T+1 Settlement is Coming to a Trade Near You
The Securities and Exchange Commission (SEC) is changing how a lot of companies do business in one important way. A change to trade settlement rules has been in the works for the past three years, but the SEC officially adopted the changes in February of last year. This past week, the changes started going into effect. The change we’re talking about is moving from a T+2 standard settlement cycle to T+1.
Here’s what you need to know:
Understanding Settlement
Before diving into the specifics of the change, let's clarify what settlement means. When you buy or sell a security in the public markets, settlement is the "official" transfer of securities and money. Since 2017, the standard settlement time for most security transactions has been T+2 (aka, trade date plus two business days). This means that if you purchase stock ABC on Monday, the transaction settles on Wednesday. During this interregnum, the delivery of the stock into your account and the payment for the stock out of your account are finalized.
The Big Change: T+2 to T+1
Starting May 28, 2024, the settlement cycle was shortened to T+1. This means that the same transaction in stock ABC if made on Monday, will now settle on Tuesday. This reduction from two days to one day might sound minor, but it represents a significant shift in how the financial industry operates.
Why This Change Matters
- Reduction in Risk: The shorter settlement cycle reduces counterparty risk, which is the risk that one party in a transaction might default before the transaction is completed. With a T+1 settlement, the window for potential disruptions is halved, enhancing the overall stability of the financial system.
- Increased Efficiency: Advances in technology have made security transactions nearly instantaneous, paving the way for this change. Most transactions between buyers and sellers are now fully automated, meaning the industry is well-equipped to handle a T+1 cycle without significant disruption.
- Enhanced Market Liquidity: Faster settlement times can improve market liquidity. When trades settle more quickly, capital and securities are freed up faster, allowing for more trades and increasing overall market activity.
Initial Adjustments and Monitoring
Despite what we anticipate to be a smooth transition given the technological advancements we just mentioned, the first few days and weeks after the change will be crucial. Broker-dealers should closely monitor trades to ensure settlements occur as expected. This heightened vigilance is necessary to address any unforeseen issues promptly and to maintain confidence.
Impacted Securities
The transition to T+1 will affect various security types, including:
- Stocks: Commonly traded shares of public companies
- ETFs: Exchange-Traded Funds, which are baskets of securities traded on an exchange
- Corporate Bonds: Debt securities issued by corporations
- Municipal Bonds: Debt securities issued by states, cities, or other local government entities
- Certain Mutual Funds: Investment funds that pool money from many investors to purchase securities
- Limited Partnerships: Partnerships that trade on an exchange
Preparing for the Change
While the shift to T+1 is largely facilitated by existing technology, it’s wise to stay informed and vigilant.
- Stay Updated: Keep abreast of any announcements or guidelines from the SEC and other regulatory bodies. The SEC’s detailed release and the Depository Trust & Clearing Corporation’s (DTCC) resources can provide valuable insights.
- Review Processes: Ensure that your trading and settlement processes are ready for the shorter cycle. This might involve updating software, training staff, or adjusting operational procedures.
- Communicate: Maintain open lines of communication with your broker-dealer or clients to understand how they are managing the transition and what you might need to do as either a broker-dealer or an investor.
The SEC's move to shorten the settlement cycle from T+2 to T+1 marks a significant step towards a more efficient and secure financial market. By reducing risk and increasing liquidity, this change is set to benefit investors and the market as a whole. As we navigate this new phase, staying informed and prepared will ensure a smooth transition and help you navigate the new landscape confidently.
For more details, you can refer to the SEC's official documentation and the DTCC's resources here and here.
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