Even in an age of instant communication and live financial data, investors have long had to wait days to take ownership of the stocks they purchased or to receive payment for the stocks they sold. No longer. As of May 28, US stock trades “settle” (complete the exchange of dollars for stock) in one day rather than two. US banks, brokers and investors were forced to review all of their post-trade technologies and procedures to ensure they were ready for the new pace of stock trading. The change poses a special challenge to investors outside the US who need to buy dollars as part of their stock trades.
1. What’s the background?
Stock trades before the computer age involved the physical exchange of stock certificates, which often took five days or more. That became a problem in the late 1960s as the stock market finally climbed its way back to its 1929 peak. As public participation in the stock market increased, trading volume skyrocketed to 12 million shares a day in 1970 from 3 million a day in 1960. With the industry’s growth prospects threatened by a “paperwork crisis,” the New York Stock Exchange created a central clearinghouse that would hold the millions of certificates owned by its member firms. That set the stage for transactions to become computer-automated.
Wall Street has returned to T+1 stock trading for the first time in a century. @rachelevans_ny explains what it means for markets https://t.co/r41ZgaoOQ8 pic.twitter.com/Py7qX8XE18
2. How did the clearinghouse speed up stock settlements?
Transferring ownership among members of the clearinghouse required only a “book entry,” eliminating the need to physically transfer shares. The Securities and Exchange Commission has been gradually shortening the settlement cycle since the early 1990s, from five days to the “T+2” implemented in 2017, where the T stands for the “trade” or “transaction” date. The shift to T+1 means retail and institutional investors now get the proceeds of their transactions in a matter of hours.
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3. What’s behind the change to T+1?
The “meme stock” trading frenzy in early 2021 highlighted the need to update the market infrastructure that transmits and settles stock trades. As amateur traders prompted by social media postings bought up shares of inexpensive stocks like GameStop Corp. and Bed Bath & Beyond Inc., operators of retail trading platforms like Robinhood Financial Inc. had to post collateral for those trades during the two days it took to settle them. As the prices rose along with the stocks’ volume and volatility, Robinhood started to restrict the purchasing of those stocks to ensure it had enough capital to cover the collateral. That drew loud rebukes from retail traders and scrutiny from regulators and members of Congress.
4. Why the need for collateral?
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Brokers are required to 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 that high volumes or volatility will force a broker to restrict trades. (US Treasuries and mutual funds 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 finalized, 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.
“Transition to a shorter settlement cycle may lead to a short-term uptick in settlement fails and challenges to a small segment of market participants,” SEC Chair Gary Gensler said in a written statement a week before the changeover.
However, there was no obvious sign of tumult during the early T+1 trading hours in New York as industry groups, banks, brokers, investors and regulators closely tracked the impact of the transition on the market.
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The Investment Company Institute, a trade group that’s helping to coordinate the transition, said on the first T+1 trading day that it was “confident we will continue to see smooth execution” of trades.
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 ($10.12 trillion)-dollar-a-day global market for currency exchanges, which typically take two days to complete. Many overseas institutions trying to buy US assets will need to secure dollars in advance to ensure they have them in time to complete a transaction. Failure to do so might cause some purchases to fall through entirely. The European Fund and Asset Management Association, which represents firms managing €28.5 trillion, has warned that as much as US$70 billion of daily currency trading could be at risk from a faster US settlement cycle.
Brokers and investors in Asia face a particular time crunch to be able to execute their trades by the US market close so they meet the industry’s 9 p.m. New York time deadline for trade “affirmation,” the last step before settlement. FX liquidity dries up in the US afternoon, when other markets are shut.
Some funds, such as Baillie Gifford, have chosen to move traders to the US. Others like Jupiter Asset Management are purchasing dollars in advance, while yet more will look to outsource their FX trading. All options come with costs. More than half of European financial companies with fewer than 10,000 staff are planning to either move people to North America or hire overnight staff, a survey sponsored by the DTCC found last year.
8. Why not T+0?
Gensler has said that modern technology could shorten the transaction process “to same-day settlement (T+0 or T+evening).” That would further reduce the risk that one part or the other would default before settlement. But the Securities Industry and Financial Markets Association, the trade group known as Sifma, says that such a change would require expensive modifications to market operations. The group said T+0 could result in many more “failed trades” and fraud because there would be less time to fix incorrect settlement instructions or spot compliance problems.
9. What are banks watching for?
Banks are carrying out their transition plans to keep on top of any potential hiccups. They’re paying particular attention to the double-settlement day on May 29 — when US trades from the old T+2 cycle will come due at the same time as the first batch of T+1 trades — and preparing for some of the world’s major indexes to rebalance their lineups at the end of the month, just days after the shift.
T+1 is also changing banks’ longer-term decisions: The securities services arm of Societe Generale SA, for example, is among non-US institutions extending the hours for some staff, while Citigroup Inc. is moving part of its team in Kuala Lumpur to a Tuesday-through-Saturday schedule instead of a typical Monday to Friday one to better align with the US trading week.
10. Are other countries making the change?
Yes. India is already on T+1, and regulators have approved a soft launch of same-day settlement in 25 stocks, as it attempts to lure back retail investors who’ve been shunning direct bets on shares in favor of more complex derivative products. China’s markets operate with a mix of same-day to T+2 settlement speeds. Canada and Mexico shifted to T+1 on the same day as the US. The UK plans to move to T+1 no later than 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.
The Reference Shelf
- One of Europe’s largest clearing houses is warning of more failed trades if the region follows the US and moves to T+1.
- Bloomberg Opinion columnist Matt Levine writes that T+1 means asset managers will have to spend a day lining up their money before they can hit the “buy” button for stocks, a departure from how trading has been done.
- Bloomberg Intelligence says the US move to T+1 may end up costing investors US$31 billion a year.
- The DTCC’s guide to the T+1 change.
