UPI moment for markets: In 21 yrs, Sebi shortened trade settlements to T+1

Stock trading has come a long way. From the trading plus five-day (T+5) settlement cycle, when shares were held and traded in physical format, equity trading cycles have become shorter, and trades are now settled in T+1 day.

The latest proposal by the market regulator, the Securities and Exchange Board of India, or Sebi, is to usher in a one hour, or T+1 hour, trade-settlement cycle. Starting March 2024, if all goes to plan, either the securities or the money  — depending on whether one is the buyer or the seller — will be deposited in a trader’s account within an hour of the trade being executed.

This would be a precursor to instantaneous trade settlements.

“India is the first jurisdiction in the world that has moved to T+1 (trade date plus one day) settlement. We are now talking about a one-hour settlement and that will be a stepping stone to instantaneous settlement. This will be in a reasonably short period of time,” the Sebi chairperson, Madhabi Puri Buch, said at the Global Fintech Fest in Mumbai earlier this month.

China is the only other country with a T+1 cycle. All other major economies, including the United States, the United Kingdom, Japan, the United Arab Emirates, and many countries in Europe have T+2 settlement cycles.

Sebi’s move comes at a time when the domestic equity markets are at an all-time high. The Nifty50 index hit the 20,000-mark milestone on Monday, testifying the bull market. The market capitalisation of NSE companies is at a record $3.8 trillion.

Retail investors, on their part, have taken to the equity markets like never before. The total number of dematerialised (demat) accounts, where investors hold their securities, has risen to 126.6 million, which is more than three times the pre-pandemic level. Last month, 3.1 million new demat accounts, which are necessary for trading and electronically holding shares, were opened with the two depositories, Central Depository Services (CDSL) and National Securities Depository (NSDL). This marked the highest additions since January 2022.

Against this backdrop, analysts are touting Sebi’s latest move on shortening the trading cycle as a “UPI moment” for the securities market, which will mark a “significant leap” in transparency and efficiency in the Indian stock market, offering investors real-time access to their assets.

Coming a long way
 

Though the Bombay Stock Exchange (BSE) had been in existence since the 1850s, trading volumes picked up in India after the country became inde­pendent in 1947. Indian stock markets, back then, did not have technologically-backed electronic systems to sell and purchase securities. Trades were executed in the “trading pit” or “trading floor”, where traders communicated verbally and made hand signals to convey trading information. The transfer of shares, too, was done through physical means.

India adopted the electronic way of trading in the mid-1990s, when the National Stock Exchange (NSE) came into existence.

Until then, securities were held in physical format and it took five days to settle a trade after the actual transaction. Investors made payments in cheques after receiving the securities, which came in the form of certificates and were delivered by post.

The “T+5” settlement cycle, where “T” represented the day of executing the trade and 5 the number of days after which the transaction reflected in a person’s account, existed till 2002. Sebi then moved to a T+3 settlement cycle, which continued till 2003, and then to T+2, which was in practice till 2022.

In January 2023, India became the second country to fully adopt the T+1 settlement cycle. 

Top of the deck 

Once implemented, the T+1 hour trade settlement cycle will put India at the top of the settlement deck among the prominent stock markets.

Analysts believe the one-hour settlement will enable quicker access to funds and securities, improve market liquidity, mitigate counterparty, market and liquidity risk, and make 

the Indian stock markets more accessible to investors.

“We do not see any impediment in the way of Sebi’s plan to implement one-hour settlement of trades first. It is highly implementable when clearing corporations and depositories are ready with the systems. Investors will get faster settlement and they will have faster cash in hand. It is like having UPI (Unified Payments Interface), where transactions are settled quickly, which will further attract resident investors to our stock market,” says A Balakrishnan, executive director, Geojit Financial Services.

According to Sebi’s communique, it will launch Application Supported by Blocked Amount (Asba)-like facility for trading in the secondary market by January 2024. Asba, which Sebi introduced to facilitate the application and allotment process for initial public offerings (IPOs), rights issues, and other securities offerings, allows investors to apply for shares without transferring the entire application amount upfront.

Not a cakewalk

That said, the shortening of the settlement cycle comes with its own challenges. Among other teething issues, analysts worry about settlement with foreign portfolio investors (FPIs).

Bhavik Gandhi, head of operations, Mirae Asset Capital Market, points out that the real challenge for FPIs would be in the form of cross-currency trades and time differences.

“Even if Sebi gives FPIs the option to ‘opt out’ of the T+1 hour cycle, how will the trades get settled if the counterparty has opted otherwise? All these questions need answering before the implementation,” he said. Counterparty is the other side in a trade.

That apart, analysts believe the move may increase the cost of executing trades because brokerages, especially the small ones, may have to invest more in technology and infrastructure to deal with the processing speed.

“The front and back offices do not interact with each other during the market hours. Thus, a workflow-level change needs to take place where either the back office is upgraded to handle real-time transactions or the front office is upgraded to interact with the depositories,” says Vamsi Krishna, chief executive officer of StoxBox.

The transition, however, may be easy for brokers if depositories provide a single interface, like UPI, which the front office can use to settle trades within  the stipulated time.

Nonetheless, the growing investor community, with 126.6 million demat accounts, is keeping brokers gung-ho on the proposed shorter trade cycle.

Backed by rapid bank transfers, the rise of UPI as a payment mechanism, superior bandwidth, the predominance of online and app-based trading, and instant gratification of security purchases, the upsides outweigh the downside.