T+1 settlement in India – keeping up with India’s speed dreams

By Sujit Kadakia, Head of India Office, Societe Generale Securities India

India is rolling out T+1 (trade day, plus one day) settlement across its equity markets this year, with the accelerated timeline already in place for the lowest-traded stocks. This is a significant change that promises to reduce risks, free up capital, improve trading liquidity, and a move that puts India at the forefront of a global push to shorten settlement periods. The US, for example, has been working on plans to move from T+2 to T+1 for two years.

The T+1 settlement however may pose considerable challenges for international investors who operate across time zones and need to manage foreign exchange risks on any Indian equity transaction. 

The regulators, exchanges, central counterparty clearing houses (CCPs), recognised these complexities with the decision to monthly phase migration to T+1 starting from February 25. The transition will be completed by the first quarter in 2023, with all of India’s listed companies moving to T+1 in the final phase. 

With the transition now underway, the interdependencies between investors, intermediaries, custodians, and currency conversions are becoming clearer. A more accommodative framework would unlock greater benefits as T+1 is scaled further. 

Risk management for all stakeholders

The Indian rupee (INR) is not a fully convertible currency but all equity-market participants in India must trade in it. As a practical matter, INR denomination is inconsequential for domestic investors, but for international capital it adds a foreign exchange step to trade confirmation and settlement. 

Large institutional investors participate in all global markets and hold a variety of assets and currencies. Such is the global nature of capital. But with India’s new T+1 framework, foreign exchange requirements may pose a potential systemic risk, if overlooked. 

India’s regulations call for brokers to execute trades on behalf of clients, but the rule only mandates execution, not settlement. Settlement obligations belong to the client’s asset custodian. 

When brokers process buy or sell orders for clients, they also communicate details to the custodian, who then makes assets available. In the case of institutional investors, the scale of transactions could be in the millions or billions of dollars, all of which must be converted to INR. 

When custodians receive trade details from brokers and clients, they also receive trade data from CCPs. They must check that everything matches, and that the client has the INR for buy trade and securities in case of sell trade to cover the trade. When all aligns, the custodian confirms the trade to the CCP, as required.

But what if a client’s INR account falls short? Foreign Exchange (FX) services close before the end of the equity trading day in India, and custodians cannot accept even one rupee less in an obligation. In India, the CCP guarantees trades so when a custodian cannot confirm, the CCP will order the broker to accept the obligation for the trade instead. But brokers, by definition, do not hold the assets and do not have visibility of a client’s ability to pay. 

Currently, the fix is for brokers to accept settlement obligations. Meanwhile, the custodians will compete FX transactions before the CCP obligation, subsequently reimbursing the broker that settled the trade with CCPs. Eventually everything balances but timing is key in this Delivery Versus Payment (DVP) mechanism which otherwise impact profitability of the transaction-based fee structure. 

In a T+1 framework, this situation forces brokers to accept additional risks. In the worst-case scenario, this may pose a systemic problem if the settlement of large trades is thrown into question, seeding chaos at broker’s continuity. 

Heading towards a common goal

This hurdle need not prevent India from realising its speed dreams. The simplest solution is to move trade confirmation deadlines at the CCPs from the end of the trading day to morning the next day – after FX services reopen. 

Such an adjustment would reduce the risks of settlement failures in a T+1 framework and allow the entire equity market to enjoy the benefits of the shortened settlement process. 

The T+1 transition has not yet affected major institutions or foreign investors, and further changes can be expected as the requirement is phased in and the implications become clearer. 

India has already moved ahead of other major markets by introducing T+1. It is now important that regulators and market infrastructure providers allow all segments of the market to benefit from the new framework. As the proverb goes: If you want to go fast, go alone; if you want to go far, go together.