In an online world where everything is instant, why does stock settlement still take 2 days?

Ever wondered why it takes two days for stocks to be credited to your Demat account when you buy stocks and two days for you to be able to withdraw money against a stock you have sold.

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When shares were traded in physical form in the 80’s, the settlement of stock trades could take a lot more than a month. After the introduction of electronic matching engines at the Exchanges, especially the National Stock Exchange (1994), and with advancements in technology and logistics (transporting physical shares from seller to buyer), the entire process of settlement was reduced to 14 days. Once the depositories came into existence - NSDL (1996) and CDSL (1999), and with conversion of physical shares to demat (the fastest in the world, thanks to SEBI), rolling settlement cycle was introduced in 2000 in India which further reduced the settlement cycle to 5 days. By 2003, the settlements started happening in merely 2 days. Why hasn’t it been reduced from 2 days to 1 day or even same day settlement (like in Switzerland) even after 17 years (2003) is a question that gets asked quite often.

What happens when you buy or sell a share?

When your buy or sell order gets matched and traded, only a small portion of the value gets blocked by the Exchange (VaR+ELM) as margins. The Stock Broker gets time till the morning of T+2 to deposit the entire purchase consideration with the Exchange if it is a buy transaction and to deliver the shares in case it is a sell transaction. Once the Exchange receives delivery of the shares from the seller (through the selling broker), it credits shares to the buyer (through the buying broker) and the money to the seller(through the selling broker). As you can imagine, this entire process takes two days.

But why 2 days?

Online brokers like us collect full money from customers before allowing the purchase of shares. Likewise, selling is allowed only if the shares are in the client’s demat account on which the broker holds a PoA or if adequate pre-authorization through e-DIS is received from the client, which then allows a broker to debit shares instantly upon a sale transaction. So technically, if there were only online brokers like us in the country, settlement could happen realistically on the same day - with the buyer receiving shares and the seller money on the same day that the transaction is executed.

But, the Broking industry has been around for quite some time (Bombay Stock exchange established in 1875 is Asia’s oldest stock exchange) and we have many Brokers who follow the traditional practice of collecting money through cheques after the execution of a buy transaction or get clients to transfer shares using a signed physical DIS slip after the sell transaction is executed. The collection of money and shares in the physical form is what takes time and hence the 2 days.

So does it mean it will never reduce below 2 days?

I am sure that reducing this from T+2 to maybe T+1 is on the regulator’s list of things-to-do. We are probably already on the way there with the introduction of this SEBI circular that mandates upfront margins in the cash segment which will go live from next month. (Had to go live in April but got postponed due to the Covid situation). Until now, one of the unique selling points of traditional brokers was that they did not insist on upfront margins (while placing a buy order) or require stocks to be available in the demat account (to place a sell order). In order to remain competitive against the online brokers, they used to offer this benefit to pay 100% of funds and/or transfer the stocks after the execution of a buy or sell trade respectively. But this flexibility was opening up brokers to client default risks and to cover this, SEBI has now mandated that all brokers have to collect a portion of the transaction value (VaR+ELM) upfront failing which the client is liable to pay a penalty. Also with this entire lockdown situation, a lot of traditional brokers also were forced to transition to online.

So yeah, with this new upfront margining system for equity trades, my guess is that we are on our way to T+1 settlement cycle in the next few years.

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icicidirect credits sale amount within 30 minutes upto 50k and even more for their prime subscribers.

How does this work out for them?

They are funding it out of their pocket and hence the 50k limit. The credit from the Clearing Corporation is received on T+2 only.

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Can 24x7 NEFT and UPI help achieve faster credit of redemption amount upon selling?
Can the realtime settlement of Bitcoin and cryptocurrency exchanges push the BSEs and NSEs of the world to level up?

Like I mentioned, if all the brokers were like us (collecting money and stocks upfront) then even same day settlement is possible. But we have a legacy issue, there are hundreds of small to mid sized brokerage firms who still collect cheques and physical DIS slips. Until they are all online, it wouldn’t be possible.

Bitcoin/Crypto exchanges etc didn’t have hundreds of years of legacy, so it could be built the way it is. I don’t think real time settlement is possible for stocks anywhere in the world for many years to come. But even moving to T+1 will be awesome.

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In present are there any physical brokers in united states, Who are still collecting cheques ?
What’s making the advanced country united states to still follow T+2 settlement ?

Well the most advanced country united states itself is in T+2 settlement so we can’t expect this happening untill a decade i guess

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No, US is not the most advanced country, India is way ahead. India is maybe 10 years ahead of US in terms of payments technology, RBI has done an amazing job. Do you know, there isn’t real-time fund transfer available in the US yet.

Btw, even in terms of the structure of capital markets (Demat under depository which isn’t affected by broking firm going down, etc), India is way ahead.

If I had to put money on it, I’d bet that India will move to T+1 before the US.

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Even after all these, why can’t it be on T date, if not real-time?

You should read the thread from start, Nithin already explained it.

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Really Good Explaination @nithin !!!

@nithin don’t completely agree with you. As an Options trader I can say that US is much ahead of India in terms of the margining system and the tools/platforms they get to trade…not to forget the liquidity and the instrument they get to trade like ETFs and Leaps…

He is referring about payment systems and not about platforms or depth of markets.

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Ya ok… I was just evaluating overall because @Mehdi_Abbas had put a generalised statement…

Hi,

Agreed fully on the stocks part that it takes T+2.

How about the ETFs? Last week I bought few niftybees and noticed that it took 2 days for me to get it in my a/c (though the count was showing after a day I think, but I was able to pledge it for margin only after T+2).

Pls let me know if its correct.

Thanks

Yes, one can pledge only once they hit your demat, it will show under holdings as T1 till they hit demat, usually takes t+2 days, after which they display under holdings.

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Settlement of ETFs also takes two days. It is the same settlement process.

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Thank you Siva and Nithin.

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