averaged in October. Then, from March, the next lowest 500 stocks will be added on the last Friday of each month, with the final batch of India’s more than 5,200 stocks moving to T+1 settlement by 27 January 2023.”¹

Sriram Krishnan, Managing Director, Co-Head, Global Transaction Banking, India and Head, Securities Services, India and Sub-Continent at Deutsche Bank, says the Securities and Exchange Board of India (SEBI), the country’s regulator, first proposed shortening the settlement cycle to T+1 back in 2002, only for the initiative to lose momentum. However, the case for reducing India’s settlement cycle to a single day has regained popular support.

As for these latest changes, as foreign portfolio investors (FPIs) largely trade the top 500 stocks, “they will have until September or October 2022 to ensure they are ready for the changes,” reflects Krishnan.

This phased-in approach is a welcome respite for FPIs – many of whom had initially expressed alarm about SEBI’s previous tight deadlines for T+1’s implementation and feared it would contribute to settlement fails and force investors to pre-fund their trades. Moreover, SEBI’s decision to pivot away from allowing the Bombay Stock Exchange (BSE) and the National Stock Exchange of India (NSE) to adopt T+1 on a voluntary basis for any equity security has also been applauded. Had these original proposals been enacted, it could have resulted in the same equity security being settled on T+1 on one exchange and T+2 on the other - creating various operational complexities.

There are several reasons as to why T+1 is being implemented in India and beyond. First, global appetite for shorter settlement cycles has grown as market participants look to mitigate settlement risk; which was reinforced by the volatility seen during Covid-19 and its meme stock trading episode.² In other words, when a few stocks gain sudden popularity with retail traders, resulting in high prices and unusually high trading volumes.

“The key benefit is that capital can be deployed more efficiently. Imagine being able to buy a stock today and sell it off tomorrow – this might actually be possible under T+1”
Sriram Krishnan, Managing Director, Co-Head, Global Transaction Banking, India and Head, Securities Services, India and Sub-Continent, Deutsche Bank

By minimising operational risk through trade settlement compression, margin demands and collateral requirements from broker-dealers will be pared back – giving investors quicker access to their funds following trade execution and settlement.³ This will, in turn, help free up liquidity.  “The key benefit is that capital can be deployed more efficiently. Imagine being able to buy a stock today and sell it off tomorrow – this might actually be possible under T+1,” says Krishnan. 

In addition, a shorter settlement cycle might also help limit systemic risk by reducing counterparties’ exposures to each other. As a risk mitigation solution, shorter settlement cycles are very compelling.

These thoughts are echoed by Vikram Kothari, Managing Director and CEO, NSE Clearing Limited. “Shorter settlement cycles promote better capital utilisation and reduce outstanding risk exposures,” he says.

Within India itself, Krishnan says the move towards T+1 is widely supported by market participants, adding that it has been facilitated by the rapid retailisation of the country’s equity markets. “In the nine months between April and December 2021, 190 million dematerialised accounts were opened by retail customers in India, signaling the increased retail participation in India’s capital markets. Local brokers, who have seen their margins shrink over the past few years, now believe the growing velocity from retail customers will be a huge boost to business. Similarly, major platform providers in India – many of whom have 30 million-plus users – are advocating for T+1 as it will produce ever greater trading volumes,” says Krishnan.

While retail investors have been very influential in driving adoption of T+1, Krishnan reports that local institutional investors and India’s stock exchanges have been pushing for change as well. A leading domestic asset manager concurs: Swarup Mohanty, CEO, Mirae Asset Management in India, expects settlement compression to bring about liquidity and counterparty risk benefits. “This will reduce margin requirements and collateral requirements from a trading perspective,” according to Mohanty.

Although domestic investors are largely supportive of the T+1 migration, FPIs do face challenges.  With foreign investment in India totalling US$655bn, the requirements of FPIs do need to be considered.

Among the primary concerns are that settlement compression could pose difficulties for investors operating in markets with different time-zones to India’s. Krishnan says this issue could create problems for FPIs during the trade confirmation and FX management processes. In the case of the latter, Krishnan adds the imposition of T+1 means FX transactions would need to be booked on either a same day basis or alternatively pre-funded, as intermediaries have to confirm trades on T day as per the notified process.

As such, this may oblige investors to pre-fund some of their India trades. Despite this, there is still time to overcome these teething issues. “FPIs have until September 2022 to figure out how they will operate under this new framework. While there are open questions, I believe these can be tackled given the amount of time we have,” confirms Krishnan.

Others agree that the transition to T+1 will largely be manageable. “We do not see major challenges as far as payments and deliveries are concerned, since the payments and deliveries to the CCP (central counterparty clearing house) are practically completed by T+1 even today,” comments Kothari. “CCPs do not pay-out funds and securities in order to ensure simultaneous pay-out to all participants.  It is more for a minority (of institutions) to adopt payments by T+1 and we do not see challenges to complete settlement on the same day. All participants including CCPs will need to ensure they have more efficient operations, which is why the exchanges have agreed to a phased-in implementation starting with stocks with low volumes”.

Once T+1 is implemented, many industry experts believe the transition to T+0 or even atomic (i.e. instant) settlement is the next logical step. “T+0 is theoretically possible today as we have the technology to make it happen. The only issue is that investors do not want to operate on T+0 as it precludes them from obtaining netting benefits and would require firms to pre-fund trades,” says Krishnan.

Through disruptive technologies such as distributed ledger technology (DLT), smart contracts and central bank digital currencies (CBDCs), Krishnan believes atomic settlement could become a reality in the next five to 10 years across India and many other markets. Finance Minister Nirmala Sitharaman announced in February that the Reserve Bank of India (RBI) would introduce a digital rupee during the financial year to 31 March 2023. The Ministry of Electronics and Information Technology’s dedicated Centre of Excellence (CoE) in Blockchain Technology is evidence of the government’s support for blockchain. “The emergence of blockchain technology holds promise for the government to foster trust and greater transparency about certain data activities and provide frictionless transactions with the citizens,” says the CoE. Settling trades would be no exception.

As policymakers in India demonstrate their commitment to innovation, further changes to the settlement cycle beyond T+1 are highly likely.

Sources

¹ See https://bit.ly/3wsEURY at fixglobal.com
² See https://bit.ly/36o3ZT8 at economictimes.indiatimes.com
³ DTCC (May 4, 2021) A shorter settlement cycle: T+1 will benefit investors and market participant firms by reducing systemic and operational risks