The Securities and Exchange Board of India’s (Sebi) on Friday proposed allowing large foreign portfolio investors (FPIs) to settle only the net value of their trades instead of each transaction – a move that is expected to cut funding cost of these investors.
The proposed overhaul is part of wide-ranging reforms planned by the regulator to attract FPI flows, besides making the country’s markets deeper and making registrations faster, chairman Tuhin Kanta Pandey said at an event earlier in the day.
From Gross to Net
The market regulator has proposed to allow net settlement across two or more stocks, benefiting exchange-traded and index funds. However, this mechanism will not apply to single-stock intraday transactions. Settling only the net value, called “netting”, the move will enhance FPIs’ operational efficiency, help reduce their cost of funding, and require these investors to fulfill only the net fund obligations rather than the gross settlement, the market regulator said in a consultation paper.
Akshaya Bhansali, managing partner at Mindspright Legal, said that the new mechanism’s benefit is primarily operational and limited to specific situations such as index rebalancing or large portfolio adjustments.
Market participants have long highlighted the inefficiencies of gross settlement, particularly during high-volume trading days and issue of allowing netting for FPIs has been under discussion for several years, Bhansali added.
On the other hand, the move is expected to increase the overall returns for FPIs and attract more foreign investors in the Indian equity market, said Vipin Kumar, assistant vice president of equity research and head of derivatives and technical at Globe Capital Market. The sale proceeds can be used to fund the purchasing obligation and this will also reduce the foreign exchange conversion slippages, he added.
What is netting mechanism?
It allows an investor to offset multiple buy-sell transactions in a day and determine a single amount for settlement. Currently, FPIs settle equity cash market trades on a gross basis, which means that each buy or sell transaction is treated separately for settlement. No margins are now collected from the brokers or the custodians in case of FPI trades in the cash market.
Under the current mechanism, FPIs need to provide funds toward purchase transactions independent of sale transactions. Buy and sell transactions are confirmed separately and any issue with the confirmation of one transaction does not impact the confirmation of the other. In the new scenario, the confirmation of buy transactions will be contingent on the confirmation of sale transactions and vice versa.
“Sebi is in receipt of suggestions that the current practice of gross settlement of transactions done by FPIs is leading to additional liquidity demand and inefficiency for FPIs,” the regulator said. There are potential costs involved due to slippage between buying and selling foreign exchange to fulfill their obligations, it added.
The market regulator’s comments to ease the norm for FPIs come amid the sharp selling activity of foreign investors in the Indian stock market since October 2024. Though the quantum of selling pressure has eased significantly over months, they remain net sellers in the market amid persistent uncertainty about US tariffs, weakness of the domestic currency, expectation of no major recovery in earnings growth, and relatively high valuation though the metric has eased in the last two years. Public comments about the latest proposal should be submitted latest by February 6, Sebi said.