What is the Settlement Period?

In the capital market, every transaction undergoes a life cycle beginning with placing a purchase or sale order, negotiation, price fixation, and concluding with transaction settlement. This is also known as a trade life cycle. The settlement period forms an essential component of any trade life cycle.

The meaning of settlement period is the time between the execution of a transaction and the final settlement. Execution of a transaction is the fixation of transaction terms between contracting parties and the final settlement is the performance of the contract.

To define the settlement period, the duties and obligations of the buyer and seller are evaluated. The buyer of the securities is liable to make the payment agreed upon by both parties to the seller whereas the seller must deliver the securities. Both individuals need to execute their obligations for the transaction to be complete. The period taken by both parties to perform their respective obligation is the settlement period. The end of the transaction is connoted by the ownership of the securities by the buyer.

What is the typical amount of time involved in a settlement period?

The settlement period varies according to the type of security and ranges anywhere between one to three days. For listed securities, the settlement period is comparatively lesser and clearly defined for each type of security by the corresponding governing authority. Any delay in a settlement beyond the period stipulated is considered to be a default and may attract a penalty. A fine or interest may be levied till the date of transaction completion.

The settlement period is a function of ‘T+’ days where ‘T’ refers to the date of the transaction. For example, if the settlement period of a transaction is T+2 days, it implies two days from the date of the transaction. In such a case, the transaction must be completed within two days i.e., the ownership of the securities and agreed-upon consideration is to be transferred to the buyer in the specified timeframe.

Technology’s part in reducing the settlement period

Initially, securities were traded physically where the seller had to physically deliver the stock certificate either by hand or by post to the broker. The broker would further hand over physical securities to the seller. The seller would make payments only upon the delivery of such physical certificates. The physical settlement would also be subject to bad deliveries and delays. Hence, in such times, the settlement period was as high as T+5 days. However, it was later reduced to T+3 days to improve the efficiency of trading.

The advent of technology has resulted in transacting efficiency where funds are transferred electronically in real-time. Most brokers require their clients to maintain sufficient funds before entering into a transaction. Most physical securities have been transferred into an electronic form and are maintained in a Demat account with a broker. Trades are entered electronically and backed by periodic account statements. Paper securities are almost eliminated. The manual intervention has been reduced significantly and the process of trading is now highly automated.

However, the settlement period definition continues to remain the same for brokers, traders, and investors. Currently, the settlement period in India is T+2 days. Hence, if a transaction is done today, the seller receives funds electronically within two trading days. Similarly, the seller receives the securities within two trading days of entering into the transaction.

How does the Settlement period Work?

The settlement period is complete only once the seller has transferred the ownership of securities and the buyer has made payments for the same. Any delay or error in the performance of duties by either party leads to an extension in the settlement period. The broker acts as a middleman and aids the smooth execution of the obligations of both parties.

SEBI Mandate for Settlement

SEBI regulates and monitors the pay-in and pay-out day settlement mechanism for securities. The pay-in day is the day when the broker makes payment or delivers securities to the exchange whereas the pay-out day is the day in which the exchange fulfills its obligations to the broker. The exchange has to ensure the payout of funds or securities is done within 24 hours of payout. Brokers are required to make payments or deliver securities within two working days of the pay-out day. SEBI issues various such guidelines which are to be adhered to by each party involved in any settlement transaction.