Sebi proposes permitting trade netting for foreign portfolio investors

MUMBAI: The Securities and Exchange Board of India (Sebi) has proposed easing settlement rules for foreign portfolio investors (FPIs) by allowing them to net funds, a move aimed at lowering funding costs and improving operational efficiency in the cash market.

In a consultation paper released on Friday, the market regulator said it had received feedback from market participants that the existing settlement framework results in operational inefficiencies and higher liquidity requirements for FPIs.

At present, FPIs must settle all trades on a gross basis, even when purchases and sales occur on the same day. As a result, an investor that buys and sells securities of equal value is required to separately fund the purchase and deliver the sale, despite the transactions offsetting each other. While custodians ultimately settle on a net basis with clearing corporations, FPIs must meet their obligations in full, leading to higher temporary funding needs.

For example, an FPI that buys shares worth ₹100 crore and sells shares worth the same amount on a single day must still arrange ₹100 crore to meet its purchase obligation. This leaves the investor effectively underinvested by that amount for at least a day, even though sale proceeds would offset the purchase.

Earlier in the day, before the consultation paper was released, Sebi chairman Tuhin Kanta Pandey said at an event that the regulator was close to making its recommendations on fund netting public.

To be sure, the proposal only addresses outright transactions, which refer to those transactions where an FPI either buys or sells a security, but does not do both in a particular settlement cycle. Settlement of intra-day transactions in a single security would still be done on a gross basis.

The long-awaited move is expected to reduce funding costs for FPIs, particularly on index rebalancing days, when large buy and sell orders are executed in stocks entering or exiting an index. At the same time, by continuing to confirm non-outright transactions on a gross basis, Sebi aims to limit the risk of FPIs influencing markets through large positions.

Index rebalancing refers to the periodic adjustment of an index’s constituents and weights to reflect changes in market capitalisation, liquidity or eligibility criteria.

“Sebi intends to extend netting to FPIs which till now is available at the clearing member level. This is an excellent move and will reduce the double counting which occurs when an investor buys and sells, but doesn’t get credit for the sell leg against the obligations of the buy leg,” said Sandeep Parekh, managing partner at Finsec Law Advisors. “The proposal may make the Indian markets a bit more attractive as they would now become more efficient. But, efficiencies may not by themselves make the market immensely lucrative,” he added.

However, experts are divided over whether the proposals will make India's cash markets more attractive to foreign investors.

“India becomes a more promising market for global investors if FPIs are allowed to net their trades. It will also attract stable foreign capital amid FPI outflows,” said Khushboo Chopra, head of business development- India at IQ-EQ, a global investor services provider.

Market participants have flagged some potential risks. Under the proposed system, buy trades would depend on sell trades being confirmed correctly. If a sale fails to be confirmed, the corresponding purchase could also fail, requiring the broker to step in to complete settlement. There are also concerns about system delays on heavy trading days.

Sebi said safeguards are already in place to handle settlement failures and that netting could, in fact, reduce risk by lowering the total amount of funds involved. Custodians will be required to upgrade their systems to support the new process.

The draft paper is open for public comments until 6 February.