A new proposition by the National Clearing Company of Pakistan (NCCPL) may lead to trades on the stock exchange being completed in a 24-cycle. The current settlement period of stock trades on the PSX operates on a “T+2” system which means trades are settled over a two day period.
Under the current system, if you trade a stock on Monday it will appear in your portfolio by Wednesday. For that small window of two days no matter what happens to the price of the stock the trade is locked in. Under the new proposal trades would be settled within 24 hours of them being made. This is what would be known within the industry as a “T+1” settlement system.
The move to shift the PSX to this faster system comes after “T+1” has been adopted in other parts of the world. In recent times China and India have shifted to the new settlement model with the US and Canada also planning to do so in the near future. The benefits outlined by the clearinghouse in regards to this change are that there is a reduction of systemic risk present in the capital markets as reduced settlement period leads to a decreased chance of a transaction being left unsettled in a volatile market.
Furthermore, as the finances of the members are not held for too long a period, NCCPL believes that it will also increase the liquidity that is available to the trading houses while making sure market risk is minimized. The goal of this change is to bring the services of the company in line with international practices which will help in reduction of risk and improve the efficiency of the markets themselves.
At this point of time, the idea is in its infancy as there are considerations that have to be kept in mind in relation to the regulatory framework and technical issues that need to be resolved before implementation can take place.
However, the industry is less enthused about the idea.
“We are already having a difficult time in running after clients to procure the funds and this will make their task more difficult going forward,” Shehryar Butt, portfolio manager at Darson Securities.
But why is this so?
Sajid Tajri, researcher at Alfalah CLSA Securities Limited states that the settlement time used to be way bigger in the earlier days when banking processes were slow. In terms of efficiency, it is better that settlement time is reduced. However, he feels that clients are slow in depositing money with the brokers.
Traditionally, clients place an order with their broker and then send a cheque to the broker later in the day. As clearing of the cheque takes time, brokers have to put up the funds for a day or two on behalf of the client while their cheque is being cleared. The brokers hold debit balances in the accounts of the clients.
Experts of the industry feel that due to the slow nature of the banking system and the response of the clients, this move will increase the working capital requirement of brokers who are not able to get the funds from their clients in due time.
There is already a feeling that the banking system is not as efficient as it should be for T+2 settlement to work and if the settlement model is changed, this will further stress the system with clients taking longer to deposit their funds.
Fahad Rauf, Head of Research at Ismail Iqbal Securities feels that “it will help settle transactions a day early, saving interest costs, if the amount is borrowed.” He does feel that this move will improve risk management and will be a positive move for the market. Ali Nawaz, CEO at Chase Securities says “(this move) substantially reduced counterparty risk as the shorter settlement period minimizes the time period counterparties are exposed to credit risk, thus reducing the likelihood of default.” He also says that there will be improved liquidity and with lower margin requirements and reduced risk, the margin costs of the market participants will reduce.
He is still cautious on being overly optimistic as he feels that brokers will need to improve their efficiency and operational infrastructure with upgradation in technology to capitalize on the benefits of this model. In a similar vein,. Experts believe that the banking sector and infrastructure needs to be upgraded. This will allow for Interbank Funds Transfer (IBFT) and Real Time Gross Settlements (RTGS) to take place. Institutional and individual clients will then be able to transfer funds and comply with the T+1 settlement model.