The Securities and Exchange Board of India (SEBI) has proposed easing settlement norms for foreign portfolio investors (FPIs) by allowing netting of funds in the cash market executed on the same day. The proposal is aimed at streamlining operations and cutting the cost of funding for FPIs.
The market regulator released a discussion paper regarding the same-day fund netting for FPIs on Friday. SEBI has sought comments on the proposal till Feb. 6.
“The transactions in securities with only outright sell or outright purchase shall be netted to arrive at a net fund obligation for outright transactions. The transactions in those securities where there are both buy and sell transactions for a given FPI in a particular settlement cycle shall be excluded from netting,” the SEBI paper said.
Under a fund netting mechanism, proceeds from an FPI's cash market sales on a given day can be used to pay for purchases made the same day, reducing the settlement obligation to a net figure.
Why It Matters To FPIs?
According to the consultation paper, the current settlement mechanism has drawn criticism from market participants for creating operational bottlenecks and higher liquidity requirements for foreign portfolio investors.
Currently, foreign portfolio investors are required to settle trades on a gross basis, even when buying and selling the same value of securities on a single day. This means investors must fully fund purchases and deliver sales separately, despite the positions cancelling each other out. Although custodians later settle net amounts with clearing corporations, FPIs face higher interim funding requirements.
The regulator clarified that the proposal pertains solely to outright transactions, defined as instances where an FPI either purchases or sells a security within a given settlement cycle. Intra-day buy-and-sell activity in the same security would still require gross settlement.
Market participants expect the long-awaited proposal to lower funding pressures for FPIs, notably during index rebalancing days that trigger heavy buying and selling in constituent stocks. By keeping non-outright transactions on a gross settlement basis, SEBI is also seeking to curb the risk of investors exerting undue influence through large positions.
The term index rebalancing describes periodic changes made to an index's composition and weight allocations to reflect evolving market values, liquidity conditions and inclusion criteria.
During consultations with custodians, clearing houses and exchanges, stakeholders raised concerns about operational risks, including the prospect of more trade rejections where sale transactions are not confirmed. They also flagged the possibility that settlement risk could migrate from FPIs to custodians due to timing differences, particularly on heavy trading days.
However, SEBI outlined that the existing safeguards, including the default waterfall mechanism and the Core Settlement Guarantee Fund (SGF), help mitigate these risks. The regulator also highlighted that custodians currently settle net obligations with clearing corporations, and no changes are being proposed to confirmation or settlement processes.
Upgrades to custodian systems will be necessary to support the new arrangements.
SEBI emphasised that gross settlement between FPIs and custodians will remain in place. Consequently, STT and stamp duty obligations will continue to be levied on each delivery.
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