Source: Wall Street News
How does T+1 benefit investors? What are the risks? T+1 has arrived, is T+0 still far away?
US stocks will have a historic moment this week.
Starting May 28, local time, the settlement cycle for US stock transactions will be shortened from T+2 to T+1, which means that investors can receive settlement funds one working day after trading for stocks sold on the same day.
This also means that stocks will keep pace with bonds, options, and ETFs, and the application of T+1 in the US financial market is constantly expanding.
What is T+1 settlement?
T+1 settlement means completing a financial transaction within one business day. For example, if a transaction occurs on Monday, it will be settled on Tuesday, and traders will officially receive cash or securities and can freely exchange them without any penalties.
The trigger for the transition of US stocks from T+2 to T+1 settlement was the 2021 Game Station incident.
At the beginning of 2021, cheap “MEME stocks” represented by Game Station sparked retail fanaticism, fueled by social media, and saw a huge increase in trading volume and volatility. As a result, trading platforms are under tremendous financial pressure, and they need to guarantee a large number of transactions during the T+2 settlement period.
To ensure sufficient capital coverage guarantees, trading platforms began restricting investors from buying these stocks. However, this act has aroused strong dissatisfaction among retail investors, as well as scrutiny and questioning by regulators and members of the National Assembly, which prompted regulators to begin implementing the T+1 settlement system.
The US securities market has been speeding up the settlement process for many years. In 1993, the US Securities and Exchange Commission (SEC) shortened the standard settlement period from the usual five days (T+5) to three business days (T+3). Subsequently, the SEC shortened the settlement period again to two days (T+2) in 2017 and introduced a T+1 settlement period in 2024.
Why is T+1 important to the market?
Financial markets use the T+1 settlement cycle for two main reasons: reducing risk and improving efficiency.
The longer it takes for a transaction to settle, the more likely it is that something will go wrong with the securities or funds. Assuming that the buyer does not have enough capital or that the seller has the wrong number of shares, it will cause the settlement to fail. Although brokerage firms and clearing houses usually have precautions, the longer the time between transaction and settlement, the greater the risk. Shortening this cycle helps reduce market risk.
Securities such as stocks can change hands many times a day. The more transactions, the greater the accounting workload of brokers, depository institutions, and clearing houses. A few days between transaction and settlement can result in an accounting backlog. Shortening to T+1 can improve settlement efficiency and promote the adoption of more automated and efficient systems in the industry.
What are the benefits of T+1 for investors?
Investors may not directly feel the transition from T+2 to T+1, but they actually benefit from a safer and more efficient market environment.
Tom Price, head of technology, operations and business continuity at Sifma, said that for retail investors, the biggest benefit of T+1 is reduced investment risk.
“While the transition to T+1 is largely seamless for retail investors, they will benefit from the overall reduction in risk associated with T+1 settlement. Reducing systemic risk is good for a healthier market, which is always better for investors.”
Shorter settlement cycles help improve market efficiency, increase liquidity, and enable stocks to be traded faster. Funds from the sale of securities will arrive faster and can be reinvested more quickly. Buying securities requires preparing capital in advance, which may affect capital turnover in some situations, such as when foreign currency exchange is involved.
Compared to T+2, T+1 also helps investors reduce transaction costs.
“Longer settlement cycles often require financial institutions to invest more money in risk management and back-office processes that involve longer settlement cycles,” said Jason Steeno, president of investment institutions CoreCap Investments and CoreCap Advisors.
What are the risks of T+1?
Settlement cycles are shortened, or more transactions fail to settle.
The SEC said that in the short term, the market may see an increase in the number of failed settlement transactions, and brokerage firms and other market participants will need an adaptation period to adapt to the faster and more efficient transaction processing process required for T+1 settlement.
For securities traders, T+1 means that additional margin notices may come sooner; they need to raise funds in a shorter period of time to prevent the brokerage from forcibly closing positions to meet the additional margin notice.
For stock lending services, the time for the lender to identify and recall the lent stock is shortened. If the borrower fails to return the shares in a timely manner, it may cause settlement failure. Frequent settlement failures can result in fines from exchanges or regulators. This has undoubtedly increased the operational difficulty of the stock lending business and the potential risk of default.
BNP Paribas wrote in a report last year: “Due to reduced time to identify and recall loans, settlement failures may result in higher amounts of fines.”
The settlement cycle is shortened, and the transaction fault tolerance rate is lower.
Under the T+1 settlement cycle, transactions are completed in half as long as before, and investors have little time to correct any errors, especially in terms of cost. Once the settlement is complete, errors are difficult to correct.
For the very few investors who still hold physical paper securities certificates, if they want to sell securities, they need to deliver these certificates one day in advance, which is more stringent than the previous T+2 requirements. However, there are now very few investors using paper vouchers.
T+1 has arrived, is T+0 still far away?
The US stock settlement cycle has gradually transitioned from T+5 and T+3 to T+2, and now the T+1 goal has finally been achieved. The next question is, can US stocks be further accelerated to achieve same-day or real-time settlement?
According to the law of the financial industry, the longer the transaction time and the higher the risk, the time risk factor can be eliminated from T+1 transitioning to T+0.
Urvin Finance CEO Dave Lauer told the media: “It removes all overnight risk from the system, and I think that's a good thing. I think it will make abusive short selling more difficult, not delivering securities, and making exploiting loopholes more difficult.”
Lauer believes that T+0 can prevent certain forms of market manipulation, thereby preventing retail investors from being harmed. In addition to this, he believes that it can also bring investors a more natural experience. Investors hope to get transaction results by placing orders on the same day.
From a technical perspective, it is not impossible to achieve T+0 same-day real-time settlement, especially in blockchain and cryptocurrency transactions, which is already a reality. Furthermore, earlier this year, the Indian stock market began adopting T+0, making it one of the first countries to use same-day settlement.
However, it seems that there are still quite a few difficulties in fully implementing T+0 settlement in US stocks. Some analysts believe that the main challenge is not technology, but financing and efficiency.
Cryptocurrency transactions can be settled in real time because the buyer deposits the full amount of funds before the transaction. Given the size and complexity of the US stock market, this will put huge financial pressure on market participants and may affect market activity.
T+1 is already a very tight settlement cycle. Further acceleration to T+0 may introduce new risk points, such as system failure, network delays, etc., which will increase the impact.
Furthermore, T+0 may conflict with the current market system in some aspects, such as situations involving cross-border transactions, currency exchange, etc., which also require coordination at the institutional level.
Some analysts believe that T+1 has achieved a good balance between reducing risk and improving efficiency — more efficient than T+2 and less risky than T+0. In contrast, although T+0 is attractive, it is probably still too early to implement at this stage, and may bring more problems than benefits.
editor/tolk