Explained: What is T+1 settlement system by SEBI? How T+1 and T+2 Works?

What is T+1 settlement system by SEBI

Why In News?

Securities and Exchange Board of India (SEBI) has extended the option to stock exchanges where they can choose between T+1 and T+2 settlement cycles. The decision came after the market regulator received request from various stakeholders to further shorten the settlement cycle.

“Based on discussions with Market Infrastructure Institutions (stock exchanges, clearing corporations and depositories), it has been decided to provide flexibility to stock exchanges to offer either T+1 or T+2 settlement cycle," Sebi said in a statement

If it opts for the T+1 settlement cycle for a scrip, the stock exchange will have to mandatorily continue with it for a minimum 6 months. 

Thereafter, if it intends to switch back to T+2, it will do so by giving one month’s advance notice to the market.

Any subsequent switch (from T+1 to T+2 or vice versa) will be subject to a minimum period. 
The T+1 settlement cycle will come into effect from January 1, 2022.

What is Settlement System?
  • In the securities industry, the trade settlement period refers to the time between the trade date that an order is executed in the market and the settlement date when a trade is considered final.
  • On the last day of the settlement period, the buyer becomes the holder of record of the security.
What does T+1 Settlement Means?

T+1 or 2 or 3  = Transaction Day + No of Day = The numbers 1, 2, or 3 denote how many days after the transaction date the settlement takes place

T+1 means that settlements will have to be cleared after one day of the actual transactions taking place.

As an example of how T+1 settlement dates work, consider an investor who buys shares of Reliance on Monday, September 5, 2021. 
  • While the broker would debit the investor's account for the total cost of the investment immediately after the order is filled, the investor's status as a shareholder of Reliance will not be settled in the company's record books until Wednesday, September 7. Means from 7th Stock will be Available in Account to Trade.
For determining the T+1 (T+2, T+3) settlement date, the only days counted are those on which the stock market is open

T+1 means that if a transaction occurs on a Monday, settlement must occur by Tuesday. Likewise, T+2 means that a transaction occurring on a Monday must be settled by Wednesday, assuming no holidays occur between these days.

How Does T+2 Settlement Work?
  • If an investor sells shares on Tuesday, settlement of the trade takes place in two working days (T+2). The broker who handles the trade will get the money on Thursday, but will credit the amount in the investor’s account only by Friday. In effect, the investor will get the money only after three days.
  • China is the only market of significant size and scale which operates on a shortened settlement cycle (T0/T+1). The Indian market had migrated to T+2 in 2003 under the then Sebi Chairman G N Bajpai.

Benefits of T+1 Settlement:

Reduced Settlement Time: A shortened cycle not only reduces settlement time but also reduces and frees up the capital required to collateralize that risk.

Reduction in Unsettled Trade: It also reduces the number of outstanding unsettled trades at any instant, and thus decreases the unsettled exposure to Clearing Corporation by 50%.
  • The narrower the settlement cycle, the narrower the time window for a counterparty insolvency/bankruptcy to impact the settlement of a trade.
Reduction in Blocked Capital: Further, the capital blocked in the system to cover the risk of trades will get proportionately reduced with the number of outstanding unsettled trades at any point of time.

Reduction in Systemic Risks: A shortened settlement cycle will help in reducing systemic risk.

Why are foreign investors opposing it?
  • Foreign investors have written to SEBI and the Finance Ministry about operational issues they would face while operating from different geographies — time zones, information flow process, and foreign exchange problems. 
  • Foreign investors will also find it difficult to hedge their net India exposure in dollar terms at the end of the day under the T+1 system

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