T+1 Settlement Cycle Incoming: Watch out for fluctuations in US stocks!

Jason Bourne Updated: 2024-05-28

How T+1 Settlement Cycle Impacts Investors?

Illustration by Intellectia.AI

The stock market is a dynamic and ever-evolving entity, with changes continually reshaping the landscape for investors. Starting Tuesday, the time required to complete stock transactions will be cut in half as the 'T+1' settlement cycle goes into effect. But what exactly does T+1 mean, and how does it impact investors? This article delves into the nuances of the T+1 settlement cycle, exploring its implications, benefits, and challenges for investors.

What is a T+1 Settlement Cycle?

To understand the T+1 settlement cycle, it’s essential to know how trades are processed. The day you place a buy or sell order is called the trade date. After this, there is a brief period to finalize the exchange of funds and securities, ending on the settlement date.

Before 2017, U.S. markets used a T+3 settlement cycle, taking three days. From 2017, the cycle was T+2, and starting May 28, it will be T+1, requiring settlements the day after the trade.

"This change means that if an investor sells their stock on Monday, they will get their money by Tuesday," explained SEC Chair Gary Gensler.

Technological advances have made these shorter periods possible. Following the SEC’s decision in February 2023 to adopt T+1, Canada and Mexico plan to implement T+1 on May 27, 2024.

Two Changes Incomming on the Transition Period

This isn’t the first time Wall Street has faced such a transformation, but industry insiders say this one will be the most challenging yet.

The 1920s, known as the "Roaring 20s," saw incredible stock market performance. At that time, T+1 settlement ended because humans couldn't keep up with the surge in trading volume, leading to the settlement period being extended to five days.

Following the Black Monday crash in 1987, the settlement time was reduced to three days, and then shortened to two days in 2017 to better reflect the modern market.

Today, due to the size of the market, the complexity of cross-border investments, and varying laws across regions, reducing the settlement time to one day presents even greater challenges.

Foreign exchange transactions traditionally settle within two days, so international investors looking to buy US stocks will need to obtain dollars faster. Despite the nominal one-day settlement period, many people actually have only a few hours to complete the job.

Michael Wynn, Head of Executive Services at Citigroup Services, explained, “Liquidity requirements may be adjusted shortly after the end of the forex trading day, between 3 p.m. and 7 p.m. New York time. In the medium to long term, we expect liquidity to improve as business returns to normal.”

T+1 settlement still faces two major tests. The first is Wednesday's double settlement day, where Friday’s T+2 transactions expire at the same time as Tuesday’s T+1 transactions. The second challenge will be the MSCI index adjustment later this week, when funds tracking the MSCI index will adjust their positions simultaneously.

Christos Ekonomidis, head of the T+1 program at Bank of New York Mellon, said, “We are prepared for the expected fluctuations. We know that transitions like this can present some issues, so the key is to have the right resources to address these issues quickly.”

How T+1 Settlement Affects Stock Trading?

Faster Settlement:

Reduction in Settlement Time: Trades will now settle one business day after the transaction date, reducing the time for the official transfer of securities and cash.
Impact on Transaction Processing: Investors will need to ensure that funds and securities are available more quickly. This may require changes in how and when payments are initiated and securities are delivered.

Operational Adjustments:

Broker-Dealer Adjustments: Broker-dealers will need to adapt their processes to handle the quicker settlement cycle, including same-day affirmation and funding.
Investor Actions: Investors may need to deliver securities certificates earlier or ensure electronic transfers are completed promptly.

Risk Reduction:

Lower Counterparty Risk: The shorter settlement cycle reduces the period during which counterparties are exposed to the risk of default, thereby lowering credit and liquidity risks.
Operational Benefits: The move to T+1 is expected to bring operational efficiencies and reduce capital tied up in unsettled trades.

Global Impact:

International Coordination: The U.S. move to T+1 may cause challenges for international investors and fund managers, particularly in terms of foreign exchange (FX) transactions and operational hours.
Market Adjustments: Other markets, such as Canada and Mexico, are also moving to T+1, while regions like the European Union and the UK are exploring similar changes but face more complex transitions due to market fragmentation.

Considerations for Investors

Payment and Delivery: Investors need to be prepared to make payments and deliver securities one day earlier than under the T+2 system. This may involve adjusting the timing of Automated Clearing House (ACH) payments and ensuring electronic securities are transferred promptly.
Margin Accounts: The T+1 settlement cycle may impact certain provisions of margin agreements, requiring investors to consult with their broker-dealers about specific changes affecting their accounts.
Global Trading: International investors may face increased FX risk and operational challenges due to the shorter settlement window. Some firms are pre-funding trades or adjusting their operational hours to mitigate these risks.

Crystal McKeon, CFP, Chief Compliance Officer of TSA Wealth Management, explains that "many clients have always thought that when you sell the investments the funds are available the same day, which is not the case."

Conclusion

The transition to T+1 settlement aims to enhance the efficiency and security of the U.S. securities market by reducing settlement times and associated risks. However, it requires significant adjustments from both market participants and investors to ensure smooth implementation and compliance.