A global association for regulated funds that is leading efforts to shorten the settlement cycle for US equities has reached out to the Securities and Exchange Board of India (Sebi) with a plea to extend the T+1 implementation timeline by 18 months.
The short transition period of four months does not provide foreign portfolio investors (FPIs), their services providers, and broker dealers sufficient time to make the necessary operational and compliance changes to accommodate a shorter settlement cycle, ICI Global said in its letter addressed to Sebi chairman Ajay Tyagi written a few days back.
ICI Global carries out the international work of the Investment Company Institute (ICI), a global association for regulated funds, whose members manage assets of more than $42 trillion.
The association believes that an optional T+1 settlement on a scrip-by-scrip basis will introduce unnecessary operational complexity and risk in the settlement system. Under this model, the same security could be on a T+1 settlement cycle on one exchange and T+2 on the other.
The systems currently used by FPIs and their service providers do not have the capability to code for different settlement cycles in the same market.
This will make it operationally challenging to track and manage which securities are settling T+1 versus T+2.
“India trades will require manual intervention during processing, delaying the process and increasing the chance for errors and operational risk, particularly during high volume volatile trading days,” ICI Global said in its note.
Due to time zone differences, a compressed confirmation deadline could result in more failed trades.
Under the existing T+2 settlement cycle, an FPI must send trade settlement instructions on T+1 for the local custodian to meet its requirement of trade confirmation by T+1.
In a shorter settlement cycle, trade settlement instructions from the FPI will need to be sent to the local custodian on T (India time), to allow the local custodian to confirm the trade by close of the business day on T.
“Currently, an FPI does not have the capability to support this new timeline given the different time zones.
"To support T+1 settlement, FPIs and their service providers would need to completely re-engineer the settlement and funding process,” ICI Global said in its note.
Under the current settlement cycle, FPIs execute an FX transaction to fund the trade after the equity trade has been executed by the broker.
A trade confirmation is required for the local custodian to book such a forex (Fx) transaction under the existing service level agreements.
In a T+1 settlement cycle, to meet the local custodian’s funding deadline, FPIs may be forced to pre-fund INR.
“Executing Fx on T-1 will subject FPIs to additional currency risk. For example, if an FPI funds INR and then the portfolio manager doesn’t trade that full position or doesn’t get the full execution, the FPI is left holding a long INR balance,” the association observed.
It further said that there was an increased likelihood of unconfirmed trades for FPIs, resulting in increased hand-delivery trades as well as trade fails.
Additional trade fails would lead to higher costs for FPIs, including regulated funds and their investors.
“In the Indian equities market, if a sale transaction fails on T+1, the mechanism to resolve this is through a buy-in at auction.
"We understand that the cost of purchasing an equity security at auction can be up to 20 per cent of the trade value,” it said.
In 2017, ICI along with Depository Trust & Clearing Corporation (DTCC), and the Securities and Futures Markets Association (SIFMA) led a successful industry effort to shorten the settlement cycle from T+3 to T+2 in the US.
Many other markets, such as Canada and Mexico followed suit.
It is leading a similar effort to shorten the settlement cycle for US equities to T+1 from May this year, with a 24-30 month timeframe for making the transition.
Photograph: Shailesh Andrade/Reuters