Capital Markets: Challenges and Developments

SEBI introduces T+1 Settlement System

Note4Students

From UPSC perspective, the following things are important :

Prelims level : T+1, T+2 settlement

Mains level : NA

The Capital markets regulator Securities and Exchange Board of India (SEBI) has introduced T+1 settlement cycle for completion of share transactions on optional basis in a move to enhance market liquidity.

What is T+1 Settlement System?

  • T+1 means that settlements will have to be cleared within one day of the actual transactions taking place.
  • Currently, trades on the Indian stock exchanges are settled in two working days after the transaction is done (T+2).
  • In April 2002, stock exchanges had introduced a T+3 rolling settlement cycle. This was shortened to T+2 from April 1, 2003.

What has Sebi allowed?

  • SEBI has allowed stock exchanges to start the T+1 system as an option in place of T+2.
  • If it opts for the T+1 settlement cycle for a scrip, the stock exchange will have to mandatorily continue with it for a minimum 6 months.
  • Thereafter, if it intends to switch back to T+2, it will do so by giving one month’s advance notice to the market.
  • Any subsequent switch (from T+1 to T+2 or vice versa) will be subject to a minimum period.
  • A stock exchange may choose to offer the T+1 settlement cycle on any of the scrips, after giving at least one month’s advance notice to all stakeholders, including the public at large.

Why T+1 settlement?

  • Reduced settlement time: A shortened cycle not only reduces settlement time but also reduces and frees up the capital required to collateralize that risk.
  • Quick settlement: T+1 also reduces the number of outstanding unsettled trades at any instant, and thus decreases the unsettled exposure to Clearing Corporation by 50%.
  • Speedy recovery of assets: The narrower the settlement cycle, the narrower the time window for a counterparty insolvency/bankruptcy to impact the settlement of a trade.
  • Risk reduction: Systemic risk depends on the number of outstanding trades and concentration of risk at critical institutions such as clearing corporations, and becomes critical when the magnitude of outstanding transactions increases.

How does T+2 work?

  • If an investor sells shares, settlement of the trade takes place in two working days (T+2).
  • The broker who handles the trade will get the money, but will credit the amount in the investor’s account only.
  • In effect, the investor will get the money only after three days.
  • In T+1, settlement of the trade takes place in one working day and the investor will get the money on the following day.
  • The move to T+1 will not require large operational or technical changes by market participants, nor will it cause fragmentation and risk to the core clearance and settlement ecosystem.

Why are foreign investors opposing it?

  • Foreign investors operating from different geographies would face time zones, information flow process, and foreign exchange problems.
  • Foreign investors will also find it difficult to hedge their net India exposure in dollar terms at the end of the day under the T+1 system.
  • In 2020, SEBI had deferred the plan to halve the trade settlement cycle to one day (T+1) following opposition from foreign investors.

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Back2Basics: SEBI

  • The SEBI is the regulatory body for securities and commodity market in India under the jurisdiction of Ministry of Finance Government of India.
  • It was established on 12 April 1988 and given Statutory Powers on 30 January 1992 through the SEBI Act, 1992.

Jurisdiction of SEBI

  • SEBI has to be responsive to the needs of three groups, which constitute the market:
  1. Issuers of securities
  2. Investors
  3. Market intermediaries

SEBI has three powers rolled into one body: quasi-legislative, quasi-judicial and quasi-executive.

  • It drafts regulations in its legislative capacity, it conducts investigation and enforcement action in its executive function and it passes rulings and orders in its judicial capacity.
  • Though this makes it very powerful, there is an appeal process to create accountability.
  • There is a Securities Appellate Tribunal which is a three-member tribunal and is currently headed by Justice Tarun Agarwala, former Chief Justice of the Meghalaya High Court.
  • A second appeal lies directly to the Supreme Court.

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