The US Stock Market Speeds Up:

All You Need to Know about the Shift to "T+1" Settlement

Bloomberg cleverly notes that the US stock market is now as quick as it was about a hundred years ago. This is because share trades in New York will settle in a single day, starting Tuesday, following new SEC rules. This is a significant change from the past century. This change, which reduces the time it takes to complete every transaction by half, is also taking place in Canadian and Mexican markets starting Monday. For some investors, one-day settlement cycles may offer more convenience. However, for others, T+1 may necessitate a closer look at how shorter settlement times could impact their investment, trading, or tax decisions. It also means that settlement will still take about 24 hours longer than any single crypto transaction, all of which settle instantly and securely thanks to the blockchain. Indeed, even in this era of instant communication and real-time financial data, investors have had to wait at least two days to take ownership of the stocks they purchase or to receive payment for the stocks they sell. That’s about to change.

Starting today, May 28,

US trades will “settle” (complete the exchange of dollars for stock) in one day rather than two.

US banks, brokers, and investors have had to revisit all of their post-trade technologies and procedures to ensure they are prepared for the new pace of stock trading. This change poses a unique challenge to investors outside the US who need to buy dollars as part of their stock trades.

 

The transition to the system known as T+1, which was abandoned in the past as volumes became unmanageable, aims to reduce risk in the financial system. However, there are concerns about potential initial issues, including that international investors may struggle to source dollars on time, global funds will move at different speeds to their assets, and everyone will have less time to rectify errors. Even though the expectation is that everything will function smoothly, the SEC warned last week that the transition might lead to a “short-term uptick in settlement fails and challenges to a small segment of market participants.” The Securities Industry and Financial Markets Association, the finance world’s primary industry group, has established the T+1 Command Center to identify problems and coordinate a response. Here is a helpful primer from Bloomberg on the origin of the change and what it will mean for markets.

1. Background Before the computer age:

stock trades involved the physical exchange of stock certificates, which often took five days or more. This became an issue in the late 1960s as the stock market finally recovered to its 1929 peak. As public participation in the stock market increased, trading volume soared to 12 million shares a day in 1970 from 3 million a day in 1960. The New York Stock Exchange created a central clearinghouse to hold the millions of certificates owned by its member firms to avoid a “paperwork crisis” that threatened the industry’s growth prospects. This paved the way for transactions to become computer-automated.

2. How did the clearinghouse speed up stock settlements?

The need to physically transfer shares was eliminated by only requiring a “book entry” to transfer ownership among members of the clearinghouse. The Securities and Exchange Commission has been gradually shortening the settlement cycle since the early 1990s, from five days to the current “T+2,” where the T stands for the “trade” or “transaction” date. The shift to T+1 means retail and institutional investors will receive the proceeds of their transactions within hours.

3. What’s behind the change to T+1?

The “meme stock” trading frenzy in early 2021 underscored the need to update the market infrastructure that transmits and settles stock trades. As amateur traders encouraged 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 began to limit the purchasing of those stocks to ensure it had enough capital to cover the collateral. This drew strong criticism from retail traders and scrutiny from regulators and members of Congress.

4. Why the need for collateral?

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 protects both sides of a trade if one party defaults or fails to fulfill its commitment.

5. What are the benefits of T+1?

The SEC has stated that a shorter settlement window reduces the chances that the buyer or seller might default before the transaction is completed. This means 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 settle at T+1.)

6. What are the challenges for T+1 in the US?

The SEC has also noted that T+1 could increase some operational risks. As the new rule was being finalized, SEC Commissioner Mark Uyeda stated 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.

7. How about outside the US?

The time it takes to settle equity transactions will be halved, putting US stocks out of step with the $7.5-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 $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 closed. 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 stated that modern technology could shorten the transaction process “to same-day settlement (T+0 or T+evening)”, especially if blockchain is used to enable instant settlement. This would further reduce the risk that one party would default before settlement. However, the Securities Industry and Financial Markets Association, the trade group known as Sifma, says that such a change would require costly 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 doing to prepare for T+1?

Financial trade groups like the Investment Company Institute have said their industry is ready for the transition. Banks have created transition plans to manage any potential hiccups. They’re paying particular attention to a so-called 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 affecting banks’ long-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 are set to make the shift to T+1 in May. 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 considering a move to T+1. The shift to T+1 settlement is a significant change in the financial industry, bringing both benefits and challenges.

It will be interesting to see how this transition unfolds and what impact it will have on the global market. What are your thoughts on this change? Share this article with your friends and sign up for the Daily Briefing, which is every day at 6 pm.