SEBI’s proposed T+1 settlement system

Context

SEBI allowed stock exchanges to start the T+1 system as an option in place of T+2

About

• While buying or selling a stock, bond, exchange traded fund, or mutual fund, there are two important dates to understand:
  • Transaction date: 'T' is the transaction date.
  • Settlement date: The abbreviations T+1, T+2, and T+3refer to the settlement dates of security transactions that occur on a transaction date plus one day, plus two days, and plus three days, respectively.

Why T+1 settlement?

• In April 2002, stock exchanges had introduced a T+3 rolling settlement cycle. This was shortened to T+2 from April 1, 2003.
• According to a Sebi paper, a shortened cycle not only reduces settlement time but also reduces and frees up the capital required to collateralise that risk.
• T+1 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.
• 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.
• Systemic risk depends on the number of outstanding trades and concentration of risk at critical institutions such as clearing corporations, and becomes critical when the magnitude of outstanding transactions increases.
• Thus, a shortened settlement cycle will help in reducing systemic risk.