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Settlement System at Stock Exchanges
Rolling Settlement

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Settlement System at Stock Exchanges - Rolling Settlement


"The next step: Rolling settlement"

For the stocks in mandatory rolling settlement, some of the equity trading in India would conform to the highest international standards, with five key ingredients: (a) anonymous order matching, (b) high quality surveillance and punishment of manipulators, (c) novation at the clearing corporation, (d) rolling settlement, and (e) depository settlement. These changes add up to a revolution when compared with India's equity market as of 1993
[Source: Ajay Shah, Columnist - Business Standard]

There are two types of settlements:

  1. One is weekly settlement (EQ) and

  2. the other is Rolling settlement (BE)

Before advent of compulsory Rolling Settlement in 2000 starting with 10 selected scrips, the market functioned exclusively under account period or weekly settlement. Weekly settlement was prevalent in NSE, while account settlement in other exchanges. In case of weekly settlement, which takes place through "futures--style settlement", the trades accumulate over a trading cycle and at the end of the cycle, are clubbed together, positions are netted and the balance is required to be settled. Under this system the transactions are not settled immediately, but only after a period of 7 to 14 days from the date of the transaction. Under the weekly settlement it is possible to buy 100 shares of ITC on Wednesday morning, sell 100 shares of ITC on the coming Tuesday evening, and have no deliveries to the clearing corporation: the two transactions net out and only money changes hands (reflecting the change in price).Where however physical settlement takes place, the members realise the sale proceeds/securities in accordance with the pay-in/pay-out schedule notified by respective exchanges.

Rolling settlement on India's equity market was first introduced by OTCEI. When demat trading began at NSE on 9 July 1997, it used rolling settlement. SEBI set up a committee on Rolling Settlement in 1999 and in the first instance SEBI brought 10 frequently traded scrips under compulsory rolling settlement with effect from 10th January, 2000. The Committee on Rolling Settlement considered that Rolling settlement is necessary for a healthy and safe market as it helps in reduction of risks and also lowering of transaction cost in the long run. All markets have moved into rolling settlement mould. It is therefore necessary to take the Indian market forward and initiate further measures for rolling settlement. SEBI made it mandatory that all demat trading should use rolling settlement. Compulsory Rolling Settlement on T+5 basis has been introduced for 414 scrips since July 02, 2001 on all exchanges. As per directives of SEBI dated May 14, 2001, the remaining scrips were to be traded on T+5 rolling settlement w.e.f January 02, 2002. Rolling settlement involves shrinking the netting period to one day. Thus under rolling settlement transactions are squared on daily basis The length of the netting period has gone from an undisciplined fortnight to a disciplined week, and with rolling settlement it now goes to a day. This means that trades net within the day. A person can buy 100 shares of ITC in the morning, sell 100 shares of ITC in the evening, and have to deliver no shares to the clearing corporation. However, if there is a net sell position of 100 shares at closing time, then shares have to be delivered a few days later.

SEBI initiated the scheme in 2000 with "T+5" rolling settlement, which means that settlement happens five working days after the trade date. Under 'T+5' rolling settlement, all open positions at the end of a date 'T' turn into delivery and payment five working days later. For example, trading commences on Thursday morning from a clean slate, and trades take place all through the day with "squaring off". The open positions present at the close of trading mandatorily result in delivery and payment on the coming Thursday.

With effect from 1st April 2002 the rolling period was reduced to T+3 and again with effect from 1st April 2003 it is further reduced to T+2.

Benefits of Rolling Settlement System

  1. To the Investor
    Earlier, before rolling settlement, the investr(seller) had to wait for one to two weeks for obtaining the money. With T+5 rolling settlement, the delay turns into exactly one week. It is easy and convenient to think "Shares sold on Thursday yield money on the next Thursday". With further shortening of the period from T+5 to T+2 the securities have become more liquid. It makes shares more attractive; investors would be more willing to supply risk capital in the country if they know that shares can be rapidly converted into cash when the need arises. For high networth investors, who actively trade at the exchange, the `velocity of trading' is higher owing to rapid turnaround under rolling settlement with short settlement delays.

  2. To the stock Market
    From the market point of view rolling settlement has eliminated the pricing glitches that use to take place on the expiration date of the earlier futures--style trading. There were frequent market crisis earlier These crises have a lot to do with the leverage and futures-market practices that used to prevail under the weekly settlement, in the absence of the knowledge of risk management and enforcement culture that are required to engage in leveraged trading. The way out is to use rolling settlement. With rolling settlement, highly leveraged trading only takes place intra-day. The leverage available overnight is limited to modest levels (like 2 to 2.5 times). This yields a robust and smoothly functioning stock market. The regulatory problems that we face on the cash market in India earlier, with futures--style settlement, belong on derivatives markets, not on the cash market. A transition to rolling settlement has helped sidestep the contentious issues about how leveraged trading on the cash market should take place.

    The path to rolling settlement is hence paved with (a) complete adoption of the depository, (b) `margin trading' facilities and (c) active derivatives markets. Once these three market institutions are well developed, rolling settlement would work much better.
    [Source Ajay Shah, Columnist, Business Standard]


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[ last updated on 15.10.2004 ]<>[ chkd-apvd-ef ]