Starting May 28, the Wall Street trading landscape will undergo its most significant transformation in years with the adoption of the T+1 settlement cycle. This shift promises to expedite the stock transaction process but also brings potential challenges that financial firms are actively preparing to manage.
The existing standard settlement cycle for broker-dealer transactions, known as “T+2,” requires two business days for a stock purchase to settle. This means the stock is officially transferred to the buyer’s account, and the cash is delivered to the seller’s account after two days. This system has been in place since 2017.
However, from May 28, this cycle will be reduced to just one business day, known as “T+1.” Gary Gensler, chair of the Securities and Exchange Commission, emphasized the benefits of this change, stating, “For everyday investors who sell their stock on a Monday, shortening the settlement cycle will allow them to get their money on Tuesday. It will make our market plumbing more resilient, timely, and orderly.”
The new T+1 rules will apply to a wide range of financial instruments, including stocks, bonds, municipal securities, exchange-traded funds, certain mutual funds, and limited partnerships that trade on an exchange. Additionally, broker-dealers and registered investment advisors will need to adhere to updated recordkeeping regulations.
Some market participants believe that a shorter settlement cycle will enhance market liquidity and reduce margin volatility by decreasing the default risk before transactions are completed. Clearinghouses, which act as intermediaries between buyers and sellers, require traders to post margins as collateral to ensure they can fulfill the transaction.
“Assuming everything goes well and we don’t see any hiccups, the move towards T+1 will be an overall benefit to our ecosystem, institutional investors, and retail investors,” said Rich Lee, head of program trading and execution strategy at Baird.
To mitigate potential issues, Baird established a T+1 committee last summer and has been engaging with clients to assist them through the transition. The company has also increased its staffing to manage the accelerated clearing process.
The impetus for the T+1 shift partially stems from the 2021 meme stock phenomenon, where Reddit-driven investors sent stocks like GameStop and AMC Entertainment to unprecedented levels in a short time frame. During this frenzy, brokerages such as Robinhood had to temporarily halt buying of these stocks due to the T+2 rule, which increased collateral requirements and led to operational constraints.
“The existing two-day period to settle trades exposes investors and the industry to unnecessary risk and is ripe for change,” said Robinhood CEO Vlad Tenev in a 2021 release. “There is no reason why the greatest financial system the world has ever seen cannot settle trades in real time.”
For more information, read the full article on CNN.