India’s ambitious move to same-day settlement and beyond

Confidence is high, and Indian authorities are in no rush to slow down capital markets reform.

While the global finance industry is racing to prepare for 28 May, when trades in US securities must settle by the next day (T+1), India is laying the groundwork for a same-day regime (T+0) as it blazes a trail to instant settlement by February next year.

It’s quite the ambition, requiring exhaustive stakeholder collaboration and technological upheaval, but if anybody can pull it off, it’s India.

The technology to achieve an even more compressed settlement period is there, but is everybody ready and what challenges do they face?

The road to instantaneous settlement

Regulators’ main motive for compressing settlement times is to make markets safer. The gap between buying a stock and taking delivery is one of risk, during which a trade can fall through. Market participants mitigate this by posting collateral with clearinghouses. A shorter transaction time is cheaper and more efficient.

India was the first major economy to migrate to a T+1 settlement. Securities regulator SEBI said in its 2022/23 annual report that the transition to T+1 in equities trading in January last year had increased efficiency and reduced the risk of outstanding trades being settled.

Nevertheless, it still gave rise to challenges as brokers and intermediaries had to adjust their back- and front-office operations. HSCB said in December that, although the move to T+1 was a success overall, ‘late settlement rates have risen – demonstrating the importance of preparation.

The phased approach that India took over the preceding couple of years helped reduce disruption.

SEBI has kept the momentum going and in December unveiled a consultation paper on plans to move the market to same-day settlement (T+0). This will be done in two phases. From March 2024, equities trades can be settled at the end of the day, on an optional basis. The second leg is expected to begin next year and will require all trades to be settled instantaneously.

The head of the regulator, Madhabi Puri Buch, said recently it had ditched a plan for an optional one-hour settlement ahead of the final step to instant. Feedback from market infrastructure experts and brokers told SEBI that, technologically, going to instant settlement from same-day settlement would be less costly and faster. The added-benefit of the one-hour option was minimal.

But other obstacles remain.

The settlement challenges

As we wrote in June 2023, the Indian market has unique challenges. The T+1 settlement requires middle and back offices to process trades faster than in most other markets. Firms need to have streamlined processing in place and deploy more automation throughout the lifecycle of a trade.

The pressure to modernize to keep pace with changing regulatory frameworks and higher volumes is only increasing, as the proposed phased shift to same-day and instant settlements shows.

While a shorter settlement period could help cut counterparty risk, require less collateral and boost market liquidity, intermediaries who rely on interest income from client funds might take a hit. India’s millions of retail investors will benefit by having faster access to their own funds.

Foreign investors, who have been increasing their exposure exponentially to India, are concerned about moving to more compressed settlements.

The Asia Securities Industry and Financial Markets Association (ASIFMA) said the phased transition whereby two settlement regimes (T+1 and T+0) exist side by side could lead to a fragmentation of market volumes. This would result in liquidity risk and increased trading costs, as, in some instances, securities might not be able to be traded fast enough.

An additional risk, as reported in ION’s blog on 12 February about the US switch to T+1, is currency conversion and funding. Different settlement jurisdictions (the standard T+2, T+1 and T+0) and time zones add complexity to the work of brokers and investors who deal in cross-currency transactions.

The funding of an equity transaction generally occurs after the matching, allocating, confirming, and affirming is complete. It is the moment the exact transaction value is known. In a compressed settlement regime, foreign investors will need to take the more expensive option of pre-funding trades to ensure they have enough rupees at hand.

SEBI confident in infrastructure

An efficient payments network is critical to trading execution and settlement. Without one confidence dwindles and financial systems become more inefficient.

One of the reasons imbuing SEBI with confidence about T+0 is a unique digital architecture called the India Stack that has been rolled out across the country in recent years. It has garnered admiration globally and revolutionized financial access for millions.

A fundamental pillar of it is the Unified Payment Interface (UPI), an interoperable system which allows instant payment. Millions of Indians and thousands of companies rely on the interface, which facilitates inter-bank peer-to-peer lending.

As far as financial markets are concerned, the infrastructure dominates IPO applications among the growing number of retail investors. India’s National Payments Corporation of India, which developed the open platform, has also begun pilot-testing a UPI for the secondary market with brokerages and clearing houses. The settlement process will operate on a T+1 basis.

Confidence can also be found in India’s already robust stock market infrastructure, which, according to one opinion piece, allows for instant trade reconciliation and helps depositories update clients on their debit and credit for securities.

Preparing for T+0

Just like the shift to T+1, the move towards real-time settlement requires a complete rethink by market participants of how they operate.

For it to work, all players involved in the lifecycle of a trade will need to have streamlined and integrated internal processes in order to maximize returns. Legacy systems will not be sufficient to scale operations to handle higher volume and instant execution.

End-to-end automation will reduce human error and, therefore, the risk of trade fails. As the settlement gap between India and other jurisdictions grows, albeit temporarily, using trading solutions to manage cross-border risk and compliance becomes more essential.

Operators in India have already adapted to T+1 with a great degree of success. Further harnessing technology, from cloud-based systems and APIs, will help them drive towards instant settlement.