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In 2021, the Depository Trust & Clearing Corporation (DTCC), the Investment Company Institute
(ICI), and the Securities Industry and Financial Markets Association (SIFMA) in the US jointly
published a financial report of great significance. It outlined industry findings as well as
recommendations for migrating to a T+1 cycle from T+2 for securities settlement.
In fact, the DTCC also did a press release highlighting the steps to achieve T+1 with reference to its report.
The report titled “Accelerating the U.S. Securities Settlement Cycle to T+1” offers firms the protocol
for reducing the securities settlement cycle, including the applications of the shift, recommendations,
and the implementation plan for the shorter T+1 cycle by the first half of 2024.
In this blog, we have highlighted the current scenario surrounding the T+1 settlement cycle in the US while discussing the benefits and impact going forward.
What is T+1 settlement?
There are two essential components behind the purchase or selling of stock, bond, mutual fund, or an exchange-traded fund: the date of transaction (T) and the date of settlement (T+n). In most cases,
settlement dates are abbreviated as T+1, T+2, or T+3 denoting the number of days it takes to settle
each transaction since its origin.
What is the current scenario?
In the US, the US Securities and Exchange Commission (SEC), along with the boards of other nations
such as Canada, Peru, and Argentina, reduced the security settlement cycle from T+3 to T+2 in
September 2017. Leading APAC markets like India, Japan, and Australia had already made the shift
to T+2 at that time. In 2022, India successfully became the second country, next to China to move to
the T+1 stock settlement cycle. Now, the US is also targeting further expediting its security
settlement cycle with T+1.
Leading industry bodies such as the SIFMA and ICI joined forces with financial market infrastructures
(FMIs) such as the DTCC and other proponents to push for this change. This was following several
disruptive events such as the COVID-19-induced equity market volatility as well as the meme stock
trading turmoil.
The endeavor aims to roll out tessful, this can pave the way toward even faster settlements, also
called the T+0 or the atomic settlement.he changes within the first half of 2024. Some industry
experts reckon that if the T+1 rollout is sucessful, this can pave the way toward even faster
settlements, also called the T+0 or the atomic settlement.
What are the benefits of T+1 settlement?
Implementation of the T+1 settlement has the potential to foster several comprehensive benefits
both for investors as well as the market at large.
Risk reduction
There is an inherent risk when trading with a counterparty not fulfilling its obligations within the time
it takes for a trade settlement into a client’s account from the time of its execution. The degree of risk
is directly proportional to the duration between the two events. This risk is further intensified during stressed market conditions and high market volatility. Such risk can end up severely impacting cash
or securities ownership transfer(s) due to unpredictable events such as a firm defaulting.
Risks like these are spread over the two days of the T+2 settlement cycle while reducing the same to
T+1 will take an entire day’s worth of risk out. Furthermore, accelerating the settlement cycle will
also help reduce broker-to-broker counterparty risk, buy-side counterparty exposure, liquidity needs, operational risk, and systemic risk.
Efficiency gains
Other than protecting investors, a reduction in the settlement cycle will create greater efficiencies in
the market. The T+1 system reduces collateral and margin for broker-dealers while allowing
investors access to substantially faster fund access post-trade execution and settlement.
The reduction in overall time increases retail participation and upcoming equity market investments.
These benefits add up significantly throughout the millions of transactions that the market will
continue to witness.
What is the road ahead?
The settlement cycle involved several complex processes. Halving the entire process duration will
ensure that the complexities are also halved, and due diligence is deployed to identify and address
the resulting operational and business impact. Overall, the instructions will have to be more accurate
the first time as opportunities to make changes will be limited. Enterprises need to be sure of the
holistic impact of this shift which will inevitably have far-reaching consequences above and beyond
just a reduction in overall turnaround time.
For non-US investors, currency conversion adds a layer of complexity to trade processing, and they
may have to pre-fund cash positions and deposit securities even before the actual trading. This may
make investing in US markets a less attractive proposition with under-investments as well as
complicated and riskier delivery securities.
