Mint Explainer: T+1, a milestone for the Indian stock market

how the change started

Following the Ketan Parekh scandal, the Securities and Exchange Board of India (SEBI) initiated comprehensive stock market reforms in 2001, in an effort to make Indian stock markets more transparent and investor-friendly. Therefore, Badla, a carry forward mechanism that encouraged excessive speculation and leverage in stocks, made way for shorter settlement cycles. Instead of badla, a separate futures and options market was born. So essentially SEBI separated the cash and futures markets.

From the T+3 settlement cycle, Indian cash markets have gradually moved to T+2, and are now moving towards T+1 rolling settlements. This means that the shares are transferred to the buyer’s demat account and the funds to the seller’s bank account a day after trade execution (T+1) – a complete turnaround of the process in just over two decades.

In 2001, both NSE and BSE had a weekly settlement cycle. All trades on BSE are settled after the weekly trading cycle from Monday to Friday. On NSE, weekly settlement was followed by Wednesday to Tuesday trading cycle.

boom in index options

Badla was a mechanism to carry forward trades from one weekly settlement cycle to another without the buyer taking delivery of the shares. In line with global best practices, SEBI transformed the exchange into a separate, transparent and better regulated derivatives market. The futures and options markets were initially cash-settled, but gradually shifted to physical delivery of shares at the end of the monthly trading cycle. Index contracts are cash-settled. The F&O market allows traders to be both hedged and speculative, with an advanced risk-management framework. To mitigate systemic risks, there are substantial margin requirements ranging from initial margin to mark-to-market.

In the early years, stock futures became popular among retail investors because they were similar to revenge. In recent years, retail participation in index options has increased. This indicates two things.

One, there is more responsible trading behavior among retail investors, who understand the nuances of the stock market better. The market has come a long way from highly leveraged badla trades to more restrained speculation. Remember, index options are cash-settled and less volatile than stocks and stock futures.

Two, SEBI has been trying over the years to rein in excessive speculation and promote stocks as long-term investments. The shorter rolling settlement cycles, along with the separation of cash and derivatives markets, and the phased transition to the new order have worked well for the Indian stock markets, seeding the equity culture in India.

Indeed, the Indian stock market has boomed after the reforms, with the Sensex rising from around 3,000 levels to over 60,000 now. This makes 2001 the moment of 1991 for equities.

Important role of JR Verma

One person who has played a key role in making the Indian stock markets more developed and transparent is JR Verma, a member of the Monetary Policy Committee (MPC) of the RBI and a professor at IIM Ahmedabad. He often makes news for breaking ranks with others in the MPC, most recently voting against further hikes in rates by the central bank.

Decades ago, Verma set the agenda at SEBI in various capacities, helping shape and reform the stock market. While a panel under Verma had initially suggested going ahead with rolling settlement, Verma later, as a SEBI board member, insisted on scrapping badla and introducing F&O in select stocks. That’s how the script went afterwards.