For those who are new to trading pit, initially the BSE Ltd, erstwhile the Bombay Stock Exchange, used to have settlement on every Fridays. So all trades that happened between Monday and Thursday had to be settled (delivery of shares to the buyers and payment of cash to the sellers) on subsequent Fridays.
Settlement was by physical movement of paper wherein the exchanges first settled the trade by delivery of shares by the seller and payment by the purchaser and then the process of physically moving the securities from the seller (involving company) to the ultimate buyer.
The entry of the National Stock Exchange - with the screen-based trading, brought a host of changes to the trading world. Initially, the NSE too started the settlement cycle on fixed days only. It had started with Wednesdays as settlement day and later shifted to Tuesdays.
The weekly settlement system had encouraged liquidity in the market because people could buy and sell without having to pay immediately thus encouraging speculative activities in the cash market. Harshad Mehta, the (in)famous stockbroker exploited this system very well during his heydays.
Because of this excessive speculative nature of trading, the system was fraught with default risks, and often the settlement cycle was extended either for want of cash or scrip.
Then came the first revolution in the securities markets on the settlement side. To reduce the risk associated with the fixed-day settlement system, the Securities and Exchange Board of India introduced rolling settlement in July 2001. The settlement process for a trade contract begins at the end of the trading day, now famously refereed as "T".
Initially it was introduced for certain scrips on T+5 basis (in 5 days from date of trade) and then expanded to all scrips in a phased manner.
All scrips moved to rolling settlement from December 2001. T+5 gave way to T+3 from April 2002 and from April 2003, it is T+2.
Road ahead
However, is this not time for India to further reform the settlement cycle to make our capital market more vibrant?
The Reserve Bank of India has completely overhauled the payments procedure where cheques are getting cleared within one day and for some high value/urgent payments on the same day.
As the banks in our country are now better equipped to transfer funds on a real-time basis under the Real Time Gross Settlement System (RTGS), there is no reason why the securities markets cannot follow in the footsteps of the RBI to give investors the same level of speed and comfort.
For that, all they have do is to integrate banking account with customer's demat account. That may not be a big deal, given the sophisticated computerised platforms being used by the stock exchanges, banks, depositories and custodians. For further safety, the accounts can be linked with one more instruments such as Aadhar Card or PAN Card.
If this improved settlement system is followed, SEBI could even consider bringing forward the settlement cycle to T+5 hours, if not in three hours, which will greatly enhance the credibility of the capital market, benefiting all the players and the economy of our country as well.
If regulators such as RBI and SEBI and other intermediaries along with finance ministry officials work together, they could easily bring forward the settlement cycle that could reduce settlement risk.
All they have to do is to connect the loose-ends to make the process foolproof and seamless.
Are we ready for it?