Securities Trading Has Just Gotten Faster

Securities Trading Has Just Gotten Faster

You probably hadn’t noticed it but the Securities & Exchange Commission (SEC) just shortened the trading settlement period for securities. As of May 28, 2024 all U.S. securities must settle within one day. What does this mean and how will it affect you?

Whenever you buy or sell a stock, bond, mutual fund, or other investment security on any U.S.-based exchange, the process probably seems instantaneous. But from a timing standpoint there are actually two steps involved. The purchase or sale typically executes within a matter of seconds if not minutes (except for open-ended mutual funds which can only be traded after-hours directly from the fund company). But you haven’t actually bought or sold the security yet. Ownership transfer is not completed until the money to/from the counterparty with which you executed the trade has been transferred. That’s called settlement.

When trading first began at the New York Stock Exchange in 1817, every trade necessitated the delivery of lots of paperwork – stock or bond certificates, trade sheets, and even paper money – before the transaction was recognized by all parties as having been concluded. Five business days were allowed for this process. (The term invented by the SEC to describe this restriction is T+5.) Despite the availability of couriers and the U.S. Postal Service, investment participants such as brokers and banks often maintained offices in close proximity to the exchange in order to expedite things. Needless to say, five days left plenty of time between the trade origination and its subsequent settlement for things to go wrong (such as the counterparty going bankrupt).

It wasn’t until 1993 – after the evolution and adoption of new technologies such as computerized clearing and fax machines – that the SEC was able to permanently reduce the settlement time down to three business days (T+3). Things remained that way for another 24 years, until further advances in trading systems and networking enabled the change from T+3 to T+2 in March 2017.

Now that the settlement cycle has been reduced to T+1, what are the consequences for investors? For the most part there should be little impact on individual investors. Almost all trading today is done electronically between accounts, circumventing the need for moving paper around. Most brokerages also require cash or sufficient margin within accounts before entering trade orders, so the risk of not being able to settle within the requisite one day is minimal. This change should also further reduce the likelihood that market volatility or some other unexpected event could disrupt trade completions.

The one area that could see some impact is with Exchange Traded Funds (ETFs) holding foreign stocks or bonds. That’s because many international securities still operate under T+2 settlement rules. It’s possible that thinly-traded foreign security ETFs could incur higher expenses if their limited liquidity forces a higher amount of share creations or redemptions in order to bridge the time gap. But since the vast majority of ETF trading volume occurs in the secondary market (that is, of existing shares between U.S.-based investors), it’s unlikely that any repercussions would be significant.

So welcome to the new world of T+1 settlement. Improved capital market efficiency is a benefit to everyone. Happy trading!

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