Explained: What instant settlement cycle will mean for markets, investors

Market  regulator Sebi has decided to move to T+1 settlement cycle for all scrips from 1 October 2023, impying that all trades will be settled one day after the date of trade instead of current T+2 settlement cycle in order to bring more transparecncy,  eliminate delays and uncertainties.

Currently  the settlement date is different from the trade date. A trade settlement is said to be complete once purchased securities of a listed company are delivered to the buyer, and the seller gets the money.

Under the current T+1 settlement cycle, if an investor sells securities, the money gets credited into her account the next day. 

What did Sebi announce?

Sebi announced that October onwards, the T+1 settlement will apply for all scrips, not just the most popular or highly traded ones. From January 27, all top listed securities, which includes shares, exchange-traded funds (ETFs), real estate investment trusts (REITs), infrastructure investment trusts (InvITs), sovereign gold bond (SGB), government bonds, and corporate bonds trading in the equity segment was being settled on T+1 basis.

Does this also mean instant settment is coming soon?

Sebi chairperson Madhabi Buch  said that the day is not far when stock market transactions will be settled instantaneously, in T+0 mode. She said Sebi is working with stakeholders to improve the timelines for settlement of transactions and achieve this goal.

“If the ASBA (in the secondary market) goes smoothly, then the next step is instantaneous settlement,” she said. “I am not sure if this (instant settlement of trades) can happen this financial year, it may spill over to the next financial year,” Buch said.

 What is instant settment?

Instant settlement refers to the process where the transaction of buying or selling shares or units is processed and completed immediately. This differs from the traditional T+2 settlement system where transactions are settled two business days after the trade date.  The current cycle of ‘T+1’ in India means trade-related settlements happen within a day, or within 24 hours of the actual transaction. 

"SEBI has implemented an Instant settlement cycle for the Indian stock since January 2023. Under this settlement period, all trades executed on a trading day are settled on the next working day, i.e., on a T+1 basis instead of the traditional two-day settlement cycle. This change has brought several implications for the stock market and mutual fund investors. The instant settlement has helped in increasing liquidity in the stock market by allowing investors to buy and sell shares more quickly, as investors will no longer have to wait two days to receive the proceeds from a sale or to purchase shares that they have already bought," said Arvinder Singh Nanda, Senior Vice President, Master Capital Services.

Why the need for instant settlement?

There are very few market in the world that settles in even T+1. Many countries are even struggling to bring the settlement to T+1 from T+2. India became the second country to start the T+1 settlement cycle in top listed securities after China in January this year.

Settlement in T+0 will enhance liquidity for traders and investors and this will ultimately increase the overall volumes. 

The plan for instant settlement largely depends on the ASBA infrastructure. Systemic lags  hinder the pace and quantum of capital formation while introducing elements of risk of financial losses across the value chain. For instance, a lot of investor capital is stuck into settlement pipelines while significant working capital of stockbroking firms are blocks to provide for margin requirements. 

"Such introduction of instant settlement will have a direct, positive impact on the cash segment where volumes can be expected to pick as investments move across stocks without delay. Right now, investors need to wait for settlement to buy another share in the cash segment or rely on limits offered by the stockbroker. While the first case renders the entire investment experience as inefficient, the second involves a lot of subjectivity on the stockbrokers’ end. Such developments can also be expected to help stockbrokers, as the degree of risk on account of defaults on margins offered to clients will drop significantly," said  Nirav Karkera, Head of Research at Fisdom.

What does instant settment mean for investors?

Immediate access of funds

"With instant settlement, investors can immediately access the funds from a sale or the shares from a purchase, increasing the fluidity of their portfolio management. This will significantly reduce working capital requirements as the money is received instantly and is no longer blocked for 2 days," said  Ankit Jain, Partner, Ved Jain & Associates.

Seize short-term trading opportunities

This will also allow investors to seize short-term trading opportunities, as they can immediately reinvest proceeds from a sale into a new purchase without waiting for settlement. The risk of default of counterparty, wherein they may fail to delivery the funds or securities would also be reduced. 

The move will also push trade volumes in cash segment and chances of default or fraud will go down as one won't be able to trade if it has no fund available in one's demat account.

"The instant settlement feature would mandate investors to have sufficient funds in their demat accounts prior to trading, thus mitigating the risk of fraud and reinforcing prudent trading practices. On the other hand, the mutual fund investors stand to gain as the faster settlement cycle will lead to quicker realization of funds, adding another layer of convenience and liquidity," said Siddharth Bhaisora, Investment Advisor at Wright Research.

"For investors, it brings enhanced liquidity and agility, empowering them to respond swiftly to market movements and capitalize on opportunities. This real-time empowerment fosters a dynamic investment environment based on up-to-date information. Mutual fund investors benefit from reduced settlement times, leading to quicker access to funds and improved efficiency. The concept also boosts transparency and trust by allowing easy tracking of transactions and holdings," said  Ankit Rajgarhia, Principal Associate, Karanjawala & Company, Advocates.

How does it impact mutual fund investors?

Mutual funds will  be able to redeem shares on the same day that they are requested, instead of having to wait two days.

" For mutual fund investors, an instant settlement will mean that they will receive the proceeds from their redemptions more quickly. and will have the benefit of investing and redemption of Mutual Funds on same-day NAV, said Nanda.