The US T+1 Trade Settlement Cycle
Part one of our T+1 trade settlement series
Capital markets across the globe are gearing up for a seismic change in the post-trade settlement cycle, as the United States transitions to a shortened T+1 settlement cycle. On 28 May 2024, the fastest trade settlement cycle in the ‘developed’ world will become effective.
The switch to T+1 trade settlement in the US is a culmination of progressive post-trade structural transformations that have been in play before the start of the century, as capital markets have become more dynamic and technologically advanced. Before the era of electronic trading, where physical stock certificates were delivered by mail, the SEC allowed for five business days for securities transactions to settle. Five days became three in 1993 as electronic trading started to gain further traction allowing for greater market efficiencies. In 2017, the SEC further shortened the trade settlement cycle to T+2, which has remained in force to this day.
T+1 settlement, effective in May 2024, brings excitement, confusion, and uncertainty for capital market participants. Over the coming days, GreySpark Partners will cover several aspects of the US T+1 transition, including what it is, its significance and its implications for capital markets firms.
What is T+1 Trade Security Settlement?
T+1 trade settlement means that any security trade-related settlements must be completed within one day of the transaction. In this instance, ‘securities’ includes US equities, corporate debt and unit investment trusts, of which a full list can be found here. In the ‘T+1’ abbreviation, ‘T’ stands for the transaction date. For example, imagine a scenario where a fund manager purchases shares of a company on Monday 8 January 2024. While the broker would debit the investor’s account for the total cost of the investment immediately after the order is filled, the investor’s status as a shareholder will not be settled in the company’s record books until Tuesday 9 January 2024. The most common standard for securities trade settlement is T+2, with jurisdictions such as the EU and the UK currently relying on a T+2 trade settlement cycle. Intuitively, one might think that moving from T+2 to T+1 settlement would half the post-trade settlement time. However, due to time zone differences, the Association for Financial Markets in Europe (AFME) anticipates an even greater fall in settlement times for some market participants. In some parts of Europe, for example, trade settlement will go from approximately 12 core business hours between the end of the trading window and start of the settlement window to only two hours.
Who is Impacted by the New Trade Settlement Cycle in the US?
All financial firms who partake in and facilitate the trading of US-listed securities, irrespective of global location, will have to comply with accelerated settlement when it goes live later this year. Retail investors will be able to benefit from quicker access to cash when their trades are executed.
As suggested, the shortened trade settlement cycle will lead to a significant fall in trade settlement times for some market participants across different jurisdictions. The shorter cycle will mean that clients will be required to complete trade allocations, confirmations and affirmations as soon as possible – and no later than 9pm on the trade date, US Eastern Time. That is 2am in the morning UK time, or 9am the next day in Hong Kong or Singapore. Collectively, this poses an enormous challenge for the capital markets industry, leaving financial firms with little choice but to remodel their operations and workflows.
Why is the US moving to T+1 Trade Settlement?
While the move to T+1 settlement in the US has been a long time coming, its implementation was largely spurred by two watershed moments — market volatility, instigated by the outbreak of the Covid pandemic, and the surging interest in meme stocks, such as GameStop, which infamously saw a group of traders squeeze hedge funds out of their GameStop short positions in 2021, undermining confidence in market integrity. Collectively, both incidents exposed counterparty risks in the US, that policy makers believed could be reduced by shortening the trade security settlement cycle.
According to BNP Paribas, the main driver of the reduced trade settlement cycle in the US is to reduce the market, liquidity and credit risks of counterparties not delivering on settlement date. This has positive knock-on effects for capital efficiency, margin requirements and the availability of liquidity. For example, decreasing the counterparty risk decreases margin requirements, freeing up more capital for market participants. Ultimately, each day a purchaser of securities owes a seller money, the seller is exposed to the credit risk of the purchaser. In volatile periods, when the market price of securities may whipsaw, the ability of a seller to recoup losses from a failed sale becomes more uncertain.
Additionally, a shorter trade settlement cycle will encourage market participants to automate and modernise workflows, as they seek to meet T+1 trade settlement requirements. In the long run, this could lead to greater efficiencies as financial firms are left with little option but to transition away from cumbersome, outdated legacy technologies, and move toward with renewed vigour.
More to follow.