Only three or four years ago, investors in India were not confident that their trades would settle at all. Even if they did, investors then had to wait weeks for the transfer to be registered and the cash or stock to be delivered. Yet on 19 December last year the Securities and Exchange Board of India (SEBI) set a target date of April 2002 to shorten the rolling settlement cycle from T +5 to T + 3. What accounts for its confidence? One factor is the smooth operation of the central securities depository – the National Securities Depository Limited (NSDL) – since it was put in place in 1996. Established in Bombay by the State-owned financial institutions which own the National Stock Exchange, by the end of last year the NSDL had in just three years completely eliminated paper securities from the equity market and replaced them with electronic book entry transfers. The fixed income market, which is still predominantly paper-based, is scheduled to go paperless by the third quarter of 2002. Registration of stock transfers now takes place on settlement date. In addition, both the National Stock Exchange and its rival, the Bombay Stock Exchange, have introduced central counter-party clearing corporations (CCPs) backed by settlement guarantee funds. “The securities settlement infrastructure in India has improved beyond recognition,” says Hari Chaitanyi, Director and Head of Custody Services at Deutsche Bank in Bombay.
In fact, the Indian market is so buoyant that it has spawned a second CSD. Its origins lie in the fierce rivalry of the 1990s between the nationwide, screen-based National Stock Exchange and the then localised Bombay Stock Exchange. Both markets are now screen-based, and nationwide, which has if anything intensified the competition between them. In late 1999, the brokers who own the Bombay Stock Exchange opened the rival Central Depository for Securities Limited (CDSL). Its four-year head-start ensures that NSDL still dominates depository services in terms of assets on deposit and in number of accounts. But since the Bombay Stock Exchange developed a nationwide trading network five years ago the two CSDs have begun to compete keenly to hold and settle transactions in the most liquid shares. “To some extent, having two CSDs makes our life as custodians more difficult,” admits Hari Chaitanyi of Deutsche Bank. “We have to maintain two interfaces, and cope with differences in their operating procedures, so it is a complication.” According to another market intermediary, in practical terms the implications have not been that great because 90 per cent of the institutions have accounts at NSDL. Very few transactions are actually going through CDSL.”
Despite this robust infrastructure, and lively pair of competitors at the trading level, switching to rolling settlement on T + 3 will not be easy. The first moves towards rolling settlement did not begin until 2000. Until then India had settled all bargains at the end of a seven-day account period (which was earlier cut from an antediluvian fourteen days). The first serious effort to shift settlement on to a shorter rolling timetable, in the shape of specifying a group of relatively illiquid stocks as the first candidates for rolling settlement on T + 5, was made as recently as last year. But SEBI has understandably adopted a cautious approach, for the good reason that an over-hasty adoption of rolling settlement risked alienating important local players. “There was considerable resistance to rolling settlement in the Indian market among local brokers and institutional investors concerned that liquidity would be adversely impacted,” explains Hari Chaitanya, Deutsche Bank. “Until recently, there was no derivatives market, and no proper securities lending and borrowing market, only a rather ingenious account period settlement system in which shares bought and sold in one five day period settled in the following week. So liquidity was thought to depend heavily on speculative trading activity within the account period. There was an understandable fear that moving to rolling settlement would lead to a sudden drop in trading volumes.”
So it was in order to test the impact on trading activity that in January 1998 SEBI chose fifteen relatively illiquid stocks as the first to be settled on a rolling basis, and allowed the account period to run in parallel for the rest of the market. Encouraged by the limited impact on trading activity, in June 2001 SEBI announced that it considered the entire Indian market ripe for a move to rolling settlement on T + 5. Around 400 of the most liquid stocks were slated to move on to the new rolling settlement timetable immediately, with the rest to follow from January 2002. (Of the 5,000-plus stocks listed in India, only a fifth are traded actively, and both foreign and local investors concentrate most of their activity in half of this number.) “From this month, the market has gone over completely to rolling settlement on T + 5,” says Chaitanyi. “Now SEBI has announced that, having reviewed how the market has worked over the last six months, it is ready to move all stocks on to rolling settlement on T + 3 from April 2002. “
One measure of how far India has come over the last five or six years is that nobody believes the new timetable is unattainable, at least in terms of the quality of the securities market infrastructure. The one obvious obstacle to success is a rickety process of information exchange between the two stock exchanges, the brokers, the investors and global and local custodians. “All of these parties are not on the same information backbone,” explains Chaitanyi. “They all use different means of communication to exchange and confirm the details of a trade.” T + 3 will be difficult to achieve unless information can flow faster and more seamlessly between the various parties, especially when custodians are dealing with foreign institutional investors based in time-zones measured in hours away, and therefore unable to respond until at least T +1. The biggest problem is that Indian brokers are not yet allowed to use SWIFT, forcing them to use proprietary networks or the public telephone system. Partly as a result, the Indian banks have tended to use SWIFT for cash transfers only, ignoring the securities message types. But Chaitanyi is hopeful of change. “There is a lot of awareness of the usefulness of allowing more intermediaries to use SWIFT, and it is slowly being adopted by more players. We expect to see some changes in that area as well.”
A much larger problem is the inadequacy of the cash payment process. “On the securities settlement side, the Indian market is as efficient as you will find anywhere,” says Chaitanyi. “The weak link is the payment process, because it is still physical. The real challenge now for the regulators is how quickly they can develop and introduce a limited form of electronic funds transfer. They say they are working on it, but the question is whether they will have a solution in place by April this year in time for T +3.” Clearly, the tighter T + 3 timetable is incompatible with the physical transfer of funds. At present, any cheque larger than Rupees 100,000 (around US$2,000) can be cleared by 3.30 p.m. the same day provided it is presented before 11.00 a. m. and both account-holders are in a major business district such as Bombay. But payments between counter-parties in different parts of the country depend on the vagaries of the postal system. Though the central bank provides a same-day electronic transfer facility between its own accounts in every key city throughout India, it does not yet link the commercial banks. “What they have not been able to achieve is electronic connectivity between all the banks and the central bank,” explains Chaitanyi. “So any transfer of cash between the banks and the central bank is still physical.” He suggests the authorities focus first on Bombay, where almost all the major securities market players are based. “It would cover 80 per cent of requirements,” says Chaitanyi.
It is a shortcoming SEBI would be wise to fix soon, for India is attracting a small but rising tide of foreign capital. Though the Indian economy was opened to foreign investment in 1992, it has remained a relatively closed economy thanks to non-convertible currency. A happy side-effect is that India escaped the worst of the Asian Flu of 1997-98. “As they say here, India missed the crisis, but India also missed the boom,” jokes one market player. In particular, India escaped the sudden hiatus in foreign portfolio (and direct) investment from which the Asian Tiger economies have yet to recover. The country has taken in a net average of US$1 billion a year in portfolio investment since the crisis. Despite another stock market scam during the year, the near-total collapse of technology stocks – on which the Indian market is heavily dependent – and the setback of 11 September, 2001 saw net investment climb to $2 billion. Certainly the foreign custodians seem more hopeful of winning sub-custody business in India than in some other markets in Asia. In terms of agent bank offerings, India is highly competitive, with Citibank, Deutsche Bank, HSBC, Standard Chartered all competing fiercely for both sub-custody and domestic custody and fund administration business.