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The US trading market will shorten the settlement cycle, increasing investor failure rates.

TraderKnows
TraderKnows
05-29

According to the regulations of the U.S. Securities and Exchange Commission, the settlement cycle in the U.S. trading market will be shortened starting this Tuesday.

Starting Tuesday, the U.S. trading market will shorten the settlement cycle. Regulators hope this will reduce risk and increase the efficiency of the world's largest market, but it is expected to temporarily increase the failure rate of investor transactions.

Rule Changes and International Trends

According to a rule change approved by the U.S. Securities and Exchange Commission (SEC) in February last year, starting May 28, investors in U.S. stocks, corporate bonds, municipal bonds, and other securities must complete settlement within one business day after the trade, rather than the previous two business days. Canada, Mexico, and Argentina shortened their market trading hours to one day on Monday. The United Kingdom is expected to follow in 2027, and Europe is also considering this change.

Background and Challenges of Shortening the Settlement Cycle

Regulators proposed the new T+1 standard following the meme stock frenzy around GameStop in 2021, aiming to reduce counterparty risk and enhance capital efficiency and liquidity in securities trading.

SEC Chairman Gary Gensler stated that shortening the settlement cycle helps the market because time is money and time is risk, making market infrastructure more robust.

However, this also brings risks as firms will have less time to raise funds to buy stocks, recall loaned stocks, or rectify trading errors, potentially increasing the risk of settlement failures and raising trading costs.

A trade failure occurs when buyers and sellers fail to fulfill their trading obligations by the settlement date, which can lead to losses, fines, and reputational damage.

RJ Rondini, Director of Securities Operations at the Investment Company Institute, expressed hope to see the expected benefits of reduced risk and reduced margin or collateral without significantly affecting settlement rates.

Settlement refers to the process of transferring securities or funds from one party to another after a trade is made. This process occurs after clearance and is handled by the Depository Trust Company (DTC), a subsidiary of the Depository Trust and Clearing Corporation (DTCC).

The U.S. will follow the example of India and China, which have already implemented faster settlement mechanisms.

Weekend Preparations

The Securities Industry and Financial Markets Association (Sifma) stated last week that market participants, including banks, depositories, asset management companies, and regulators, were working hard over the weekend to ensure a smooth transition. A virtual command center has been created, and more than 1,000 participants will join conference calls to discuss the transition.

On Wednesday, the market will face another major test as trades executed on Friday (still T+2) and Tuesday (the first day of T+1) will both settle on this day, leading to expected higher trading volumes.

Although the DTCC and market participants have conducted months of testing, an initial increase in the trade failure rate is expected. When the U.S. shortened the settlement cycle from three days to two days in 2017, a rise in the failure rate was also observed.

Rondini said it is normal to see some slight changes in settlement rates, but he expects settlement rates to normalize quickly.

A survey by ValueExchange showed that market participants expect the failure rate to rise from the current 2.9% to 4.1% on average after the implementation of T+1. Sifma expects the increase in failure rates to be minimal, and the SEC indicated there may be a short-term rise.

Brian Steele, President of Clearing and Securities Services at DTCC, stated that over 90% of the industry has participated in this process since testing began in August 2023. He noted that since the industry's shift to T+2 in 2017, there is still a "deep muscle memory" within the industry.

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Risk Warning and Disclaimer

The market carries risks, and investment should be cautious. This article does not constitute personal investment advice and has not taken into account individual users' specific investment goals, financial situations, or needs. Users should consider whether any opinions, viewpoints, or conclusions in this article are suitable for their particular circumstances. Investing based on this is at one's own responsibility.

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Settlement Price

The settlement price refers to the price at the end of a trading period used to calculate the profit or loss of an investor's trading activities during that period.

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