T plus 1 settlement

What Is T plus 1 settlement?

T plus 1 settlement, often abbreviated as T+1, refers to the standard practice in financial markets where the settlement of a securities transaction occurs one business day after the trade date. Within the broader category of Financial Market Operations, T+1 marks the point when the legal ownership of a security officially transfers from the seller to the buyer, and the corresponding funds are delivered. This contrasts with previous settlement cycles that required more time for the transfer of funds and assets.

The trade date is the day an order to buy or sell a security is executed, while the settlement date is when the transaction is finalized. For a broker-dealer, this means that if a transaction takes place on Monday, the actual exchange of securities and cash would be completed by the close of business on Tuesday. The move to T+1 settlement aims to enhance the efficiency and stability of securities transactions across various markets.

History and Origin

The evolution of the settlement cycle reflects the advancement of financial technology and market infrastructure. Historically, the settlement of securities transactions involved the physical delivery of certificates and funds, a process that could take several days or even weeks. As markets became more sophisticated and technology advanced, these cycles gradually shortened.

In 1993, the U.S. securities industry transitioned from a T+5 (trade date plus five business days) to a T+3 settlement cycle. Further technological improvements and the desire to reduce systemic risk led to another reduction in 2017, moving the standard settlement cycle to T+2 (trade date plus two business days).²¹

The most recent and significant shift to T+1 settlement in the United States was largely driven by a combination of factors, including increased market volatility experienced during events like the "meme stock" phenomenon in early 2021. This volatility highlighted potential vulnerabilities in the financial system related to the time lag between trade execution and settlement.²⁰,¹⁹,¹⁸

On February 15, 2023, the Securities and Exchange Commission (SEC) adopted new rule changes to shorten the standard settlement cycle for most broker-dealer transactions from T+2 to T+1.¹⁷,¹⁶ The SEC stated that this change was intended to "promote investor protection, reduce risk, and increase operational and capital efficiency."¹⁵ The compliance date for these new rules was set for May 28, 2024, at which point the U.S. market officially transitioned to T+1 settlement.¹⁴,¹³ This move was coordinated with other markets, including Canada and Mexico, which also shifted to T+1 around the same time.¹²,¹¹

Key Takeaways

• T+1 settlement means that the final exchange of securities and cash occurs one business day after the trade is executed.
• This accelerated cycle aims to reduce credit, market, and liquidity risk by shortening the time frame between transaction and completion.
• The transition to T+1 in the U.S. market was mandated by the Securities and Exchange Commission (SEC) and became effective in May 2024.
• Faster settlement provides investors with quicker access to sale proceeds and can lead to more efficient use of capital for market participants.
• The change necessitates updates to operational efficiency and processes for financial firms involved in trading and settlement.

Interpreting the T plus 1 settlement

Interpreting T plus 1 settlement involves understanding its implications for various market participants and the overall financial system. The primary goal of moving to a T+1 settlement cycle is to reduce the exposure period for market participants to potential risks. In a T+2 environment, there were two business days during which a trade could fail, or market conditions could significantly change between the trade date and settlement date.

By reducing this window, the T+1 settlement cycle significantly mitigates counterparty risk, which is the risk that one party to a trade will default on their obligation before the settlement is complete. A shorter settlement period also helps to reduce the capital required to cover potential losses from unsettled trades, thereby improving capital utilization within the financial system. This increased speed allows for more efficient deployment of capital and reduces the overall systemic risk in the market, especially during periods of high market volatility.

Hypothetical Example

Consider an investor, Alice, who wishes to sell 100 shares of XYZ Corp. stocks on Monday, June 2nd.

Under the T+1 settlement cycle:

1. Trade Date (T): Monday, June 2nd. Alice's order to sell 100 shares of XYZ Corp. is executed on the stock exchange.
2. Settlement Date (T+1): Tuesday, June 3rd. By the end of this day, the ownership of the 100 XYZ Corp. shares will officially transfer from Alice to the buyer, and the cash proceeds from the sale will be credited to Alice's brokerage account. This means Alice can typically access these funds for other investments, such as purchasing bonds, or for withdrawal, on or after Tuesday, June 3rd.

This accelerated process ensures that both parties to the trade fulfill their obligations more quickly, reducing the time during which either party is exposed to market fluctuations or the risk of non-delivery.

Practical Applications

T+1 settlement impacts nearly all facets of the capital markets, from individual investors to large institutional players and regulatory bodies.

