Stock market settlement cycles: India's shift from T+2 to T+1 explained

As the stock market shift from T+2 to T+1 settlement cycle, find out what settlement cycles are and what this means for India's stock market

Securities and Exchange Board of India (Sebi) Chairperson Madhabi Puri Buch has announced that October onwards India will move to a T+1 settlement cycle for all scrips. The transition from T+2 to T+1 has been rolled out in phases since 2021, however, this latest announcement still comes as a surprise as it would make India one of the largest economies to make this shift.

 

Understanding stock market settlement cycle

The concept of settlement cycles plays a crucial role in ensuring smooth and efficient trading processes in the stock market. Settlement cycles determine when securities and funds are exchanged between buyers and sellers after a trade takes place. For investors, having a clear understanding of these cycles is essential to navigate the stock market landscape effectively.

 

What is a Stock Market Settlement Cycle?

A stock market settlement cycle refers to the period within which securities and funds are delivered and settled after a trade is executed between a buyer and a seller. This process involves the transfer of ownership and funds, finalising the transaction, and completing the trade. The settlement cycle acts as a critical link between trade execution and actual ownership transfer.

 

When does settlement occur in India?

In India, the settlement cycle for equity trades follows a rolling settlement system. The rolling settlement cycle for most stocks used to be T+2, which means the settlement occurs on the second trading day (excluding weekends and market holidays) after the trade execution date (T).

For example, if you buy or sell shares of a company on Monday (T day), the settlement will occur on Wednesday (T+2 days).

Different segments of the stock market, such as the cash market, derivatives, and government securities, can have varying settlement cycles.

 

Importance of a settlement cycle

Here are some of the reasons why the settlement cycle is important:

• Risk mitigation: A well-defined settlement cycle reduces counterparty risk, ensuring that both the buyer and the seller fulfill their obligations. This also helps maintain confidence and stability in the financial system.
• Market efficiency: An efficient settlement process enables quick ownership transfer and availability of funds. This, in turn, enhances market liquidity and facilitates smoother trading operations.
• Regulatory compliance: The settlement cycle is governed by market regulators like Sebi to maintain transparency, fairness, and investor protection.
• Margin requirements: For investors trading on margin, the settlement cycle determines when they must meet their payment obligations or cover margin calls.

 

Settlement cycle changes: T+2 to T+1

In July 2001, Sebi introduced the rolling settlement system, replacing the fixed settlement cycle that led to poor delivery, distrust among traders, and frequent defaults. Initially, certain scrips followed a T+5 settlement (5 business days from the trade date), which was later expanded to all scrips by December 2001, according to a report by Businessline. As the system evolved smoothly, the settlement cycle was reduced to T+3 in April 2002 and further to T+2 from April 2003, and now, the move is towards T+1.

In September 2021, the Securities and Exchange Board of India (Sebi) permitted stock exchanges to introduce a T+1 settlement cycle on any of the securities available in the equity segment, from January 1, 2022.

Following this, NSE, BSE, and MSE in November 2021 announced through a joint statement that the T+1 settlement cycle would be implemented in a phased manner, beginning on February 25, 2022. In the first phase, the bottom 100 stocks were made available for the introduction of T+1 settlement. From March 2022, on the last Friday (trade day) of every month, the next bottom 500 stocks were made available for introduction to T+1 settlement every month till January 2023.

On January 27, 2023 India's domestic equity market shifted to the T+1 settlement cycle.

Now, Sebi has announced that starting from October 1, 2023 it will move to T+1 settlement cycle for all scrips, making India one of the first major economies in the world to make this shift.

 

What are the benefits of a shorter settlement cycle?

Sebi’s shift to a shorter settlement cycle was motivated by the need to better align India with global trends. The shift would also allow opportunities for the growth of retail investors and seamless UPI (Unified Payments Interface) gateway functionality on a real-time basis.

Quick settlements also help mitigate default risks for high-volume transactions and provide investors with faster access to liquidity. This also increases transparency which can safeguard investors from potential fraudulent activities.

By becoming the first major economy to adopt a T+1 settlement cycle for all scrips makes the Indian securities market more competitive on the international stage, attracting foreign investment and driving economic growth.