Source: Broker China
Author: Chen Ming

Tuesday (May 28) was a historic moment for the US stock market. Starting on the same day, the transaction settlement cycle for US stocks changed from T+2 to T+1, and the last time this was done (T+1 settlement) was 100 years ago in the 1920s.

When will US stocks return to T+1 settlement after nearly a century? What impact will this change have on the US stock market?

T+1 settlement

On Tuesday local time, the settlement time for US securities transactions was changed from “T+2” to “T+1,” meaning that investors can receive settlement funds one business day after trading for stocks sold on the same day.

Previously, the US stock market implemented a T+0 trading system, but a T+2 settlement and delivery system was implemented, that is, it takes two working days from purchasing the stock to the “settlement” of the transaction, or officially transferring the stock to the buyer's account and delivering the cash to the seller's account.

Starting Tuesday, this settlement cycle only takes one business day, or “T+1.” Recently, US Securities and Exchange Commission (SEC) Chairman Gary Gensler said in a press release: “For ordinary investors who sell stocks on Monday, shortening the settlement cycle will enable them to get their money on Tuesday. This will make our market pipeline more flexible, more timely, and more orderly.”

The new rules will apply to stocks, bonds, municipal securities, exchange-traded funds, some mutual funds, and limited partnerships traded on exchanges. Traders and registered investment advisors are also required to comply with the new record keeping rules.

Some investors say that a shorter settlement cycle will help release more liquidity in the market and reduce margin volatility, as this reduces the chance of default before the transaction is completed. Clearing houses located between buyers and sellers collect security deposits from traders as proof of their ability to trade.

Other analysts believe that the US stock transaction settlement cycle has been shortened from T+2 to T+1, which 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.

Rich Lee, head of trading and execution strategy at an independent investment bank and financial services firm, said: “Assuming all goes well, we don't see any issues. The shift to T+1 will bring overall benefits to our ecosystem, institutional investors, and retail investors.” Rich Lee said a T+1 committee has been formed since last summer to ensure that such issues do not occur. Employees are always discussing with customers how they can help them through this process. The company is also staffed to handle their role in clearing transactions in a shorter period of time.

Why the change?

According to some US media, the current move for US stocks to switch to T+1 settlement was in 2021$GameStop (GME.US)$After “meme stocks” had a “retail war on Wall Street,” regulators decided to launch them in order to reduce risk. The so-called “meme stocks” are transliterated from English MEME, and are also known as retail group stocks.

In the “meme stock frenzy” in early 2021, retail investors heavily traded game stations,$AMC Entertainment (AMC.US)$Cheap stocks such as 3B Home Furnishing and their options have led to$Robinhood (HOOD.US)$Retail trading platforms must provide collateral (i.e. security deposit) for these transactions within two days. As the price of these stocks rose and trading volume and volatility increased dramatically, Robinhood temporarily suspended trading of GameStop, AMC, and other stocks on its platform, partly because the T+2 rule boosted collateral requirements for brokers such as Robinhood. Investors can only wait for their transactions, while the brokers' cash is locked up before settlement, making it impossible to allow more purchases to ensure they have enough money to pay for the transaction. This aroused strong condemnation from the retail community, as well as the closeness of regulators and members of the National Assembly, and prompted regulators to begin considering implementing a T+1 settlement cycle system.

Robinhood CEO Vlad Tenev said in a February 2021 press release: “The two-day transaction settlement period has exposed investors and the industry to unnecessary risks, which are now mature and can be changed. There's no reason the world's greatest financial system can't settle transactions in real time.”

The US Depository Trust and Clearing Corporation (DTCC) has also stated that settlement time is equivalent to counterparty risk, and margin requirements aimed at reducing these risks are a cost. The immediate benefit of switching to T+1 is that it may reduce the risk of buyer and seller default before the transaction is completed, saving costs, and reducing market risk and margin requirements.

In February 2023, the US Securities and Exchange Commission (SEC) passed rule amendments to shorten the standard settlement period for most broker-dealer transactions from T+2 to T+1, with certain exceptions. The compliance date for the rule amendments is May 28, 2024. This means that starting May 28, local time, the settlement cycle for US stock transactions will be shortened from T+2 to T+1.

About 100 years ago, in the 1920s, the settlement of US stocks was also subject to the T+1 system. At the time, it was known as the “Roaring 20s,” partly due to amazing stock market performance. The reason for ending T+1 was due to the manual nature of transactions at the time, which meant it was impossible to keep up with the surge in trading activity. Eventually, the settlement cycle became T+5. In 1993, the US Securities and Exchange Commission (SEC) shortened the standard settlement period from T+5 to T+3. In 2017, the SEC once again shortened the settlement period to two days (T+2).

The market is concerned about short-term risks

According to Bloomberg, the ultimate goal of switching to a T+1 settlement cycle is to reduce risk in the financial system. However, outsiders are worried that there may be problems in the early stages, including that it may be difficult for international investors to obtain US dollars on time, and everyone will have less time to correct their mistakes.

While hopefully everything will go smoothly, the US Securities and Exchange Commission (SEC) also said last week that in the short term, the market may see an increase in the number of failed settlements and challenge a small number of market participants. The Securities Industry and Financial Markets Association, a major industry organization in the financial world, has launched the so-called “T+1 Command Center” to detect problems and coordinate responses.

Companies in various fields have been preparing for months to relocate employees, adjust shifts, and comprehensively review work processes, and many say they are confident in their preparations. However, whether other counterparties and intermediaries are also arranged in such an orderly manner raises doubts.

Although DTCC and market participants have been conducting a series of tests for several months, it was initially anticipated that more deals would fail. In 2017, when the US changed the settlement period from three days to two days, the failure rate increased.

The T+1 system is also facing two major direct tests: First, this Wednesday is a “double settlement day”, that is, last Friday's T+2 transactions expire at the same time as this Tuesday's T+1 transactions. Second, on the third trading day after the T+1 settlement comes into effect (this Friday), MSCI's major global stock indices will be adjusted quarterly. Some investors said that one of the most influential trading days this year may put pressure on the equity and bond trading market to adapt to the new mechanism. This global stock index rebalancing means that fund managers must resize their holdings to keep the ETFs they issue continuing to track the MSCI index.

“This (Friday) is usually one of the biggest trading days of the year,” said Rajed Walsh, head of Northern Trust's Global Banking and Markets Client Solutions Group in an interview with the media. Changes in settlement times have not given the ETF industry enough time to thoroughly assess and address all risks.

Some analysts have suggested foreign exchange market fluctuations that may occur at that time: Friday's trading wave may put pressure on the foreign exchange market, causing the foreign exchange market to lack liquidity during the afternoon session in the US, and foreign exchange transaction costs may rise as a result. US Bloomberg commented that with the acceleration of the US securities trading process, the time to complete each transaction will be halved to one day. The surge in the number of failed transactions, operational errors, and additional costs are major concerns in the industry. Bloomberg mentioned in the report that global funds are facing mismatches, and the speed of cash inflows and outflows is different from the speed at which they trade assets. This change poses a special challenge for overseas investors who need to buy dollars to trade stocks.

Editor/jayden