Foreign investors up in arms as Sebi plans to shift to T+0 settlement

• Sebi is likely to issue a consultation paper on how markets can move to instantly settle stock transactions.
• Talk of a dual stream settlement cycle has unsettled foreign institutional investors.
• Concerns around "market fragmentation" are taking centre stage as the move may lead to two settlement cycles.
  

A move towards same day settlement on a split and optional basis has raised concerns about dividing the market from institutional investors. A SEBI consultation paper on the matter is expected shortly.

At the start of this year, on January 27 to be precise, India completed its last lap in implementing “T+1” (trade date plus one) settlement, meaning that trades on the stock exchanges (BSE, NSE) complete within one day. Interestingly, this put India as one of the only markets to achieve the feat along with China. SEBI has heralded its most recent move to a short settlement cycle on the stock exchange (“T+1 Settlement) as a success. According to its 2023 annual report, the move has increased efficiency and reduced risk.

The Indian market regulator now wants to go one step further. Discussions within SEBI and media reports suggest that a move to T+0 settlement is now imminent. One of the key features being talked about is separate segments for T+1 and T+0 participants. What this means is that investors could choose to settle on a same day basis if they wanted or stick to the current T+1 model – in other words, a dual stream settlement cycle. Whilst nothing official has been announced, participants Business Insider spoke to were bracing for a consultation paper by the market regulator. SEBI, BSE and NSE did not reply to emails requesting comment for this story.

With institutional investors only just digesting the move to T+1 settlement, there’s nervousness in the ranks. A lobby representing foreign institutional investors, the Asia Securities Industry and Financial Markets Association (ASIFMA) had previously written an open letter to the former SEBI chairman urging the Indian market regulator for more time and dialogue during the prior implementation of T+1 settlement.



Source: Previous 2021 Open Letter By Asia Securities Lobby “ASIFMA” Regarding The Move To T+1


“If these changes get implemented, essentially one segment, zero day settlement, will be retail and the other will be for institutions, including foreign investors… liquidity gets fragmented” said an institutional sales trading head, whose firm deals with both foreign institutions and is part of regional lobbying, but was not authorised to speak to the media.

This idea of fragmentation has up until now been less of a problem in India markets. 93% of the equity share volume is transacted on a single exchange: the National Stock Exchange, with the remaining 7% on Bombay Stock Exchange, per SEBI data. India has long resisted new technology such as the use of dark pools (trading platforms outside the normal exchange) and alternative trading venues or segments as is more common in Europe and the US.

India is currently one of the least fragmented markets in the world with most volume happening on one exchange and in one segment.


Source: SEBI Data


The risk of dividing volume between different segments is well known to regulators around the world. Such fragmentation potentially can detract from…important Exchange Act objectives, including the efficient execution of transactions, best execution of investor orders, price transparency” reads a 2013 study by the US Securities Exchange Commission into market fragmentation.

From a practical perspective, this might “end up becoming like the 6 lac series” said a sales person at a global bank. What they were referring to is the now discontinued foreign window for trading. Until July 2018, both NSE and BSE had a separate foreign window where foreign institutions could buy stocks from other overseas investors in case the stock had breached India’s foreign investment limits. In generally liquidity in this window was sporadic and traded on a pre-arranged basis


Source: BSE Circular In May 2018, Discontinuing The Separate 6 Lac Series (the 6 Lac Series was a separate window for foreign investors to transact)

“Market fragmentation is clearly a concern when a market has two settlement cycles. The parties we spoke to are conscious about this and are looking at how to prevent this”, said Eugenie Shen, Head of ASIFMA’s asset management group, which represents some of the largest global funds investing in India, including Capital Group and Blackrock.

The other challenge for FPIs (Foreign Portfolio Investors) and some institutions is that the settlement cycle is arguably more complex than retail investors. There are foreign exchange transactions to be executed, multiple different market infrastructure institutions to coordinate (including a local and foreign custodian) and the functional currency for most funds is not the rupee. As a result, institutional investors do not normally “pre-fund” trades as is consistent with the practice in global markets.

Retail investors are unlikely to feel the pinch and might even celebrate the move. Large platforms like Zerodha generally insist on pre-funding. “Stocks are mostly bought with full upfront money”, said Nitin Khamath in a previous tweet. These investors would benefit from getting their funds quicker if selling, and receive shares quicker if buying.

Retail investors make up over 35% of the daily trading activity on the exchanges, according to data published by NSE, and as a result are the largest constituent of the Indian stock market. Foreign investors make up around 15%. A liquid and efficient exchange requires both these sides of the market to interact and trade. In other markets, due to fragmentation, there are challenges in this flow being matched together.

All told, what is left is a battle between institutional complexity, technology and the speed of such a move to same day settlement. That dialogue is likely to pit the needs of retailers and institutions at opposite ends of the spectrum.