• For Investors: T+1 means quicker access to funds from securities sales. If an investor sells stocks or bonds, the cash proceeds become available one day sooner than under T+2, allowing for faster reinvestment or withdrawal. Similarly, buyers take legal ownership of their purchased securities more rapidly.¹⁰
• For Broker-Dealers and Financial Firms: The shift to T+1 demands significant adjustments to back-office processes, technology systems, and operational efficiency. Firms must ensure their internal systems can handle the accelerated timelines for trade processing, confirmation, and allocation. The Securities Industry and Financial Markets Association (SIFMA), the Investment Company Institute (ICI), and the Depository Trust & Clearing Corporation (DTCC) collaborated extensively to provide guidance and resources for the industry's transition.⁹,⁸
• For Clearing and Settlement Systems: Organizations like the Depository Trust & Clearing Corporation (DTCC) and its subsidiary, the Depository Trust Company (DTC), which act as central clearing house entities, are crucial in facilitating T+1. They ensure the smooth and efficient exchange of securities and funds between trading parties. The DTCC's National Securities Clearing Corporation (NSCC) Clearing Fund, which is designed to mitigate risks from unsettled trades, saw a decrease in average value post-T+1 implementation, indicating reduced capital at risk.⁷
• Regulatory Compliance: Regulatory bodies like the Securities and Exchange Commission (SEC) and FINRA adjusted their rules to accommodate T+1. FINRA, for instance, implemented changes for equity trade reporting effective with the May 2024 shift.⁶ Investors can find detailed information on the implications for them through resources provided by the Financial Industry Regulatory Authority (FINRA).⁵

Limitations and Criticisms

While T+1 settlement offers numerous benefits, its implementation also presents challenges and potential drawbacks for certain market participants.

One primary concern is the compressed timeline for post-trade processing. Firms, especially those with complex international operations or manual processes, face increased pressure to complete allocations, confirmations, and affirmations by the end of the trade date. This shorter window leaves less time to correct errors, which could potentially lead to a temporary increase in trade failures.⁴ The Securities and Exchange Commission (SEC) acknowledged that "a shorter settlement cycle may lead to a short-term uptick in settlement fails and challenges to a small segment of market participants."³

Additionally, the accelerated cycle can impact foreign exchange (FX) transactions for cross-border securities transactions. If a U.S. equity trade settles T+1, but the associated FX transaction requires a longer settlement (e.g., T+2), this creates a timing mismatch that introduces additional liquidity risk and operational complexities for global investors and firms.

For certain less liquid securities, or those requiring manual processing or specialized legal review, the T+1 timeframe might be particularly challenging. This could include some mutual funds or specific types of bonds that do not typically trade on highly automated exchanges. While the rule applies broadly to stocks, Exchange-Traded Funds, and corporate and municipal bonds, exceptions exist for certain securities or where parties expressly agree to a different settlement period.²

T plus 1 settlement vs. T plus 2 settlement

The fundamental difference between T plus 1 settlement and T plus 2 settlement lies in the duration of the settlement cycle.

The confusion often arises because T+1 represents a shortening of the previous T+2 cycle. While the mechanics of a trade remain the same (execution of buy/sell orders), the crucial distinction is the compressed timeframe for the actual exchange of assets and funds. This acceleration reduces the window during which market participants are exposed to the risks associated with an unsettled trade, such as price fluctuations or the failure of a counterparty to deliver.

FAQs

What does "T" stand for in T+1?

In T+1, "T" stands for the trade date, which is the day a buy or sell order for a security is executed in the market.

Which types of securities are affected by T+1 settlement?

The T+1 settlement cycle generally applies to most securities transactions in the U.S. market, including stocks, corporate and municipal bonds, unit investment trusts, and Exchange-Traded Funds (ETFs). Some exceptions may apply, such as certain mutual funds or specifically agreed-upon transactions.

How does T+1 benefit investors?

T+1 settlement benefits investors by providing quicker access to the proceeds from their sales of securities. This allows for faster reinvestment opportunities or withdrawal of funds. It also reduces the time the investor is exposed to the market after making a trade, lowering their personal risk related to market movements before settlement.

Does T+1 settlement mean funds are instantly available?

No, T+1 settlement means the official transfer of ownership and funds occurs one business day after the trade date. While this is faster than previous cycles, it does not mean funds are instantly available on the trade date itself. The availability of funds for withdrawal or new purchases will depend on your broker-dealer's policies and internal processing times after settlement is complete.

What is the next potential step after T+1?

The industry has discussed a move to T+0, or same-day settlement, as a potential future step. However, this transition would present even greater operational challenges and requires significant technological advancements and industry coordination. The Securities and Exchange Commission has indicated interest in exploring T+0 in the future but has not yet proposed a timeline for such a change.¹