Over the last decade, India has implemented a number of positive measures, which have helped open up its vibrant domestic capital markets to foreign portfolio investors (FPIs).
Despite all of the recent turmoil, India’s reform zeal shows no sign of dissipating. Earlier in the year, India became one of the first economies to shorten its trade settlement cycle from T+2 to T+1, while discussions are currently underway on how to further streamline the FPI registration process. So what do these changes mean for global investors in India?
T+1 takes effect for listed domestic equities in India
While the US and Canada have decided to wait until 2024 before adopting T+1 for domestic equities, India is racing ahead with changes to its settlement cycle. Having previously operated a T+2 model, the Bombay Stock Exchange (BSE) and National Stock Exchange of India (NSE) have both been incrementally introducing a T+1 settlement cycle for equities listed on their respective venues on a bottom-up basis since February 2022.
Chaitanya Joshi, Head of Financing and Securities Services, India, at Standard Chartered, anticipates that all publicly traded equities in India will eventually settle on T+1 by January 2023. “However, we expect these changes will only impact the securities held by FPIs in September or October 2022,” he adds.
The decision by the Securities and Exchange Board of India (SEBI) to implement T+1 has been driven by a number of risk considerations. A shorter settlement duration will mean that investors incur less market and counterparty risk during the trading lifecycle, enabling them to benefit from reduced margin requirements and collateral optimisation.
With less capital trapped inside Central Counterparty Clearing Houses (CCPs), there will be greater liquidity available in the market.
Aside from unlocking liquidity, T+1 could also help drive efficiencies in post-trade processes, which have historically been heavily intermediated and manually intensive. A T+1 model will encourage intermediaries including custodians to enhance the existing technologies as well as adopt new ones, in what will help improve automation within the industry” says Chaitanya.
While shorter settlement cycles can facilitate operational synergies, there are risks, which will become increasingly apparent once T+1 is applied to more widely traded securities.
The Exchange & Clearing Corporation announced that the market cut off time for trade confirmations is 1930HRS on day T. Custodians and FPIs have highlighted this could result in challenges around settlement instruction timelines. Under T+2, the number of trade fails is negligible. A T+1 settlement cycle could possibly lead to an increase in fails, and with it, penalties. The T day cut off time also creates FX liquidity issues, which could see investors having to pre-fund their trades.
However, custodians and FPIs are looking for ways to remedy this situation. Industry associations including Association of Global Custodians (AGC) and Asia Securities Industry & Financial Markets Association’s (ASIFMA) have made representations to the Regulators & Market Infrastructure Intermediaries to consider a T+1 morning trade confirmation. Through a Custodian Group, a proposal has been submitted to the Exchange & Clearing Corporation for a cut-off time of T+1 at 0900HRS. A morning cut off time means clients can avoid pre-funding their trades, while it will also minimise the number of trades getting converted to hand delivery settlement.
Early indications seem to suggest that the Exchange & Clearing Corporation is sympathetic to the idea of permitting trade confirmations to take place on T+1 morning. If this is agreed and implemented, then such a move would also certainly make the settlement process easier for FPIs when trading Indian equities on the Stock Exchanges.
Putting the finishing touches on market access
SEBI has implemented a number of positive changes supporting easier market access for FPIs.
Most recently, SEBI consolidated the number of FPI categories from three to two; eased Know-your-customer (KYC) rules for Category 1 investors (i.e. government institutions, banks, broker-dealers, swap dealers, pension funds, insurance/re-insurance companies, asset managers); and relaxed the broad based criteria that will open up the FPI route to entities that were unable to meet this eligibility criteria.
Despite these marked improvements, there is still more work to be done. SEBI has eased the regulatory framework for FPIs relaxed certain KYC rules for FPIs – especially around things like documentation requirement for KYC. However, the Reserve Bank of India (RBI) is yet to make these changes to its own KYC rules and this has been highlighted to RBI by the industry. Such consistency will help simplify KYC, and reduce the amount of documentation required to enter the local market
Additionally, there have been temporary provisions in place allowing custodians to accept scanned documents for registration purposes from FPIs operating in markets subject to COVID-19 lockdowns.
Custodians are requesting that SEBI let them continue with the practice of accepting signed scanned documents as part of the FPI registration process while examining similar practices that may exist in other foreign jurisdictions.
A market with a positive future
Having introduced a raft of market reforms, India is becoming an increasingly popular investment destination for FPIs. ‘Also the increase in limits to invest in local debt markets via the Voluntary Retention Route (VRR) will help sovereign wealth funds, pension funds and global corporates to raise their investments in the Indian fixed income securities. We have emerged as a leading provider for this route used by Foreign Portfolio Investors.’ says Chaitanya Joshi.
If T+1 is deemed to be a success, and the country further simplifies documentation requirements for FPIs, we can expect to see an acceleration of capital inflows to the market.