Same-day Settlement of Trades: Liquidity Concerns Raised by Foreign Portfolio Investors
Historically, institutional investors have extensively utilized the T+1 settlement method. Today, however, the scenario is changing rapidly, with the Securities and Exchange Board of India (SEBI) ushering in T+0, or same-day settlement, of trades as a new norm. Not all participants are embracing this alteration with open arms; significant concerns stem from Foreign Portfolio Investors (FPIs) on account of potential liquidity fragmentation they foresee.
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FPIs Plea for More Time
SEBI’s proposal for transitioning to the T+0 settlement technique does not have unanimous support. A significant opponent to this shift is the group of Foreign Portfolio Investors. They assert that the move towards instant settlements may disrupt market liquidity and exacerbate volatility in trading volumes. With the calendar year drawing to a close against a backdrop of festive holidays, these investors have expressed the need for additional time to explore viable alternatives and provide substantive feedback on the same.
This opposition by FPIs, as reported by Business Line, revolves around the potential market instability that the proposed T+0 settlement policy might induce. The concern is that this new model would disintegrate the market liquidity, affecting trading volumes adversely.
SEBI’s T+0 Policy Proposition
SEBI is seemingly adamant in its drive towards achieving a phase-wise shift to T+0 settlements in the equity cash market. They have invited stakeholders and market participants to submit their feedback by the 12th of January, only a few days into the new year.
The first phase of this transition is designed to involve the top 500 listed shares, segmented into three tranches according to market capitalization, from least to most. This initiative implies a gradual, carefully orchestrated movement towards the new settlement method, keeping market stability and investor involvement in mind.
The same-day settlement format allows trades executed until 1:30 pm to be settled the same day by a deadline of 4:30 pm. Officially highlighted in a consultation paper released in the previous month, this plan underpins the enactment of the T+0 settlement method.
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Segmenting the Trading Landscape
Significantly, the introduction of the T+0 settlement procedure does not eliminate the traditional T+1 system. The two are to coexist in tandem, manifested through optional T+0 settlements for retail investors, while institutional investors continue with T+1 settlements.
This dual operation introduces two distinct trading segments—T+0 and T+1. This scenario potentially opens a can of worms, given that matching buyers and sellers across the two segments might prove challenging.
As Business Line points out, when retail investors on the T+0 segment wish to offload their securities, they may struggle to find institutional buyers since they still operate on the T+1 settlement. Similarly, FPIs looking to sell securities may face a dearth of retail buyers as they would prefer settling on T+0.
Pre-funding Challenges in T+0 Settlement
The introduction of instant settlements, or T+0, carries with it the implication of pre-funding. In simple terms, the seller will need to provide funding for both cash and securities before executing the trade. Following confirmation of the trade, the Clearing Corporation (CC) points it to the appropriate recipient for settlement.
A central concern for institutions, as cited by a senior official handling FPIs, is the challenge presented by pre-funding. Domestic institutions often do not have a clear idea of the volume of securities they will purchase on a given day until around 2-2.30 pm, when they receive buy requests. As a result, institutions may find it exceedingly difficult, if not impossible, to trade on a T+0 or immediate basis.
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Building an API-Based Interface
To accommodate the demands of instant settlement, SEBI proposes building an API-based interface between depositories and Clearing Corporations. This measure would allow real-time information on early pay-in, significantly smoothening the process flow.
In this system, only limit orders would be permitted, ensuring the Clearing Corporations could validate pre-funding adequacy against the limit price. Upon placement, all orders on the exchanges would be sent to the Clearing Corporations for pre-funding validation. For buy orders, the Clearing Corporations would check the availability of appropriate pre-funding to cover the trade value along with other charges.
Next Steps in the Adoption of T+0 Settlement
In light of the concerns raised by various market participants, particularly Foreign Portfolio Investors (FPIs) and institutions, it is crucial for SEBI to facilitate open communication, collective problem-solving, and considerate implementation of the same-day settlement initiative.
Encouraging Stakeholder Dialogue
To thoroughly assess the pros and cons of the T+0 settlement process, SEBI should ensure it conducts extensive stakeholder engagements. Engaging in discussions with market participants such as FPIs, retail investors, and domestic institutions will provide valuable insights and suggestions that can shape the T+0 settlement policy to be more efficient, inclusive, and less disruptive.
Considering the year-end holiday season, SEBI must accommodate additional time to enable stakeholders to work through their concerns and formulate alternatives or recommendations that can enhance the proposed policy. This approach will help SEBI create a more robust framework for implementing the T+0 settlement system, which will minimize any adverse consequences on the market.
Phased Implementation
As outlined, SEBI is proposing a phased transition to instant settlements, beginning with the top 500 listed shares. It is crucial to closely monitor and evaluate the impact of this shift on market stability and liquidity throughout the implementation process.
In the event that unintended consequences emerge during the rollout, SEBI should be prepared to modify or halt the implementation. Ensuring that the transition to T+0 settlement is well-executed will minimize the potential negative impact on market participants and preserve market confidence and liquidity.
Assessing Pre-funding Solutions
One of the main challenges associated with the T+0 settlement process pertains to the pre-funding mechanism for institutions. SEBI should work closely with market participants to explore possible solutions that address these issues without significantly hindering the functioning of the market. In doing so, regulators can craft a harmonized outcome that reconciles the pre-funding requirements with the trading objectives of these various stakeholders.
Addressing Liquidity Fragmentation
To mitigate the potential liquidity fragmentation caused by T+0 settlements, SEBI should consider implementing mechanisms that minimize any disruption in trading volumes and transaction efficiency. This goal could be achieved by incentivizing market participants towards a uniform mode of settlement or introducing alternative time-bound trading sessions for different market segments.
By fostering a smooth connection between the T+0 and T+1 settlement segments, SEBI can ensure that the trading process is not adversely affected, and investor interests are not hampered.
Final Thoughts
The journey toward the same-day settlement of trades may bring multiple challenges to the fore. Nevertheless, the adoption of T+0 settlement signals a pivotal moment for the Indian financial markets and is poised to impact the investing landscape dramatically. Careful evaluation, stakeholder engagement, and phased implementation remain critical to the success of this significant transformation. SEBI, along with the various market participants, must work together to chart the future of the Indian financial ecosystem with precision and aplomb.
In conclusion, the transition to T+0 settlement, driven by SEBI, seems to be a mixed bag. On the one hand, the quick settlements could improve efficiency and expedite profits for investors. On the other hand, it brings with it potential hurdles, especially for institutions and FPIs. As the market regulators and stakeholders grapple with these nuances in the evolution of the trading landscape, the world would be closely watching the Indian market’s journey towards same-day settlement of trades.
