Are you a player in the stock market? If you are – you know how the entire market works. But, being a beginner, it is never possible to know the A to Z of the stock market. Honestly, not everyone is a born pro at the stock market – everyone is a rookie, and that is the only factor that can make you a professional later on. So, take one step at a time in the learning process of the stock market. The more you learn, the better it becomes to face the market as a whole. Moreover, you would not want to be someone who does not know the alphabet in a market that is filled with people who use the dictionary. Now, that was just an analogy to prove the point, you see. So, make sure you know every move you will be making in this market down the road. This post is going to talk about the settlement period.
What is the Settlement Period with Securities?
The interval between the transaction date, when an order is executed, and the settlement date, when the security changes hands and payment is paid, is referred to as the settlement date in the securities industry. When the seller and the buyer enter into a deal, each party must fulfill their share in order for this transaction to be completed.
During the settlement period, the seller must commence the transfer of ownership of the security to the buyer in exchange for the appropriate sum agreed upon by both parties during contract execution.
When ownership of the security is transferred, payment is paid, and the buyer becomes the new holder of the security, the trade is termed settled. Different types of securities have different settlement periods, which can range from one day to three trading days after the trade date.
The Shift of Settlement Period
The settlement period has undergone several significant developments. The settlement term was previously up to 5 business days, which was a convenient option for completing the transaction, but it has now been decreased to 3 business days. This is also why the settlement term is referred to as T+3. The SEC reduced the period from five business days to three business days in 1993. (Security and Exchange Commission).
When securities were traded via postal systems, the SEC was content with the time period of T+3, but with the digital era, it became much easier to transfer shares, bonds, securities, and stocks. As a result, in 2017, the SEC established a shorter settlement term of only two business days. The transactions must be completed within T+2 days.
If the seller does not transfer the security, share, or stock to the buyer within the settlement period, a penalty or interest cost is assessed each day until the transaction is completed. For instance, if you have bought stock from Nifty media and it needs to be settled within three days. The seller does not transfer the security to you within that period. Therefore, there will be interest each day until it has been completed.
How Did a Settlement Come About?
Section 17A of the Securities Exchange Act of 1934 was amended by Congress in 1975 to direct the Securities and Exchange Commission to construct a nationwide clearance and settlement system to ease securities transactions. As a result, the SEC established rules to oversee the process of trading securities, including the concept of a trade settlement cycle.
The SEC also established the length of the settlement period. Originally, the settlement period provided both the buyer and seller time to perform what was required to fulfill their share of the trade, which used to be hand-delivering stock certificates or money to the corresponding broker.
Money is now sent instantly, but the settlement period remains in place as a rule and for the convenience of traders, brokers, and investors. Most online brokers now demand traders to have enough funds in their accounts before purchasing shares.
In addition, printed stock certificates are no longer used to signify ownership in the industry. Although some old stock certificates still exist, today’s securities transactions are nearly entirely documented electronically via a procedure known as book-entry, and electronic trades are backed up by account statements.
Types of Settlements in the Indian Stock Market
Stock market trade settlements are basically classified into two types:
a) Spot: This occurs when the settlement is completed quickly after the T+2 rolling settlement principle.
b) Forward: This occurs when you agree to settle the trade at a later date, such as T+5 or T+7.
The Bombay Stock Exchange and the NSE Settlement Period
The National Stock Exchange and the Bombay Stock Exchange have announced that the T+1 settlement cycle will be phased in, beginning with the bottom 100 equities in terms of market value on February 25, 2022. Following that, 500 more equities will be added based on the same market value criterion on the final Friday of March 2022 and every month thereafter. Those who deal in equities that come within the T+1 settlement cycle will receive their money or shares in less than 24 hours.
Foreign portfolio investors (FPIs) were vehemently opposed to the implementation of the T+1 settlement. Because FPIs invest in India from different countries and time zones, obtaining permits for stock transfers and other procedures from their custodians or head offices may be problematic. It might become a real-time process of stock and money transactions for them. Domestic brokers opposed it due to the high cost of revamping their back office and front office operations. Both sought more time. Therefore SEBI and the exchanges chose a phased approach.
The settlement period is the time it takes for the securities to be handed over to the new owner and the transaction to be completed. A settlement period in the securities market is the time between the trading day, week, month, and year when the deal is performed and the settlement date when the trade is final. This is an important element that you have to remember when trading in the stock market.