In today’s Finshots, we tell you why SEBI is making way for faster trade settlements.

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Notice how when you try to buy a share, it takes a day before you finally see it in your account? Well, SEBI now wants to revolutionize that. They want you to be able to see it within an hour!

What’s going on, you ask?

Okay, first some background. When you trade shares via your broker, all you probably see is a nice looking looking screen where you hit ‘buy’ or ‘sell’. But behind the scenes, there’s a lot going on involving multiple parties.

Let’s imagine that you want to buy 10 shares of Company A at ₹500 per share. You’ll first need to deposit ₹5,000 to a trading account with your broker. We’re ignoring any extra brokerage charges or fees to keep things simple. So, once the money is in the account, you can hit the ‘buy’ button. And then an elaborate dance begins.

The broker begins speaking to the stock exchange where the company is listed. And the exchange then tries to find someone who’s willing to sell it at the price you seek. If the price is right, the order is executed.

That’s when another entity comes into the picture — they’re called the clearing house. These are folks who then verify how much money you owe to the seller. And what security should hit your account. Now this is no mean feat. Because you’re not the only one trading in the market, right? There are millions of trades happening every day. And they have to match all of this. So it could get quite intense.

But once the details are sorted, then comes the settlement process.

The money moves from the broker to a special clearing bank — of which there are only 15 that work with NSE. And the two depositories who actually hold the shares on behalf of every investor in the country start the process of moving the required shares from one account to another.

You get the shares. The seller gets the money.

Two decades ago, this entire process took about 7 days. They'd issue physical certificates. Cheques would change hands. And people could misuse it. But things changed in the 2000s. As computer and online trading became ubiquitous, SEBI moved to a T+5 settlement cycle. With T denoting the day in which the trade was placed. Within a couple of years, that moved to T+3 and then to T+2.

Everything was getting faster.

And that’s how it remained for nearly two decades. The world followed T+2. And so did we.

But last year, SEBI got more ambitious. It thought, “How about we move to a T+1 cycle? Everything gets settled within 24 hours.”

So we did it in January this year. They took it in phases. It didn’t disrupt the markets. And soon, we became only the second country in the world, after China, to do this. The praises began to flow.

But now, as if that wasn’t enough, SEBI’s mulling over a T+0 settlement. Which means that if you buy a stock, it’ll appear in your account within an hour. The tech is ready. We’re capable even if no one else in the world has got there. And this could be game changing.

How so, you ask?

See, if you sell shares today and get the money in your account only tomorrow, you’ll simply have to wait before you can make a trade. Your money is blocked for 24 hours. But faster settlement puts an end to that. The money hits your account in a flash and you can place your next trade almost immediately. This might further improve liquidity in the market.

But wait…you can still buy shares even when you’re waiting for the money to hit the account, right?

You can. But that’s with the help of leverage or margin or, in simple terms, a loan which your broker extends to you. Now doing so is always risky. Things can go wrong. Your trade might be a bust. And you might not have enough money. It’s a risk for the broker because their money is at stake. And the enthusiasm to buy a stock without waiting for money in your account can hurt your finances too. So faster trade settlements could mean that these types of leveraged trades might reduce. (Of course, it won’t probably affect the ones who are intent on trading by using margins).

Apparently, not having to wait around for money and stuff already benefits the investor community to the tune of ₹3,500 crores each year.

The only ones who might complain are foreign investors.

These folks operate from different timezones. They trade in multiple countries. They deal with forex fluctuations. And they have to communicate with custodians who hold securities for them before settling trades. There are global custodians who have to transfer money to local custodians such as banks in India. And they say that this process takes time. If settlement is immediate, they always have to pre-fund their account with millions of dollars. And if they don’t feel like buying a stock, it might sit idle and they won’t earn interest on it.

But they moved from T+2 to T+1 fairly easily. No reason why T+0 can’t be a possibility, eh?

Although, there could be one hiccup. As per what Nithin Kamath, the founder of Zerodha*, said a couple of years ago (published by LiveMint):

“The majority of trading volumes on the stock market is from intraday traders who are buying and selling stocks without taking or giving delivery of the stock. So if you did buy shares of a company from an intraday trader on the exchange, he might not have any shares to instantly transfer to your Demat account.”
Typically an intraday trader will exit his position before the end of the day and that obligation to deliver the stock will eventually land with someone who holds the stock. At the end of the day all such buy and sell obligations are crystallized, brokers transfer the stocks and money to the clearing corporation that settles the transaction.
“While instant settlement is impossible, even T+0 is extremely tough considering the time required for brokers to crystallize the obligations and then clearing corporations to settle.”

So yeah, let’s just wait and see how this SEBI revolution plays out. Because the next thing on SEBI’s agenda does seem to be instant settlement.

Until then…

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*Zerodha, through its Rainmatter Fund, is an investor in Finshots.