On July 9, 1997, about 25 years ago, the National Stock Exchange (NSE) implemented the T+5 stock settlement mechanism. From February 25, 2022, India will become only the second country after China to move to the T+1 stock settlement mechanism in a phased manner.
"Settlement marks the official transfer of securities to the buyer's account and cash to the seller's account. Indian stock exchanges follow T+2 days settlement i.e. settlement of funds & securities happens on two business days after the day the order executes, or T+2 (trade date plus two days). For example, trade executed on Monday, would typically settle on Wednesday," said Anupam Agal, Head Operations & Legal, Motilal Oswal Financial Services.
What Is T+1 Stock Settlement Mechanism?
Under this new mechanism, the buyer and seller of shares will get their shares and money, respectively, within 24 hours. The T+1 settlement mechanism will make the existing share purchase and its sale process much faster and more convenient for all stakeholders. ‘T’ in T+1 represents the ‘Trade’ day and ‘+1’ means a day extra.
At present, when you buy a share on ‘T’ day (transaction day), the stock broker blocks the funds immediately but makes the actual payment to the stock exchange the next day (T+1). The stock exchange credits the money or share as per the transaction requested on the next day (T+2).
“Settlement cycle means the time taken to settle the securities transaction, i.e. for buyers, it is the time taken to receive shares in their demat account, and for sellers, it is the time taken to receive funds in their account. Currently, this time is T+2,” says Priyansh Saxena, assistant vice president-investments, Orowealth, a wealth and investment management fintech startup.
Say, you buy a share X under limited mode on Monday (the transaction day). The money in your trading account will get blocked immediately but BSE or NSE will receive the money the next morning, Tuesday (T+1). After receiving the money, the exchange will match the order and credit your demat account with shares and the seller’s account with the money on the next day (T+2), i.e. Wednesday. From Thursday morning, you can trade using the shares you received.
"India will be the second large market after China to implement the T+1 settlement cycle of stocks. Most markets in the world are in the T+2 settlement cycle. What this means is that when you buy stocks, it hits your demat account after two days, and similarly, when you sell stocks, you get to withdraw the funds after two days. These two days will now get reduced to one day," said Nithin Kamath, CEO and co-Founder of Zerodha.
What Will Happen On February 25?
The circular from the Securities and Exchange Board of India (Sebi) regarding this proposed change had come out on January 1, 2022. Starting February 25, recognised stock exchanges like NSE and BSE will start implementing this change in a phased manner.
Since this is quite a big change and most Foreign Portfolio Investors (FPI) may face difficulty in implementing this change in their backend trading systems, NSE and BSE have decided to implement this change in a phased manner.
“Both the BSE and NSE have laid out a roadmap to transition to T+1, which means all participants concerned in the markets can start gearing up for it. They have started with the bottom 100 stocks by market cap, which allows low-risk tests of the systems and establishes protocols,” says Kanika Agarrwal, co-founder, Upside AI, a Sebi-registered portfolio management service and fintech start-up.
The stock exchanges and other stakeholders have decided to first group securities in the descending order of their average market capitalisation in the month of October 2021. From this list, the bottom 100 stocks will be settled using the T+1 mechanism starting February 25.
Why Has Sebi Decided To Implement This Change?
There have been several instances in the past when a buyer did not get his shares due to short selling by the seller. There have also been several incidents of brokers failing to pay the funds held by their clients since technically they have to pay stock exchanges on T+1 day. So, Sebi decided to eliminate most of the problems in stock settlement by implementing a faster settlement cycle.
“The new system will incentivise internet-based trading as the trades get settled directly on the investor level, which nullifies the broker risk. Furthermore, this will also mitigate the risk to client collateral, which should directly vest with the Clearing Corporation, which will ensure safety for clients in case of defaults. This will reduce the overall risk of default of payment and non-transfer of shares,” says Deepak Singh, chief business officer at RelianceSmartMoney.com.
Apart from this, a faster stock settlement cycle will also result in reduction of settlement risk for a brokerage firm and may also result in reduction of other stock broking operational risks.