There are cost implications to consider as well. As per SEC estimates, the cost of implementing the
transition will be between $3.5-4.95 billion. Moreover, each institution will need to spend around
$5.5 million to be compliant.
As a preliminary step, stakeholders would need to identify and outline the processes, products, and markets that will require modifications to be congruent with the T+1 shift. This will involve financial and segregation requirements, foreign exchange and securities lending, and other processes such as broker processing and post-trade affirmations.
The migration to T+1 opens possibilities to improve capital and operational efficiencies. For
instance, this might just present the opportunity to financial institutions (FIs) for shifting their digitization efforts toward the back office and cope with scalability and volume challenges with
automation. Now, FIs will need to implement automated tools and systems with in-built
operational controls and real-time process support. Why? To eliminate redundant processes, save
time and expenses and reduce chances of manual errors.
DTCC margin requirements went up with meme stock trading, leading to the suspension of trading
for these volatile stocks. Even though T+1 lowers the capital requirements at these brokers, the
volumes would still need to be managed.
With the central banks aiming to implement central bank digital currencies, distributed ledger
technology (DLT) and digital assets are becoming more mainstream. The enablement of these
new asset types is directed at promoting a T+0 settlement cycle. The question of whether or not
T+1 is relevant to this is yet to be answered.
In the end, industry participants will influence how the SEC’s proposal for T+ 1 settlement is
translated into a final rule. The 2024 timeline gives all the stakeholders ample time and the
opportunity to shape their strategies for a seamless implementation.
Have you noticed that after buying or selling a stock, bond, or mutual funds, you have to wait for two days for that stock to reflect in your demat account or the fund to come in your account? Well, the period to do so, i.e., T + Day Settlement – will reduce to just one Day, i.e., T + 1 from T+2. Cheers to this, as the Security Exchange Board of India (SEBI) has put out a circular providing flexibility to stock exchanges to offer T+1 settlement cycles for stocks. The circular means that the credit of shares can be done the next day itself (T+1). Are you still confused about what T+1 Settlement means, or do you want to know the history of settlement? Well, we’ll cover this shortly.
History of Trade Settlement Cycle in India
Initially, all the trading settlements (i.,e delivery and payment of shares and stocks) on BSE i.e, the Bombay Stock Exchange, used to happen between Monday and Thursday. And final settlement used to occur on Fridays.
This settlement was through the physical movement of paper. The exchanges used to settle the trade by delivering the shares to the purchaser and payment to the seller. And later, physically moving the securities from the seller (involving the company) to the ultimate buyer.
The NSE – National Stock Exchange – with tech-backed and screen-based trading brought various changes to the trading world, especially in India. The NSE also started the T1 day settlement cycle on fixed days only, i.,e Wednesdays as settlement days. Later, they shifted this to Tuesdays.
This weekly settlement system infused liquidity in the market because traders and others could buy and sell without having to pay immediately, which ultimately led to speculative activities in the cash market. The wildly infamous Harshad Mehta scam was a result of this.
This speculative nature of trading showcased the loopholes in the system, like default risks, and often extended the settlement cycle either for want of cash or scrip.
As a case study from the Harshad Mehta scam came the first revolution and resolution to the loopholes in the securities markets on the settlement side. To reduce the risk associated with the so-called fixed-day settlement system, SEBI introduced rolling settlement in July 2001. The settlement process for a trade contract begins at the end of the trading day, now famously termed as “T”.
Initially, it was introduced for limited scrips on a T+5 basis (in 5 days from the date of trade) and then expanded to other scrips in a very planned manner.
All scrips moved to rolling settlement from December 2001 onwards. T+5 was replaced with T+3 in April 2002, and later it was replaced by T+2 in April 2003.
What is T + Day Settlement – T+1, T+2, T+3?
