T 2 settlement

What Is T+2 Settlement?

T+2 settlement refers to a standard in the financial market where the final exchange of cash and securities occurs two business days after a trade is executed. This process falls under the broader category of market operations, specifically related to the post-trade lifecycle. The "T" stands for the trade date, which is the day a buy or sell order is matched and executed, while "+2" indicates that the settlement takes place two business days later. Prior to this, the standard settlement cycle in the United States was T+3, meaning three business days after the trade. The T+2 settlement cycle aims to reduce the time between trade execution and final settlement, thereby mitigating various forms of settlement risk for market participants.

History and Origin

Historically, the settlement of securities transactions involved a much longer timeframe due to manual processes requiring the physical delivery of share certificates and checks. In 1993, the U.S. moved from a T+5 settlement cycle to T+3, a significant step forward in efficiency.²⁷,²⁶ The push for further acceleration gained momentum in the 21st century, driven by technological advancements and the desire to reduce exposure to market fluctuations.

On March 22, 2017, the U.S. Securities and Exchange Commission (SEC) adopted amendments to shorten the standard settlement cycle for most broker-dealer securities transactions from T+3 to T+2.²⁵ This change, which became effective on September 5, 2017, was designed to enhance efficiency, reduce risk, and align the U.S. with other major global markets that had already adopted shorter settlement cycles.²⁴,²³ Key industry organizations, including the Securities Industry and Financial Markets Association (SIFMA), the Investment Company Institute (ICI), and The Depository Trust & Clearing Corporation (DTCC), played a crucial role in coordinating the industry-wide transition.²²

Key Takeaways

• T+2 settlement means transactions are finalized two business days after the trade date.
• This cycle applies to most stocks, corporate bonds, municipal securities, exchange-traded funds (ETFs)), and certain mutual funds.²¹,²⁰
• The primary goal of T+2 settlement is to reduce market risk, liquidity risk, and overall systemic risk within the financial system.
• The U.S. officially transitioned to T+2 settlement on September 5, 2017.¹⁹,¹⁸

Interpreting the T+2 Settlement Cycle

The T+2 settlement cycle is straightforward in its interpretation: it provides a standardized timeline for the completion of a trade. For a broker-dealer and their clients, understanding this cycle is critical for managing cash flows and security positions. If an investor sells a security on Monday, the funds and securities would officially change hands on Wednesday, assuming no market holidays. Conversely, if an investor buys a security on Monday, payment must be received by their brokerage firm by Wednesday.¹⁷,¹⁶ This standardized period provides predictability and facilitates the smooth functioning of global capital markets.

Hypothetical Example

Consider an investor, Sarah, who decides to sell 100 shares of XYZ stock.

1. Trade Date (T): Sarah places her sell order on Monday, which is executed at 10:00 AM Eastern Time. This is the trade date.
2. Day 1 (T+1): Tuesday. This is the first business day after the trade. During this time, the trade is processed by clearinghouses, and relevant account adjustments are prepared.
3. Settlement Date (T+2): Wednesday. By the end of this day, the ownership of the 100 shares of XYZ stock officially transfers from Sarah to the buyer, and the cash proceeds from the sale are officially transferred to Sarah's brokerage account. Sarah can then typically access these funds for withdrawal or new investments.

This two-day window allows for the necessary administrative and risk management procedures to be completed between the initial agreement and the final exchange of assets.

Practical Applications

The T+2 settlement cycle has pervasive practical applications across the investment landscape:

• Risk Management: By shortening the time between trade execution and settlement, the T+2 cycle significantly reduces counterparty risk, as market participants are exposed to each other for a shorter duration. This directly lessens the potential for losses if one party defaults before the trade is finalized.¹⁵,¹⁴
• Capital Efficiency: A shorter settlement cycle can lead to more efficient use of capital. Less capital is tied up in unsettled trades, which can reduce the need for margin and other forms of collateral. This improves capital velocity for firms and institutional investors.¹³
• Operational Streamlining: The move to T+2 settlement necessitated improvements in post-trade processing, driving automation and efficiency in back-office operations. This includes faster affirmation of trades and reconciliation of accounts. Firms needed to adjust to having less time to prepare for closing.¹²
• Market Harmonization: The adoption of T+2 aligned the U.S. with many other major global financial markets, which also operated on a T+2 or T+1 basis. This harmonization can simplify cross-border transactions and reduce complexities for international investors.¹¹,¹⁰

Limitations and Criticisms

While the T+2 settlement cycle brought numerous benefits, certain limitations and criticisms were acknowledged during its implementation and even more so with the ongoing move towards T+1.

One challenge revolved around the compressed timeframe for certain operations, particularly for global investors. For example, foreign exchange (FX) transactions that are needed to fund securities purchases often settle on a T+2 basis. Under a T+2 securities settlement cycle, this could occasionally create mismatches if an FX transaction for an international investor didn't settle until the same day the security needed to be paid for, leaving little room for error. The accelerated timeline placed pressure on clearinghouse operations and participant systems to ensure all confirmations and allocations were completed promptly. Some critiques focused on the operational burden on smaller firms that might have struggled to adapt their legacy systems to the faster pace.

The inherent lag, even if only two days, still leaves some degree of exposure compared to real-time or instantaneous settlement. This ongoing settlement risk exposure has been a key driver for the industry's further move to a T+1 settlement cycle.

T+2 Settlement vs. T+1 Settlement

The key difference between T+2 settlement and T+1 settlement lies in the duration between the trade execution and the final settlement of funds and securities.

T+1 settlement is the current standard for most U.S. securities transactions, marking a further acceleration from T+2.⁵,⁴ While T+2 was a significant improvement from T+3, the industry's continuous drive for reduced risk and increased efficiency has led to this even shorter cycle.

FAQs

What does T+2 mean in trading?

T+2 in trading means that the settlement of a transaction—the actual transfer of ownership of securities to the buyer and cash to the seller—occurs two business days after the trade date, which is the day the trade was executed.

Which securities settled T+2?

Before May 28, 2024, most U.S. securities, including stocks, corporate bonds, municipal securities, exchange-traded funds (ETFs)), and certain mutual funds, settled on a T+2 cycle. As of May 28, 2024, the standard settlement cycle for these securities in the U.S. changed to T+1.

##³# Why did the U.S. move to T+2 settlement?
The U.S. moved to T+2 settlement to reduce risks such as market risk and liquidity risk that arise from unsettled transactions. A shorter settlement cycle means less time for market volatility to impact trade values and less exposure to potential defaults by counterparties. It also aligned the U.S. market with international standards.,[^1²^](https://www.sifma.org/wp-content/uploads/2017/08/t2_industry_webinar_20170720.pdf)