The relevance of T+0 settlement cycle

The economic purpose of trading platform has two main objectives -- price discovery and risk management. Price discovery takes place both in cash and derivatives markets efficiently when we have diversified participants in the platform. Speculators, arbitragers, hedgers and investors, though with different objectives, will bring efficient price discovery for the benefit of all stakeholders. This will also have significant impact on capital mobilisation by companies for their economic activities. however, Securities & Exchange Board of India’s (SEBI) recent paper ‘Introduction of optional T+0 Instant Settlement of Trades… in Indian Securities Markets’ has sparked a debate in market circles.

Equity market has listed about 5,000 stocks, out of which only 183 are available for trading in derivatives segments besides four indices. During December 2023, cash market trading volumes for NSE and BSE together accounted for R22,73,479 crore and derivatives market accounted for R90,00,76,609 crore. This indicates that 99.75 per cent of the trading volumes are concentrated in derivatives segment.

For June 2023, for about 94 per cent of delivery-based trades with value up to R1,00,000 per transaction, investors made early pay-in of funds and securities. however, the open interest at the end of the day in cash market is about 20 per cent and the remaining turnover is contributed by the speculators, arbitragers, and hedgers. By adopting T+0, we are creating a platform for only investors, which will result into inefficient price discovery with increased impact cost and illiquidity. This will result in investors staying away from the market due to illiquidity and higher impact cost. Subsequently, companies’ ability to mobialise money from the market will slow down.

The proposed settlement ‘eliminates the risk of settlement shortages, since both funds and securities will be required to be available before placing the order. This also eliminates the risk for market participants and reduces the risk exposure of clearing corporations (CCS). however, the regulator is more concerned of the profitability of CCS and not retail investors cost of trading.

‘The option is expected to provide flexibility in terms of faster pay-out of the funds against the securities to the sellers and faster pay-out of securities against the funds to the buyers’; and, finally, ‘allow better control over funds and securities by the investors.’ But, is there any grievance in retail investors the existing T+1 mechanism where they will not be trading seamlessly to use their margin funds in the market?

For the Securities market Ecosystem, the proposed mechanism lead to ‘shorter settlement cycle that will further free up capital in the securities market thereby enhancing the overall market efficiency’. here, the moot point is retail investors are not going to trade like speculators for whom the trading capital matters quite a lot. Besides, the option is expected to enhance the overall risk management of ccs as the trades are backed by upfront funds and securities. It is important to flag, as per the paper, investors who are taking delivery have upfront funds and stocks in the present context itself and not able to understand how ccs are benefitted in the new regime.

There are potential concerns in the consultation paper. Orders for T+0 or instant settlement cycle and T+1 settlement cycle, may lead to liquidity fragmentation and affect efficient price discovery and increase the cost of trading, as funds and securities shall have to be made available upfront before placing the orders. Further, it would result in divergence in the price of same security in T+0 and T+1 settlement cycle besides increased impact cost due to lack of liquidity in this segment. as far as the justification for mitigation of potential concerns, the consultation paper mentions two things -- on liquidity fragmentation, there will be participants who can access both T+0 and T+1 markets and would bridge price and liquidities gaps between the two segments; Further, divergence, if any, that emerge between the T+ 0 and T+1 settlement cycle may be bridged by the arbitrageurs, thereby allowing for liquidity and effective price discovery in both segments. Both these points talk about the role of arbitragers when T+0 has no place for arbitragers to participate.

The example given in the paper for Possible arbitrage Opportunities in forex market will not be applicable for stock market since securities are not fungible like currency. Besides, the issue of divergence of prices for same scrip between the two segments can also be addressed by introduction of price bands between segments (of say + 100 basis points), which ensure limited divergence in the prices between the T+1 and T+0 settlement cycle. Over a period of time, with increase in participation in this segment and active arbitrages, the divergence in prices may be reduced. By bringing these price bands, cash market will be converted like Z group trading in the present environment. So, this does not seem to have any merit. are these changes really required? 

Dr. Siva Reddy Kalluru is Faculty and Associate Dean, Gokhale Institute of Politics & Economics. Prabhakar Patil is professor, IIM, Mumba