Instant settlements are good, but education needed
There is a flurry of activity in stock market regulation. Madhabi Puri Buch, chairperson at the Madhabi Puri Buch, the stock market regulator, said there was a plan to introduce instant trading settlement of trades. A settlement is when you, as a buyer, receive shares in your demat account or, as a seller, get money to your bank account. Currently, stock exchanges settle trades the next day.
Instant trade settlement is the ultimate level of financial market efficiency. In the stock market vocabulary, that is ‘T+0’. The US stock markets follow a T+2 cycle where trades are settled two days later. The US Securities Exchange Commission will introduce a ‘T+1’ system in May 2024.
Why will it be transformational
A lot of money will be saved. The answer is that simple. There is a risk to trade and settlement. If the buyer fails to pay up, the settlement guarantee mechanism settles the trade. The money is recovered later. Similarly, if, as a seller, your demat accounts do not have shares, the trade is settled by your broker on your behalf. Later, you have to pay up for the difference in the price and compensate your broker. If trades are settled instantly, the risk to the trading system is reduced. However, it does not go away. You may still not have the money or shares to put up. Brokers will still require you to maintain adequate funds before you execute trades. Ms Buch already announced that reducing trading settlement cycles to T+1 has resulted in savings of thousands of crores of rupees. There is no reason why more cannot be saved.
If you have looked up your stockbroking services, brokers give you instant cash into your account after you sell your shares. That is probably applicable to the most liquid shares in the market and offered only by brokers willing to use their capital to guarantee that payment. If stock markets offer an instant settlement, all those exotic features that brokers with a strong balance sheet offer would become redundant. Yes, there is research offered by top brokers. It tells you the right time to buy or sell shares. However, very few of you invest in equity markets to bother about value-added services offered by brokers. As such, for retail investors like you, it is a nice-to-have feature.
If you are a regular investor in equity markets or invest through mutual funds, you can expect money to hit your account faster if you sell shares or bonds. Similarly, shares or bonds would be credited to your demat account if you are a buyer. The process of mutual fund purchases and redemptions can also be expedited. Mutual funds take longer than stock exchanges to process your redemption or investment requests. While money goes out of your account, the credit of mutual fund units takes time.
Similarly, money redemption after you sell mutual fund units takes time. The instant settlement in the stock market will change all of that. You will get money in and out faster than today. The instant settlement will make India attractive to institutional investors. There is a good chance that domestic and foreign institutional activity may see a big jump. India’s stock markets will have an excellent international standing and attract more money. Considering the latest outlook for India’s growth, Indian equity and debt could turn into an attractive asset class.
While all of that is fine, the government must focus on encouraging individuals to invest regularly and for the long term. With merely 2-3% of the population investing in the equity markets, it is not a significant achievement for a nation with 140 crore people. You must adopt a ‘buy and hold’ strategy for your equity investments to create meaningful wealth. There is a difference between stock market trading and investing. While trading is for the adrenaline and hope of a quick profit, it is risky. Also, with an instant trade settlement, day trading may lose relevance. Your focus must be on investing to benefit from the long-term appreciation in share prices.