T+1 Settlement Trading Era Begins: What You Need To Know

The T+1 settlement era goes live in the U.S. on Tuesday, May 28, 2024, replacing the prior T+2 settlement system. This transition marks a significant shift in how trades are settled in the financial markets.

Here is an explainer on what it means for your trading activity.

Understanding Settlement Cycles

Under the T+2 settlement cycle, a trade settles two business days after the trade date. For example, if you purchase a stock on Monday, the settlement occurs on Wednesday.

In contrast, the T+1 settlement cycle accelerates this process, settling trades one business day after the trade date. Therefore, a stock bought on Monday will now settle on Tuesday.

Challenges With The T+2 Settlement System

The T+2 settlement period exposed its flaws during the meme stock frenzy of 2021. Vlad Tenev, CEO of Robinhood, highlighted these issues in a post on social media X:

“The 2-day period to settle trades exposes investors and the industry to unnecessary risk.”

During the GameStop Corp.‘s GME 2021 mania, the drawbacks of the two-day trade settlement period became evident.

Clearinghouse deposit requirements soared overnight, restricting investors’ ability to purchase certain securities, causing widespread frustration and concern.

Designed to mitigate risk, clearinghouse deposit requirements inadvertently introduced new risks due to the lengthy settlement cycle, according to Tenev.

The market volatility seen in 2021 underscored the need for a more efficient settlement process.

Benefits And Costs of Moving From T+2 To T+1

Gary Gensler, chair of the Securities and Exchange Commission (SEC), recently emphasized the advantages of a shorter settlement cycle: "For everyday investors who sell their stock on a Monday, shortening the settlement cycle will allow them to get their money on Tuesday. Shortening the settlement cycle also will help the markets because time is money and time is risk. It will make our market plumbing more resilient, timely, and orderly.”

Key benefits of moving from a T+2 to a T+1 system include improved liquidity and lower counterparty risk.

A shorter settlement cycle reduces counterparty risk by minimizing the time between the trade date and the settlement date. This allows investors to reinvest their capital more quickly, enhancing overall market liquidity. This change is particularly beneficial for active traders and those managing large portfolios.

J.P. Morgan Chase & Co. highlighted in a study that the shift to T+1 is a significant change for the industry, requiring trades to be instructed correctly and on time. The elimination of the one-day cushion between trade execution and settlement necessitates precise and timely processing of trades.

While the new standard is expected to increase capital efficiency, liquidity, and reduce counterparty risk, it also introduces challenges.

Firms must streamline settlement systems and processes both operationally and technologically to ensure a smooth transition. Collaboration and coordination among all market participants are crucial for the successful implementation of T+1.

Implementing a T+1 settlement cycle involves initial costs related to system upgrades, process adjustments, and staff training. Bloomberg’s analysis estimates these initial costs to be around $30 billion.

Larry Tabb, head of market structure research at Bloomberg Intelligence, noted that the shorter settlement cycle shifts costs from banks and clearinghouses to institutional investors, increases operational pressures, and may lead to information leakage.

Expert Insights on the T+1 Shift

Speaking on Benzinga’s Premarket Prep on Tuesday, Dennis Dick, CFA, remarked that the impact of the T+1 shift on retail trading activity is negligible.

He also dismissed the possibility of moving to T0 (real-time) settlement due to the complexities involved in correcting trading errors instantly.

“Trading errors happen,” Dick stated. “Sometimes stocks trade outside of trading ranges, and trades get busted. How do you fix those mistakes if it’s instantaneous settlement and the money is gone? I just don’t think going to T0 would be easy. One day settlement allows people and brokerages to correct trades that are erroneous.”

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Image created using artificial intelligence via Midjourney.