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Beginning next Tuesday, the process of buying or selling stocks is set to become much quicker. However, this does not necessarily guarantee a smoother experience, at least not initially. As a result, several financial firms are making preparations to handle any potential difficulties that may arise.
Currently, broker-dealer transactions follow a settlement cycle known as “T+2.” This means that it takes two business days from the date of purchase for the transaction to be officially settled. During this time, the stock is transferred to the buyer’s account, and cash is delivered to the seller’s account. This has been the industry standard since 2017.
However, starting on May 28, this settlement cycle will be shortened to just one business day, or “T+1.”
“In a press release, Securities and Exchange Commission Chair Gary Gensler expressed that the shortened settlement cycle will benefit everyday investors who sell their stocks on Mondays by allowing them to receive their money on Tuesdays. Gensler believes that this change will enhance the resilience, timeliness, and orderliness of our market plumbing.
The new rules regarding the shortened settlement cycle will be applicable to various financial instruments, including stocks, bonds, municipal securities, exchange-traded funds, some mutual funds, and limited partnerships traded on exchanges. Additionally, broker-dealers and registered investment advisors will be required to comply with new recordkeeping rules.
According to some investors, the shorter settlement cycle is expected to increase market liquidity and decrease volatility in margins. This is because the reduced chance of default before the transaction is finalized minimizes the collateral traders have to provide. Clearinghouses, which act as intermediaries between buyers and sellers, collect margins from traders as a measure of their ability to fulfill the transaction.”
According to Rich Lee, the head of program trading and execution strategy at Baird, assuming there are no issues, the transition to a T+1 settlement cycle will be advantageous for our ecosystem, institutional investors, and retail investors. Baird has established a T+1 committee to ensure a smooth transition and has been engaging in discussions with clients to provide support during the process. Additionally, the company has increased staffing to efficiently handle trades with a shorter settlement time frame.
The decision to shorten the settlement cycle is partly in response to the meme stock frenzy of 2021. During this period, investors on Reddit drove up the prices of stocks such as GameStop and AMC Entertainment through social media hype, rather than traditional market fundamentals.
In 2021, Robinhood and other brokerages faced a temporary suspension on the buying of stocks like GameStop and AMC on their platforms. This suspension was partly attributed to the T+2 rule, which increased collateral requirements for brokers such as Robinhood. As a result, investors had to wait for their trades to settle, while brokers had their cash locked up, unable to make further purchases to ensure sufficient funds for trade coverage.
Robinhood CEO Vlad Tenev expressed the need for change in a press release in February 2021, stating, “The existing two-day period to settle trades exposes investors and the industry to unnecessary risk and is ripe for change. There is no reason why the greatest financial system the world has ever seen cannot settle trades in real time.”