Despite instant communication and live financial data, investors must wait several days to acquire ownership of purchased stocks or receive payment for sold stocks.
Beginning May 28, US trades will settle in one day instead of two. This change prompts US banks, brokers, and investors to update their post-trade technologies and procedures. It also presents a challenge for international investors who require dollars for stock trades.
1. What’s the background?
Before the computer age, stock trades required the physical exchange of certificates, often taking over five days. In the late 1960s, as the stock market rebounded to its 1929 peak, trading volume surged from three million shares daily in 1960 to 12 million in 1970, leading to a “paperwork crisis.” The New York Stock Exchange established a central clearinghouse to address this, laying the groundwork for computer-automated transactions.
2. How did the clearinghouse speed up stock settlements?
Ownership transfers within the clearinghouse now rely on simple “book entries,” eliminating physical share transfers. Since the early 1990s, the Securities and Exchange Commission has steadily shortened settlement cycles from five days to the current “T+2,” where “T” represents the trade date. Moving to “T+1” will ensure retail and institutional investors receive transaction proceeds within hours.
3. What’s behind the change to T+1?
The “meme stock” frenzy in early 2021 underscored the urgency of updating market infrastructure for transmitting and settling stock trades. Amid amateur traders fuelled by social media, platforms like Robinhood Financial had to secure collateral for trades on stocks like GameStop and Bed Bath & Beyond, which took two days to settle. Rising prices, volume and volatility prompted Robinhood to restrict stock purchases, eliciting criticism from retail traders and scrutiny from regulators and Congress members.
4. Why the need for collateral?
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Brokers must post collateral, also known as margin, in a fund held by the Depository Trust & Clearing Corp — the modern Wall Street clearinghouse for stock trades. This way, both sides of a trade are protected if one party defaults or fails to hold up its commitment.
5. What are the benefits of T+1?
The SEC has said that a shorter settlement window means lower odds that the buyer or seller might default before the transaction is completed. That translates to lower margin requirements for the broker and a lower risk of high volumes or volatility, forcing a broker to restrict trades. (US Treasuries and mutual funds have already settled at T+1.)
6. What are the challenges for T+1 in the US?
The SEC has also said that T+1 could increase some operational risks. As the new rule was being finalised, SEC Commissioner Mark Uyeda said that speeding up settlements would mean less time for participants to address errors in the transaction process and for regulators to block the potential proceeds from frauds, among other challenges.
7. How about outside the US?
The halving of the time it takes to settle equity transactions will put US stocks out of step with the US$7.5 trillion ($10.1 trillion) a day global market for currency exchanges, which typically take two days to complete. Many overseas institutions trying to buy US assets must secure dollars in advance to ensure they have them in time to complete a transaction.
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Failure to secure dollars in advance could result in some purchases falling through entirely. The European Fund and Asset Management Association, representing firms managing EUR28.5 trillion ($41.5 trillion), has cautioned that a faster US settlement cycle could jeopardise up to US$70 billion of daily currency trading.
Brokers and investors in Asia must rush to execute trades before the US market closes to meet the industry’s 9 pm New York deadline for trade affirmation, the final step before settlement. FX liquidity diminishes in the US in the afternoon when other markets are closed.
Some funds, like Baillie Gifford, relocate traders to the US, while others, such as Jupiter Asset Management, pre-purchase dollars or opt to outsource FX trading, each incurring costs. A DTCC-sponsored survey last year revealed that over half of European financial firms with fewer than 10,000 staff plan to move personnel to North America or hire overnight staff.
8. Why not T+0?
SEC Chair Gary Gensler suggested leveraging modern technology to achieve same-day settlement (T+0 or T+evening), reducing default risks. However, Sifma argues that such a change would necessitate costly market operation modifications, potentially leading to more failed trades and fraud due to limited time for error correction and compliance checks.
9. What does the industry say about the move to T+1?
Financial trade groups, including the Investment Company Institute, affirm that their industry is well-prepared for the transition. Despite requests for an extension until September, the SEC has indicated no intention of changing the May deadline as it finalised the transition rule in February 2023.
“It is the industry, and not the regulators, who will do the work to shorten the cycle and rushing the implementation for no apparent reason will only add risk when the underlying goal is to mitigate risk,” Sifma said after the SEC finalised its rules.
10. Are other countries making the change?
India is already on T+1 settlement, with regulators approving a soft launch of same-day settlement in 25 stocks to attract retail investors back to direct share investments. China’s markets have varying settlement speeds from same-day to T+2. Canada and Mexico are set to transition to T+1 in May, while the UK aims to shift by the end of 2027.
The US is also pressing the European Union to align with T+1, and the bloc’s financial regulation chief, Mairead McGuinness, has said the “question is no longer if, but how and when” the bloc will make the move. Australia is also weighing a move to T+1. — Bloomberg Quicktake
