By Deepak Shenoy
There’s a valuable lesson in every new technology, and one of them has been the power of an instant money transfer using UPI. Couldn’t we do that in the stock markets too? Pay from your bank account and instantly receive shares in your demat account? All it’s about is moving a few electronic records from one place to another. In a recent statement, Sebi said it is evaluating a move to instant settlement.
Currently, the stock market system involves exchanges, clearing corporations, brokers, and the individual trading parties. When you pay, the money flows to your broker, who pays the clearing corporation, which then settles the counterparty trades done on an exchange. It is similar for the seller of shares, which move to a clearing corporation account before hitting the buyer’s demat account.
The cycle was long. In the distant past, trades would be “settled” once in 15 days. More recently, it was reduced to “T+2”, two days after every trading day, as trades were paid for using cheques, which themselves took at least one day to clear. With technology like the Real Time Gross Settlement System (RTGS), this was recently reduced to one day (T+1).
How would you move this to an instant settlement mechanism? It would involve using UPI and the large depositories (NSDL and CDSL) to work together through the exchange mechanism and instantly debit and credit the appropriate accounts. There is already a proposal to have trade settlements directly from an investor’s account using UPI-based Application Supported by Blocked Amount (ASBA), which can allow instant settlement too.
Why would this even be required?
Every settlement has a chance of failure. Someone may have sold shares they do not own, hoping to have squared off the trade at the end of the day, but could not. The buyer of those shares cannot get them because the seller cannot provide the shares, so then the shares are bought in an exchange-run auction on another day. There is a delay in the buyer’s acquisition of shares, and then, there are penalties on the seller and perhaps, his broker as well.
Instant settlement will mean you simply cannot sell shares you do not own, and you have to buy using money you already have in your account. There is a clear advantage in that there is less failure stress on the settlement system. And for another, you can be sure you own a share the instant you pay the money, avoiding the fear that a broker or the exchange may not be able to fulfil the purchase in time. Lastly, an instant settlement system can be done at any time of the day when it is fully automated, so “after-hours” trading can actually happen in India too.
There are other implications. The intrinsic leverage offered by a daily settlement system will simply die. To explain: some brokers would allow you to trade “intra-day” with as much as four times the money as you have, as long as you square off the trade before the market closes. With instant settlement, there is no leverage and the intra-day players need much more of their own money.
The institutional trading system will benefit in terms of receiving immediate cash when they sell, allowing them the ability to immediately buy from that cash. Currently, because of trading limits, brokers might limit their buying to just 80% of their sell trades, unless they place more money as margin. However, many foreign institutions may not be able to participate easily, as their money takes a day to make its way through the international money transfer system to the clearing corporations. They opposed the move to T+1 strongly, and an instant settlement system will drive them to tears.
The biggest impact could be on liquidity. Buyers and sellers of shares do not come exactly at the same time in the markets, and when you want to sell, a buyer of shares may not be around. To solve this, there are jobbers and market makers who will buy from you when you need to buy, and then wait for an actual buyer that comes in at a later time in the day. They sell shares they have bought from you. Now, typically, such a transaction is leveraged, and has lower securities transaction tax as well, allowing the market maker to provide a very small price difference (the “spread”) between the seller and the buyer. With instant settlement, transaction taxes go up more than 10 times, and higher upfront finance costs means that these spreads will increase. In other words, you’ll pay more when you want to buy, and get less when you want to sell, because the intermediation costs will increase.
The regulator’s intentions are in the right place, but the current impact may be too much to provide for absolutely instant settlement. Reducing it to end-of-day, or effectively, T+0, may be a good first step, where the impact to liquidity can be reduced. In the longer term, instant settlement is unavoidable in this dynamic and tech-driven world.
The writer is Founder and CEO at Capitalmind, a Sebi-registered portfolio manager