What Is T plus 2 Settlement?
T plus 2 settlement refers to a financial market convention where the final transfer of securities to the buyer and funds to the seller occurs two business days after the trade date, or "T" (Transaction Date)39. This process is a critical component of securities settlement, a broader category within financial markets infrastructure that ensures the completion of executed trades. Before the actual settlement, the buyer and seller are exposed to certain risks, and the T plus 2 settlement cycle was designed to balance the need for timely finality with the practicalities of post-trade processing.
In this system, if a trade date falls on a Monday (T), the settlement date would be Wednesday (T+2), assuming no holidays. The T plus 2 settlement cycle applied to a wide range of securities, including stocks, bonds, Exchange-Traded Funds (ETFs), and certain mutual funds37, 38. This timeframe aimed to reduce counterparty risk and enhance liquidity compared to longer settlement periods.
History and Origin
The evolution of securities settlement cycles has been driven by the continuous pursuit of greater efficiency and reduced risk in financial markets. Historically, settlement periods were much longer, with trades in the United States often settling in five business days (T+5). This extended period was largely due to manual processes involving physical stock certificates and checks. The introduction of technologies like fax machines and the establishment of centralized entities such as the Depository Trust & Clearing Corporation (clearing agencies) helped facilitate a reduction in these times36.
In 1993, the U.S. moved to a T+3 settlement cycle, a significant step towards modernizing post-trade processing. More recently, in 2017, the Securities and Exchange Commission (SEC) amended Exchange Act Rule 15c6-1 to shorten the standard settlement cycle for most broker-dealer transactions from T+3 to T plus 2 settlement35. This change, effective September 5, 2017, was part of a global trend towards shorter settlement cycles, with many other countries already having adopted T+233, 34. The move was intended to "enhance efficiency, reduce risk, and ensure a coordinated and expeditious transition by market participants to a shortened standard settlement cycle."32
Key Takeaways
- T plus 2 settlement means the exchange of securities and funds occurs two business days after the trade execution date.
- This cycle was adopted in the U.S. in 2017, succeeding the previous T+3 standard.
- The primary goals of T plus 2 settlement were to reduce counterparty risk, improve liquidity, and lower margin requirements in financial markets.
- It applied to most equity, bond, ETF, and mutual fund transactions.
- As of May 28, 2024, the U.S. market transitioned to a T+1 settlement cycle, making T plus 2 settlement a historical standard for most securities.
Interpreting the T plus 2 Settlement
Understanding T plus 2 settlement was crucial for investors, broker-dealers, and other market participants because it dictated the exact timing of fund and securities transfers. For a buyer, it meant that payment for purchased securities had to be delivered to their broker-dealer by the end of the second business day following the trade. Conversely, for a seller, the securities had to be delivered to their broker-dealer by the same deadline to receive the sale proceeds.
This settlement period also impacted other financial operations. For instance, in the context of receiving dividends, an investor had to ensure their purchase of a stock settled before the record date to be eligible for the dividend payment. The T plus 2 settlement cycle aimed to provide a balance: it was fast enough to significantly reduce exposure to market fluctuations between trade and settlement, yet allowed sufficient time for back-office processes, particularly for institutional trades that involve allocation, confirmation, and affirmation steps31.
Hypothetical Example
Consider an investor, Sarah, who buys 100 shares of XYZ Corp. on Monday, July 15th, at 10:00 AM ET. Under the T plus 2 settlement regime, Monday is the trade date (T).
- Trade Date (T): Monday, July 15th. Sarah executes her buy order.
- T+1: Tuesday, July 16th. This is the first business day after the trade. The broker-dealer would typically process the internal records and prepare for the transfer.
- Settlement Date (T+2): Wednesday, July 17th. By the end of this day, the 100 shares of XYZ Corp. would officially be transferred into Sarah's brokerage account, and the corresponding funds would be transferred out of her account to the seller.
If Sarah had sold the shares on Monday, July 15th, the proceeds from the sale would similarly become available to her by the end of Wednesday, July 17th. This two-day window allowed for the necessary administrative steps to be completed by all parties involved in the transaction.
Practical Applications
The T plus 2 settlement cycle played a significant role across various facets of financial markets:
- Risk Management: By shortening the time between trade execution and settlement from T+3 to T+2, the exposure to counterparty risk and market volatility was reduced. This meant less time for a party to default or for significant price movements to occur before the transaction was finalized29, 30.
- Liquidity and Capital Efficiency: A quicker settlement cycle meant that cash and securities were freed up faster, improving market liquidity and allowing investors to reinvest funds or access capital more quickly26, 27, 28. This also led to lower margin requirements for broker-dealers and other market participants24, 25.
