This article first appeared in Capital, The Edge Malaysia Weekly on December 24, 2018 - December 30, 2018

EARLIER this month, Bursa Malaysia Bhd issued a consultation paper seeking public feedback on its proposed move to introduce a shorter securities settlement cycle of two days (T+2) from the current three-day cycle (T+3).

The proposed key changes — expected to be introduced by the second quarter of 2019 — include amendments to the cut-off times relating to the tradeable balance in the securities account, the delivery and settlement between a broker and its clients and between the broker and Bursa Malaysia Securities Clearing Sdn Bhd.

It would also require amendments to the applicable timing in respect of buying in, cash settlement, selling out and discretionary financing.

Bursa Malaysia explained that the review to migrate from a T+3 to T+2 settlement cycle was initiated to keep pace with changing market trends and the needs of market participants and investors.

One notable benefit of T+2, as highlighted by the local bourse, is that it will strengthen competitiveness in the marketplace through the harmonisation of post-trade infrastructure with major global exchanges in the US, Europe and Asia-Pacific, which already operate on the shorter settlement cycle.

Another benefit of T+2 is improved operational efficiency, as the shorter settlement period would make securities and funds available earlier to investors and reduce counterparty settlement risk as a result of the shorter exposure to unsettled trades.

This proposal is part of Bursa Malaysia’s ongoing efforts to reduce systemic risks and align the clearing and settlement processes of the Malaysian capital market with international practice.

So, what’s the catch? Well, nothing really, unless you are an excessive speculator who is not backed by a large pile of cash.
 

Contra trading

In theory, a longer settlement period would allow more people to speculate, whereas a shorter settlement cycle means less time and, hence, less opportunity for speculators to trade via contra trading.

A facility provided by brokerage firms, contra trading allows traders to buy and sell shares within three days without putting any money up front. Contra trading is often deemed risky as a trader could overtrade and suffer huge losses.

So, will T+2 discourage or encourage contra players to trade?

Some people are of the view that without T+3, there will be fewer contra players because T+2 makes it more difficult for contra traders to strategise their positions. But some quarters argue that contra players could still cope with T+2, although trading patterns would become faster.

Hong Leong Investment Bank Bhd dealer representative Frank Lin points out that the only market participant who will be adversely affected by T+2 is the T+3 contra player, as he has to settle a day earlier.

“It is true that contra players dislike a shorter settlement period in a weak market, but think of this in a different way. If a stock they chose has not performed or has gone south, it would be better to cut the position earlier than to stretch it. In my opinion, contra players will grumble but will continue to participate if the settlement period is shortened,” he tells The Edge.

GrandPine Capital Sdn Bhd head of research Alfred Chen concurs that T+2 would discourage contra players.

“Contra players are more daring to place a bigger bet in a T+3 settlement cycle than T+2 because a shorter time frame means more uncertainty. Contra players can increase their trading frequency with T+2, but why do that if you see less volatility?” he says.

Rakuten Trade Sdn Bhd vice-president of research Vincent Lau is of the view that contra players and market participants will adapt to T+2. Perhaps some will switch to margin trading.

“Contra players will indeed have to trade more and churn liquidity, which will benefit overall market vibrancy,” he says.
 

Taking the market to the next level

Other than the short-term impact on contra players, most industry experts are of the view that T+2 is the right move to curb excessive speculation.

Not only does a shorter settlement cycle reduce market volatility, but sales proceeds also accrue faster, which is fairer to sellers.

Mohamad Yasin Abdullah, chief operating officer and head of brokerage at Maybank Investment Bank Bhd, highlights that a T+2 settlement period is in line with other major global markets.

In Asean, this includes markets such as Thailand, Singapore and Indonesia, which have already implemented T+2.

“We support this initiative by Bursa Malaysia. A shorter settlement cycle will benefit investors as they will receive cash and shares one day earlier. This will reduce operational and systemic risks and improve efficiency in the financial system,” he says.

Rakuten’s Lau says T+2 is the right step forward as Malaysia’s equity markets will continue to evolve in line with other financial centres globally. “This will lead to higher market turnover, better operational efficiencies and reduce counterparty risks. Moreover, market participants would receive funds earlier and be given the opportunity to redeploy their funds or re-enter the market.”

Stockbrokers would also stand to benefit as their trading limit will be better utilised with the increased trading and turnover, says Lau.

