In a welcome development, the stock exchange regulator has taken one more step towards a shorter T+1 trade settlement cycle for stock exchanges. This will be beneficial for all stakeholders. But the manner in which it is rolled out needs to be well planned to avoid chaos on the bourses. The regulator is right in shortening the settlement cycle to T+1, which means that the seller will get the money and the buyer would have access to the securities on the trading day succeeding the transaction day. In the existing T+2 cycle, trades are settled two days after the transaction day. Shorter trade settlement is the way forward for bourses, eventually culminating in real-time settlement. Technological progress and improvement in market infrastructure have made it possible to process pay-ins and pay-outs quickly. Speedier trade closures reduce counterparty risk, which arises from the possibility that either the seller or the buyer may not fulfil their obligations. Lengthy cycles entail higher risk, requiring intermediaries to collect higher margins from clients. Such counterparty risk tends to increase during periods of market volatility, strengthening the case for quick trade settlement.
Indian stock exchanges will be among the first to introduce T+1 settlement cycle. It is therefore important that the implementation is smooth, without technical glitches. However, the proposal to provide flexibility to exchanges to offer either T+1 or T+2 settlement is not a good one. It will make the functioning of Smart Order Routing, wherein trades are directed to any exchange based on price, cost, etc., difficult. Similarly, interoperability in clearing trades and arbitrage trading between exchanges will also not be possible with variations in trade settlements between exchanges. Providing flexibility to implement the T+1 cycle in some securities only will compound the confusion. Trading will get further concentrated in the larger stock exchanges, with the exchanges with lower turnover losing out. A better way to go about this would be to ask all exchanges to implement T+1 in one category of stocks, say just A group stocks, at the outset. The shorter cycle can be implemented in other categories in a phased manner.
The exchanges should conduct rigorous tests to ensure that the systems are prepared for the change. Brokers and other intermediaries should also be provided technical support by the exchanges to help them transition to the new system smoothly. If the intermediaries need more time to get their systems ready, then the move could be deferred by few months. Many foreign portfolio investors have expressed concerns, with most global exchanges still following the T+2 system. While FPIs doing arbitrage trading between Indian and other global exchanges may be affected, those investing in India may not be impacted. Moreover, with other global clearing corporations pitching for T+1 settlement, it may soon become the norm globally. The discrepancy may be short-lived for foreign investors.