Malaysia will shorten its securities settlement cycle by the end of this year at the latest, according to Ungku Razak, deputy president of the Kuala Lumpur Stock Exchange (KLSE).

Razak told delegates at a custody and settlement conference on Wednesday that the KLSE had a specific launch date in mind for a T+3 securities settlement cycle and it "would be in December", adding that the exchange would start a mock run of the operations with industry participants soon. Malaysia currently runs on a T+5 settlement cycle.

"The move to shorten the settlement cycle from 5 days to 3 days will have a positive impact on the industry. While the change will impose some operational challenges, the benefits will be in the form of reducing risks for investors and minimizing risks to the settlement system," says Razak.

But under a T+3 environment, being able to quickly rectify discrepancies will become more important for custodians than under T+5 as the time for processing shortens. Malaysia at present allows transactions to be settled in two modes. One is institutional settlement system, or ISS; the other is ordinary trade settlement.

With ISS, once a trade is executed the broker will have to initiate the settlement and enter all transaction details into the system immediately, allowing custodians to view details of the trade on the screen and expediting the pre-matching process. Ordinary settlements, on the other hand, require custodians phoning brokers to do pre-matching, increasing the processing time and margin for error. Is that reason enough to make ISS mandatory? Not yet, says Razak.

"Right now there is no plan (to make ISS mandatory). It's optional at the moment. But we've been looking at the issue. It's not just a cost expense issue, we want to give investors the choice," he says.

Custodians prefer their clients choose ISS as their settlement option because it is more efficient and save the custodians on paper work. The downside is that it will cost more.

According to Shaik Ismail Hakim, manager of custody and clearing at HSBC in Malaysia, a sell order, or "transfer out", under ordinary transfer costs RM10 each transaction and nil for buy orders. With ISS, it costs RM25 each trade irrespective of the nature of the transaction. But apart from efficiency, ISS has other benefits, too, such as a longer processing window.

"The custodian banks as a group have called for the processing window to be extended when T+3 is introduced. While the processing window closes at noon for ordinary trades, it will be 5 pm for settlement done via ISS," he says.

Custodians are keen for clients to use ISS for settlement because it reduces paperwork. But some clients are concern about the cost as custodians are not likely to absorb it. Custodians are now hoping that, with the reduction in brokerage commissions in Malaysia and other countries, clients may find the lowered transactions costs in securities trading will compensate the increase in the settlement fee via ISS.