After you make a trade in the market, your trade gets settled after a certain number of days. This period is called the settlement cycle
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Settlement cycle is a term that you no doubt come across often. If you’re a regular investor into individual securities, you will know that the shares you buy today don’t reflect in your demat account the same day. They do after a certain time has passed. This is called the settlement cycle for the trade.
In this article, we’re going to understand what a settlement cycle is, what the standard for Indian investors and the SEBI is, and what the term T+1 or more generally, T+n means.
Understanding the settlement cycle in stock investing
Traditionally, the Indian stock market followed a T+2 settlement cycle. Here’s how it worked:
T (Trade Date): The date on which a security is bought or sold on a stock exchange.
T+2 (Settlement Date): The date by which the delivery of the security and the corresponding payment must occur.
In simpler terms, if you buy shares on Monday (T), the shares and the payment would be exchanged by Wednesday (T+2).
T+1 settlement shortens this cycle by one day. With T+1, the delivery and payment for a trade must be completed by the next business day following the trade date.
Why has the market shifted to T+1?
The move to T+1 aims brings several benefits to investors in the stock market:
- Reduced settlement risk: A shorter settlement cycle, meaning that the sooner you get your shares in your demat, the lesser the risk is. Although this doesn’t apply appropriately to the stock market (since it’s highly regulated and the chances of default are miniscule), theoretically it does enhance the overall stability and efficiency of the market.
- Increased liquidity: Faster settlement frees up capital sooner, leading to increased liquidity in the market. You can re-use the funds from a sale more quickly to invest in other opportunities if your transaction gets settled faster on the market.
The impact of a shorter investment settlement period on market participants
Here is an overview from the perspective of all three major participants in a typical stock market transaction:
- Investors: Investors like you benefit from the shorter settlement cycle a lot. A shorter settlement time means that you have faster access to your funds after selling securities. T+1 can also potentially lead to tighter bid-ask spreads due to increased liquidity. However, sometimes traders might have to adjust their strategies a little bit to compensate for this cycle. For retail investors parking their money in the stock market for the long-term, this hardly makes a difference.
- Brokers: With a shorter cycle, brokers will need to adapt their back-office operations to ensure that transactions do get settled within the stipulated time frame. This might involve upgrades to infrastructure and processes.
- Depositories: Depositories like CDSL (Central Depository Services Ltd.) will play a crucial role in ensuring smooth and timely settlement of trades under T+1. They might need to enhance their processing capabilities to handle the increased volume of transactions.
Frequently Asked Questions
Yes, that’s the whole point of the exercise. Traditionally, you’d wait two days (T+2) to receive funds after selling shares. With T+1, you’ll get your money by the next business day.
One of the biggest considerations you have to make is about the increased liquidity due to T+1, which could lead to narrower bid-ask spreads, impacting your entry and exit prices. Monitor how spreads behave during the initial T+1 period and make changes accordingly.
Some brokers might offer after-hours order placement (AMO) even with T+1. However, these orders might not be executed until the next trading day (T+2) due to settlement considerations. Double-check with your broker about their specific AMO policy under T+1.
T+1 might not apply to IPOs initially. IPO settlement cycles can involve multiple stages and might take longer than T+1. It might help to stay informed about the specific settlement timeline for the IPO you’re interested in.
The core principles of long-term investing – diversification, asset allocation, and a focus on fundamentals – remain crucial even with T+1. While short-term volatility is possible during the transition, the long-term benefits of a more efficient market can be positive for all investors.