GrandPine Capital’s Chen says T+2 is a good move to improve efficiency and fairness to every participant in the stock market.

“T+3 led to some brokerage firms or investment banks offering T+7 and even T+10 to selected clients. This is unfair to new investors who would be unaware that they are betting against investors who have double or triple the holding power they have in short-term trading. T+2 may increase fairness for market participants,” he says.

Hong Leong Investment Bank’s Lin believes that a one-day shorter settlement period would not make much of a difference in improving operational efficiency and reducing counterparty settlement risks.

“In a weak or dull market, it does not matter whether it is T+2 or T+3. In a highly volatile and bull market, the T+2 settlement will help generate more volume and liquidity, but only marginally as there is only one day difference,” he observes.

Lin says that looking back to when T+5 was cut down to T+3, trading volume was not adversely affected over the long run. In fact, together with other factors, trading volume has increased over the years.
 

Short-term impact on trading volume

GrandPine Capital’s Chen believes that T+2 could reduce short-term trading volume, as it could de-motivate investors.

“Short-term players will be afraid of settlement one day earlier, simply because they will have to close their position if they don’t have the capital to pick it up. They may trade with a smaller number of shares instead,” he says.

However, he acknowledges that in the long run, the Malaysian market is headed in a healthier direction with T+2.

“I prefer T+2, or even T+0, if Bursa Malaysia is planning to do so. I think it will keep local retail investors from speculation, at least keep them from using credit facilities for short-term trading. It’s too dangerous for them.

“If T+2 is the first step in Bursa going towards T+0, I would be happy to see this happen. Even if some retail investors want to make fast money from the stock market, they cannot gamble by borrowing capital anymore,” Chen adds.

Rakuten’s Lau says he has no preference for T+2 or T+3. But considering that it is currently still at the consultation stage, investors would be better informed and prepared for the change when it is implemented.

“A T+2 settlement cycle would potentially increase trading velocity as the cycle is being shortened. Market participants will adapt to the new norm just as when our market went from T+7 to T+3,” he says.

Asked for his preferance, Hong Leong Investment Bank’s Lin replies, “As a dealer’s representative of an investment bank, a shorter settlement period is always good from the angle of faster turnover, lower capital requirement, and reduced risk.”

Bourse playing catch-up

In a move to keep up with global trends and align itself with international standards, Bursa Malaysia is looking to reduce the settlement period from the current three-day cycle (T+3) to two days (T+2).

The settlement cycle refers to the number of days it takes to settle a stock market transaction. It starts with the trade date — referred to as “T” day — on which the buy or sell transaction occurs and the settlement date on which the exchange of cash and securities takes place.

The settlement date depends on the settlement cycle adopted by the market. Bursa Malaysia currently has a T+3 settlement cycle, which was implemented in December 2000.

Over the last couple of years, the global securities industry has moved to a shorter settlement cycle of T+2. The new securities settlement and depository framework system enables simultaneous settlement of money and securities.

For instance, the European Economic Area securities markets moved to the T+2 settlement cycle in 2014.

In Asia-Pacific, some markets are already in a T+1 and T+2 settlement cycle. Taiwan, India, South Korea, Dubai and Hong Kong have settled on a T+2 settlement cycle.

Australia and New Zealand migrated to a T+2 settlement cycle in March 2016, and the US market did it in September last year.

In Asean, Thailand implemented a T+2 settlement cycle on March 2 this year, followed by Indonesia on Nov 26 and Singapore on Dec 10.

Joining other developed markets, including the US, Europe and Hong Kong, as well as its counterparts in Southeast Asia, Bursa Malaysia is now playing catch-up by initiating a review of its current settlement cycle from T+3 to T+2.

The migration to a shorter settlement cycle is expected to increase efficiency, reduce settlement risk and market exposure, and also align the local bourse with international best practices of the leading global exchanges.

Japan’s stock exchanges will also shorten their stock settlement cycle by one business day from July next year, in a move to enhance their international competitiveness, four years after the plan was introduced.

It will apply to all Japanese exchanges, including the Tokyo Stock Exchange (TSE), Osaka Exchange, and Nagoya Stock Exchange.

TSE had said earlier this year that the T+2 system is “a recognition of the urgency and importance of realising a secure and efficient securities settlement system for enhancing the international competitiveness of Japan’s securities market”.

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