- Operational Streamlining: The transition to T plus 2 settlement pushed financial firms to enhance their post-trade processing systems and workflows. This included improvements in allocation, confirmation, and affirmation processes, which are crucial for institutional trades23.
- Global Harmonization: The move to T plus 2 settlement in the U.S. brought its settlement cycle in line with many other major global markets, facilitating smoother cross-border transactions and reducing complexities for international investors21, 22.
The collective efforts of industry bodies like the Securities Industry and Financial Markets Association (SIFMA), the Investment Company Institute (ICI), and the Depository Trust & Clearing Corporation (DTCC) were instrumental in advocating for and implementing this shorter settlement cycle, highlighting its benefits for financial systemic risk reduction20.
Limitations and Criticisms
While T plus 2 settlement offered significant advantages over longer cycles, it also presented certain operational challenges and drew some criticisms. One notable limitation was the compressed timeframe for processing cross-border transactions, particularly for investors in different time zones, where the two-day window might still pose difficulties for timely fund and security transfers18, 19. This could lead to increased operational risk if processes were not sufficiently automated and streamlined.
For participants in the securities lending market, the shorter settlement cycle could create pressure to complete loan transactions more quickly to ensure timely delivery of borrowed securities, potentially impacting market functioning if not managed effectively17. Although T plus 2 settlement reduced risks compared to T+3, it did not eliminate all risks. The period between trade date and settlement date still left parties exposed to the possibility of a counterparty default or significant market changes, particularly during periods of extreme market volatility15, 16.
Furthermore, while the benefits of T plus 2 settlement were largely evident, some research suggested that the "realized spread" or "price impact" from the change was most pronounced for hard-to-borrow securities, implying that while overall transaction costs decreased, the impact wasn't uniform across all market segments13, 14.
T plus 2 Settlement vs. T plus 1 Settlement
The primary distinction between T plus 2 settlement and T plus 1 settlement lies in the duration of the settlement period following the trade date.
| Feature | T plus 2 Settlement | T plus 1 Settlement |
|---|---|---|
| Settlement Period | Two business days after the trade date (T+2) | One business day after the trade date (T+1) |
| Effective Date | Standard in the U.S. from September 2017 to May 2024. | Became standard in the U.S. on May 28, 202412. |
| Risk Exposure | Reduced counterparty risk compared to T+3. | Further reduces counterparty risk and systemic risk. |
| Capital Efficiency | Improved over T+3, but less efficient than T+1. | Higher capital efficiency as funds are freed faster. |
| Operational Impact | Required operational adjustments from T+3. | Demands even greater operational speed and automation. |
The transition to T plus 1 settlement represents the next step in shortening the settlement cycle, building on the efficiencies gained from the move to T plus 2. This continuous effort in post-trade processing aims to further mitigate risks and enhance the overall efficiency of financial markets10, 11.
FAQs
What does "T+2" mean in trading?
"T+2" stands for "Trade date plus two business days." It refers to the standard period within which a securities transaction, such as buying or selling stocks or bonds, must be officially settled. This means the buyer receives the securities, and the seller receives the funds, two business days after the trade was executed9.
Why did the U.S. move to T plus 2 settlement?
The U.S. moved to T plus 2 settlement in 2017 to reduce counterparty risk, improve market liquidity, and enhance operational efficiency7, 8. A shorter settlement period means less time for market fluctuations or a party to default on their obligations before the trade is finalized, thereby reducing overall systemic risk in the financial system.
Is T plus 2 settlement still the standard in the U.S.?
No, as of May 28, 2024, the standard settlement cycle for most securities transactions in the U.S. has been shortened further to T plus 1 settlement5, 6. T plus 2 settlement is now a past standard, superseded by the even faster T+1 cycle.
How does T plus 2 settlement affect investors?
For investors, T plus 2 settlement dictated when funds from a sale would become available or when payment for a purchase was due. If an investor sold shares on a Monday, the funds would typically be accessible on Wednesday. Similarly, if they bought shares on Monday, they needed to ensure funds were available by Wednesday. This timing was also important for events like dividend eligibility, which depended on the settlement date.
What types of securities were subject to T plus 2 settlement?
Most routine securities transactions, including stocks, corporate bonds, municipal securities, Exchange-Traded Funds (ETFs), and most mutual funds traded through a broker-dealer, were subject to the T plus 2 settlement cycle3, 4. Some securities, like government bonds, already settled faster (T+1), and others like firm commitment offerings priced after market close had different cycles1, 2.