London December 2 2024: Even in an age of instant communication and live financial data, investors have had to wait days to take ownership of the stocks they purchased or to receive payment for the stocks they sold. No longer. Since May 28, US stock trades have “settled” in one day rather than two. Global 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 has posed a special challenge to investors outside the US because global currency trading — as well as many local stock markets — still typically settle on a two-day standard.
How did we get here?
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.
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. (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.
What’s behind the change to T+1?
The “meme stock” trading frenzy of 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 such as 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 purchases 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.
Why the need for collateral?
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, known as the DTCC. This way, both sides of a trade are protected if one party defaults or fails to honor its commitment.
What are the benefits of T+1?
The SEC 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.)
Has the shift to T+1 been a success?
Apart from a few teething problems, it’s gone well. Gauges of trade failures even dipped below recent averages, pointing to a smooth transition.
That said, the switch has brought significant costs for financial firms, which needed to overhaul arcane back-office processes and relocate some traders across oceans. The scale of the changes caught out some market participants, according to a Citigroup Inc. poll. The impact appears to have been felt unevenly, with the likes of asset managers hit with higher funding costs, while banks and other intermediaries have seen expenses drop.
How about outside the US?
The halving of the time it takes to settle equity transactions puts US stocks out of step with the $7.5-trillion-dollar-a-day global currency market, where trades typically take two days to complete. Many overseas institutions trying to buy US assets now need to secure dollars in advance to ensure they have them in time to complete a transaction, or they rush the trade through, creating the risk of errors.
Brokers and investors in Asia and Europe face a particular time crunch: They must be able to execute their trades by the US market close so that they meet the industry’s 9 p.m. New York time deadline for trade “affirmation,” the last step before settlement. The trouble is, foreign-exchange liquidity dries up in the late US afternoon, when other markets are shut. Some asset managers, such as Baillie Gifford, have chosen to move traders to the US. Others, such as Jupiter Asset Management, are purchasing dollars in advance, while yet more have been looking to outsource their foreign-exchange trading.
There are also complications for investors whose portfolios span multiple jurisdictions. For instance, when you fund a purchase of a US stock with the sale of a European one, the cash from the sale will arrive a day after the US payment is due.
Are other countries moving to T+1?
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 weekend as the US. The European Union’s markets regulator has proposed an Oct. 2027 transition to T+1, which aligns with the UK’s planned timeframe.
Why not T+0?
SEC Chair Gary Gensler has said 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 trade group 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.
