In the realm of equity investing, executing a successful trade involves a series of interconnected processes. Settlement date is an integral part of every trade transaction that takes place. Understanding it is more than simply a formality. Whether you are just starting out or a seasoned trader, it is crucial to know the concept of settlement date to manage your financial assets efficiently and avoid common pitfalls.
The concept plays a fundamental role in the finalisation of trade and transferring ownership. This article is a walkthrough of the definition, history, types as well as working of the concept of the settlement period, offering a comprehensive insight into its importance.
What is settlement period?
The settlement period, also referred to as the settlement cycle, refers to the timeframe between the trade date and the settlement date in a securities transaction.
Trade date: The date at which you place an order to buy or sell the stock and make the required payment.
Settlement date: The date at which the trade is finalised and ownership of the shares is transferred.
Ever since trading was established, the industry has revolutionised in many aspects. It took another great leap in making trading cost—and time-efficient as technology upgraded and online trading was established. Now, for most securities, the settlement takes place in one business day from the date of order execution. It is also written as T+1 where T represents the transaction date.
History of settlement period
In the beginning, the settlement date was T+5 for most of the securities at the stock exchange. In 1993, the Securities and Exchange Board of India (SEBI) reduced it to three business days for most securities.
With the advent of online trading, the transactions of shares became an automated process. So, keeping in pace with the technology, in 2017, SEBI further reduced the settlement period to two business days. Today, the cycle has been further reduced, making it T+1 for most securities.
Types of settlement dates
There are different settlement dates for different types of marketable securities. Following are the two types of settlement dates known currently:
- Bonds, stocks and ETFs: The transfer of ownership for these stocks took place within 2 business days after the trade date. In 2022, SEBI announced that a new rolling settlement would take place in phases. Since February 2022, various batches of stocks have been implemented with the T+1 settlement cycle. Finally, from 27th January 2023, all the batch of securities consisting of stocks, bonds and debentures were moved to the T+1 settlement date.
- Mutual funds: The period of the settlement cycle for mutual funds depends on the chosen scheme. Based on the scheme, the trade cycle can be either T+1 or T+2. For example, debt and equity mutual funds settle within 1 day whereas other mutual funds such as gold mutual funds and hybrid mutual funds can have a settlement cycle of T+2.
How a settlement works
To illustrate, let us consider the situation of selling a stock. The following is what the working of a settlement process would look like:
- Once you sell stocks from your demat account, the shares become ineligible for further transactions. These shares are then earmarked for settlement.
- These shares are then transferred to the Demat account of the respective buyer within one business day after the date of the transaction.
- To process the pay-in, the reserved shares are debited from your demat account and moved to the clearing corporation.
- Your linked bank account is credited against the shares sold. This amount is credited to the bank account after the deduction of all applicable charges, namely, brokerage, transaction fees and the applicable tax.
Settlement period example
Settlement period can be understood with the help of an example. The scenario is as follows for T+2 Settlement:
- Trade date: Let’s assume that you purchase the shares of a company on Tuesday, 14th May 2024. This is the date when the transaction takes place.
-
- Settlement period: In this case, we assume the transaction period to be T+2 which means that the settlement would occur within 2 business days after the trade date.
- Settlement date: Since the cycle is for T+2, the next business day would be two business days from the trade date, that is 16th of May, Thursday.
On Thursday, the following events will take place:
- Shares of the company XYZ will be electronically transferred to your brokerage account.
- The legal ownership of the purchased shares would be transferred to your name.
If you would have sold the shares, you would receive 80% of the amount in your trading account immediately. The rest would be credited after the settlement is done. These funds can only be withdrawn once the transaction is completed i.e. after the settlement date.