When you buy or sell a stock or bond or any other security, there are two critical aspects to it: one is the transaction date i.,e T, and the second is the settlement date. Therefore the abbreviations T+1, T+2, and T+3 refer to the settlement cycle dates of security transactions that happen on a transaction date plus one day, two days, and three days, respectively.
As the term suggests, the transaction date represents the exact date on which the actual transaction was carried out. For example, if you buy 50 shares today, then today’s date becomes the transaction date which is T. This date doesn’t change, as it will always be the date on which you made the transaction.
Why Delay the Actual Settlement Day?
Earlier, security transactions were done manually as compared to today’s electronic and now we are also moving towards blockchain. Coming back to the topic, investors had to wait for the delivery of their stock/bond/securities, which was in an actual certificate form, and the payment happened only after receiving the hard copy of the certificate. Since delivery times vary and prices tend to fluctuate, market regulators had to set a cutoff period in which the overall trading transaction needs to be settled.
Initially, the settlement date for stocks was T+5 i.,e five business days after the transaction date was initiated. Until recently, when the overall settlement was set to T+3. Today, it’s T+2 or two business days after the transaction date, thanks to technological advancements and electronic trading.
Current Scenario
India is the second largest market after China to implement the T+1 settlement cycle of stocks. Most international markets like the US, Europe, etc are still in the T+2 settlement cycle. Well, this means when you buy a stock or a bond, it will start reflecting into your demat account after a period of 2 days. And when you sell it, again, it will take two days to reflect into your system.
Here is the press release 2 from the exchanges. It says that starting Feb 25th, 2022, 100 stocks (starting with the lowest market cap) will move to the T+1 settlement cycle on both exchanges simultaneously. From March 2022, 500 stocks ranked from the bottom will move to the T+1 settlement cycle.
The Bombay Stock Exchange being an older exchange has almost 5000 active companies listed and being transacted, and National Stock Exchange has virtually 1800 active companies. The ~3000 additional on BSE are lower market cap companies (mostly penny stocks). So this means that in around ten months from Feb, or by Oct 2022, all the stocks in Indian markets will be on the T+1 settlement cycle.
Why Not T+0 or Instant Settlement?
This question of why we can’t have an instant settlement in today’s world where UPI is powering almost 4+ billion bank transfers a month, all settled instantly, keeps coming up. This is very different from a typical banking transaction, where money is immediately transferred from one account to another. Here the cash and stocks (with stocks comes with respective rights as a shareholder) both are involved and usually stocks can’t be settled due to intraday trading.
If you observe the majority of trading volumes on the stock markets across the world is seen from intraday traders who are constantly buying and selling stocks without actually taking or giving delivery. Typically these intraday trader exits their position before the end of the day, and that obligation to deliver the stock will eventually land with someone who holds the stock. Zerodha’s Founder Mr. Nithin Kamath commented on T+1 settlement – “While instant settlement is impossible, even T+0 is extremely tough considering the time required for brokers to crystallize the obligations and then clearing corporations to settle.”
Why Did SEBI Opt for a Phased Roll-Out of the New Settlement Cycle?
There was a great resistance seen from Foreign Portfolio Investors (FPIs) against the implementation of the T+1 Settlement. Since FPIs invest in India from different countries and time zones, this can be a bit of a challenge for them to get the necessary approvals for the stock transfers and complete procedures from their respective custodians or head offices. For them, this could become a real-time process of stock and money transfers. Domestic brokers argued against it as the new T+1 Settlement involves the high cost of changing their back and front office operations. Both of them wanted more time; hence SEBI and exchanges opted for a phased manner.
What Is the Settlement Cycle System Followed in Other Developed Markets?
Most large stock markets, like in the US (progressing towards the T+1 Settlement), Europe, and Japan, still follow the T+2 settlement cycle of trade settlement.
As NuSummit is the technology consultant for the capital market players stay tuned with us to learn more information about this development, we’ll be writing more about this in our next blogs. You may also want to understand and check out our other solutions – XpressSTP on capital market offering which is really benefitting the entire capital market industry.
