June 23, 2024

Transitioning to T+1 Settlement

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The Securities and Exchange Commission (SEC) made a significant move on February 15, 2023, voting to adopt rule changes that will shorten the standard settlement cycle for broker-dealer transactions in securities. This shift, from the current two-business-day cycle (T+2) to a one-business-day cycle (T+1), is set to take effect on May 28, 2024, marking a pivotal moment in the world of investment and trading. This article delves into the implications and considerations surrounding this transition.

At its core, the settlement cycle dictates when ownership of a security transfers from the seller to the buyer. Under the T+2 system, brokerage firms are expected to receive payment from buyers within two business days of executing a trade. This process, which has evolved significantly since the early days of stock trading, is undergoing yet another transformation with the move to T+1 settlement.

Historically, the settlement process involved physical paperwork and the exchange of stock certificates, a cumbersome and time-consuming endeavor. Over the years, advancements in technology have gradually shortened settlement times. From the early days of five-business-day settlements, the introduction of digitization in 1993 reduced the cycle to three business days (T+3). Further progress led to the adoption of the T+2 standard in March 2017.

The SEC’s decision to transition to T+1 settlement is rooted in its mission to promote investor protection, reduce risk, and enhance operational and capital efficiency. By compressing the settlement cycle, regulators aim to align market practices with the rapid pace of modern trading, leveraging technology to streamline processes and mitigate potential risks.

While the move to T+1 settlement offers several benefits, including increased efficiency and reduced counterparty risk, it also presents challenges and considerations for market participants:

Shorter settlement cycles may strain securities lending activities, posing challenges for market participants engaged in short selling or borrowing securities. Reconciling voting authority for shares on loan could also complicate proxy voting processes.

The transition to T+1 settlement may affect liquidity dynamics, with smaller market players facing increased pressure to meet tighter deadlines and manage liquidity requirements. Aligning ex and record dates on the same day under T+1 settlement may lead to reconciliation issues for corporate actions.

The move to T+1 settlement is expected to reduce counterparty credit exposure policy (CCEP) margin requirements by 41%, enabling firms to manage liquidity and capital more efficiently.

As the industry prepares for the transition to T+1 settlement, questions arise about the possibility of future innovations, including real-time settlement (T+0). While immediate adoption of T+0 settlement may pose technological challenges, regulators envision a future of agile and efficient capital markets, driven by continuous innovation and collaboration among industry stakeholders.

The shift to T+1 settlement marks a significant milestone in the evolution of market infrastructure. While challenges and uncertainties lie ahead, market participants must remain vigilant, adaptable, and committed to embracing change in an ever-evolving financial landscape.

Financial Desk

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