Today marks a historic moment for the US stock market. Currently, the US stock market follows a 'T+0' trading system and a 'T+2' settlement cycle. This means that when investors buy a stock, they can sell it on the same day, but the money will not be available for 2 days. In March of this year, the US Securities and Exchange Commission (SEC) announced that starting May 28th, the standard settlement cycle for US stocks will be shortened from 'T+2' to 'T+1', meaning that investors will receive the settlement cash on the next business day after the trade.

What is T+1 settlement?

T+1 settlement refers to completing a financial transaction within one business day. For example, if a trade occurs on Monday, the settlement will take place on Tuesday, and the trader will officially receive the cash or securities and can freely exchange them without any penalties.

What are the US stock T+1 settlement rules?

The catalyst for the transition from T+2 to T+1 settlement in the US stock market was the GameStop event in 2021.

In early 2021, 'meme stocks' like GameStop saw a surge in trading volume and volatility driven by retail investor enthusiasm on social media. This put enormous financial pressure on trading platforms like Robinhood, as they needed to provide collateral to cover the large number of trades within the T+2 settlement period.

To ensure they had enough capital to cover the collateral, Robinhood began restricting investors from buying these stocks. This action sparked strong backlash from retail investors and drew scrutiny from regulators and Congress, prompting the regulatory authorities to push for the T+1 settlement system.

As technology has played an increasingly important role in the market, the SEC has been shortening the settlement time frame. In 1993, the SEC reduced the standard settlement period from the usual 5 days (T+5) to 3 business days (T+3). Later, in 2017, the SEC further shortened the settlement period to 2 days (T+2), and now, in 2024, they are introducing the T+1 settlement period.

Significance of T+1 Settlement for the Market

· Reduced Trading Risks

The T+1 settlement will shorten the settlement cycle for securities transactions, reducing the trading risks for market participants. A shorter settlement period means faster delivery of funds and securities, which can help mitigate the impact of market volatility on investors and financial institutions.

· Improved Market Efficiency

Shortening the settlement cycle can help improve market efficiency, allowing investors to access funds and securities more quickly, facilitating faster capital turnover and investment decision-making, and optimizing the allocation of market resources.

· Enhanced Financial Stability

T+1 settlement can help reduce the risks associated with fluctuations in securities prices and values during the transaction process, thereby enhancing the overall stability of the financial market. This can lower the uncertainty faced by investors and financial institutions, supporting the stable development of the market as a whole.

Assuming a smooth transition without any issues, the move to T+1 settlement is expected to bring overall benefits to the market ecosystem, institutional investors, and retail investors.

Benefits of T+1 Settlement for Investors

· Reduced Investment Risks

The shorter T+1 settlement cycle can lower the overall system risk, creating a safer and healthier market environment for retail investors.

· Improved Market Efficiency and Liquidity

The shorter settlement period allows for faster trading of stocks, with quicker access to funds after selling, enabling faster reinvestment.

· Lower Transaction Costs

Compared to T+2 settlement, the reduced costs for financial institutions in risk management and back-office processes will be passed on to investors, leading to lower transaction costs.

· Minimal Impact on Capital Turnover

While T+1 settlement requires investors to have funds ready in advance, this impact is generally negligible for most investors, except in cases involving foreign currency exchange or other special circumstances.

T+1 Risks and Challenges

The SEC states that the shorter settlement cycle may lead to a short-term increase in settlement failure rates, posing risks to a small number of market participants. On the other hand, investors have less time to correct errors. As transaction settlement speeds up, investors need to detect and correct trading errors more quickly.

For margin traders, T+1 means margin calls may come faster, requiring them to quickly raise funds to avoid forced liquidation by their broker.

For securities lending, lenders have less time to identify and recall lent shares. If the borrower cannot return the shares on time, it may result in settlement failures. Frequent settlement failures can lead to fines from the exchange or regulators. This undoubtedly increases the operational difficulty and potential default risk of securities lending activities.

Is T+0 Still Far Away?

Technically, T+0 same-day settlement is possible, especially in blockchain and cryptocurrency trading. India has already adopted T+0.

However, fully implementing T+0 in the US stock market faces challenges, mainly around financing and efficiency rather than technology.

Cryptocurrency trading can settle instantly because buyers pre-fund their trades, but this would be a huge capital burden for US stock market participants.

T+1 has already achieved a good balance between reducing risk and improving efficiency. T+0 may introduce new risks like system failures and may conflict with existing market structures.

Overall, T+1 is seen as a reasonable compromise, more efficient than T+2 but lower risk than T+0, which may be premature to implement broadly at this stage.