U.S. stocks have entered the era of T+1 settlement

The official account of Beijing Business Daily

2024-05-26 23:18Published on the official account of Beijing Business Daily in Beijing

At present, the U.S. stock market implements the T+0 trading system, but implements the T+2 settlement and delivery system. That is, an investor buys a stock and can sell it on the same day, but the settlement of the transaction is not done immediately. After the three-day holiday, the "T+1 settlement era" of U.S. stocks will officially open on Tuesday. For retail investors, the money from selling stocks can be quickly used for new investments. But equally, the T+1 settlement mechanism may also bring some operational risks.

Half the time

Starting from May 28, local time, the settlement cycle of U.S. stock transactions will be shortened from T+2 to T+1, that is, the exchange of US dollars and stocks will be completed within one day after the transaction is completed.

The reason for the T+1 shift is mainly due to the impact of the "MEME shares" trading boom centered on cheap stocks such as game stations on trading platforms in early 2021. At the time, retail investors were buying up the shares in large quantities due to social media, forcing trading platform operators like Robinhood Financial to guarantee these transactions during a two-day settlement period.

But as the share price, its trading volume and volatility rose, Robinhood began restricting purchases of these shares to ensure that there was sufficient capital to cover the collateral, an act that sparked backlash from retail traders and scrutiny from regulators and members of Congress, prompting regulators to begin rolling out T+1 settlements.

Regarding the benefits of T+1, the SEC said that a shorter settlement window means that buyers and sellers are less likely to default before the deal closes. This shift means that the broker's margin requirements are lower, and the high volume or volatility will also force the broker to limit the risk of trading. Previously, U.S. Treasuries and mutual funds had achieved T+1 settlement.

The SEC also said that T+1 may add some operational risk. As the new rules are finalized, SEC Commissioner Mark Uyeda said that halving the settlement time will mean less time for investors to resolve errors in the trading process and for regulators to stop fraud.

As for why T+0 settlement is not implemented, SEC Chairman Gary Gensler said that modern technology can shorten the trading process to "same-day settlement (T+0 or T+evening)". This will further reduce the risk of one party or the other defaulting before settlement. But the Securities Industry and Financial Markets Association says the change would require costly changes to market operations. The group said T+0 could lead to more "failed transactions" and fraud, as there would be less time to fix incorrect settlement instructions or discover compliance issues.

Failed to settle?

At the moment, many institutions are concerned that the T+1 system may increase the chances of settlement failure, as the compression of settlement time may make mistakes more likely to occur and reduce the chance of correcting them. Most critically, it makes it more difficult for buyers and sellers to ensure that their funds and securities are ready.

In a survey conducted by research firm Coalition Greenwich in April and May, only 9% of sell-side firms said they expected the T+1 settlement transition to go smoothly, 38% warned that buy-side managers were not prepared, 28% felt that the trading platform was not fully ready, and nearly a fifth expected a large number or serious problems that could cause huge chaos.

It is worth mentioning that just three days after the T+1 settlement of US stocks took effect, the quarterly adjustment of MSCI's major stock indices around the world will also officially take effect, and one of the most influential trading days of the year may bring more pressure to the market that is still adapting to the new mechanism. This rebalancing of global equity indices means that fund managers must resize their holdings to keep their ETFs mandated to continue to track MSCI indices.

During the last rebalancing, the average global equity volume in both developed and emerging markets soared by about 120%, with a whopping $47 billion traded, according to statistics from Northern Trust. In the U.S. stock market, this figure increased by about 199%. Some market participants are concerned that the number of failed deals could increase significantly, which could hamper the efforts of some institutional investors to align their portfolios with MSCI benchmarks.

A person engaged in U.S. stock analysis told Beijing Business Daily that settlement failure could lead to regulatory penalties, loss of trading capital, and even in rare cases, when the transaction size is large enough, it can lead to the collapse of all parties to the transaction. However, in the modern market, settlement failures are rare and often stem from technical issues or human error.

Be prepared

For investors outside the U.S., there is also a need to adapt to this change as soon as possible. According to Bloomberg, the halving of the settlement time for U.S. stock trading will disconnect the U.S. stock market from the $7.5 trillion global currency trading market, which typically takes two days to complete. Many overseas institutions trying to buy U.S. assets need to get U.S. dollars in advance to ensure they have U.S. dollars in time to complete the transaction. Failure to do so may result in some purchases failing altogether.

Brokers and investors in Asia will also face special time-critical challenges as they need to execute trades before the US market closes in order to meet the time constraints. New York time is the deadline for the transaction to be "confirmed", which is the last step before settlement. The European Fund and Asset Management Association, which manages 28.5 trillion euros, has warned that up to $70 billion of daily currency transactions could be at risk due to the acceleration of the US settlement cycle.

However, many companies have already prepared in advance. Some funds, such as Palmerjefo Investments, have chosen to move traders to the United States. Jupiter Asset Management has also bought dollars in advance, while more companies are looking to outsource their forex trading. A survey sponsored last year by the U.S. Depository Trust and Clearing Corporation found that more than half of European financial firms with fewer than 10,000 employees are planning to relocate employees to North America or hire night shift workers.

Financial and trade groups, such as the Association of Investment Companies, have said their industries are preparing for the transition, and banks have put in place transition plans to deal with any potential issues. In particular, they are focused on the so-called double settlement date on May 29, when the US stock trades of the old T+2 cycle will expire at the same time as the first T+1 trades.

On the news, T+1 is also changing the long-term decision-making of some banks. For example, Société Générale's securities services arm extended the working hours of some of its employees, while Citigroup relocated part of its team to Kuala Lumpur and adopted a Tuesday-Saturday schedule instead of the typical Monday-Friday schedule to better align with the U.S. trading week.

JPMorgan's internal model shows that about a quarter of the currency transactions it processes for its clients are expected to be affected. Brown Brothers Harriman is running a "T+1 simulation" of customers to identify those with potential problems.

Beijing Business Daily reporter Zhao Tianshu

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