US financial market shifts to T+1 settlement cycle this month

May 07, 2024 (MLN): The US, world’s largest financial market, will transition to a shorter settlement cycle of T+1 from the existing T+2 settlement cycle starting from May 28, 2024.

The T+1, where the T stands for the “transaction” date means the time it takes to settle equity transactions will be halved to just one day.

The US Securities and Exchange Commission (SEC) has said that shortening the settlement time reduces the risk of unsettled trades—that is, the risk of a counterparty failing to deliver cash or securities.

The sooner the parties have allocated, confirmed, and affirmed the trade information for their transaction, the lower the likelihood of a settlement failing since the parties will have more time to identify and resolve any potential errors.

Shortening the cycle also means reducing the credit, market, and liquidity risks of the clearinghouse.

"Nearly all commenters agree that shifting the transition to T+1 could be highly beneficial across time," says the statement by the SEC.

For investors, quicker access to the results of a transaction has obvious benefits.

A reduction in settlement cycle duration could reduce exposure to potential disruptions caused by price volatility while also lowering the value of outstanding obligations.

These benefits may result in reduced margin requirements as well as enhanced operational efficiency.

To note, US Treasuries, mutual funds, securities options markets, and much of the derivatives markets already settle at T+1.

Challenges for T+1

The SEC has also said that T+1 could potentially increase some operational risks.

Speeding up settlements would mean there will be less time to address errors within the process and, in some circumstances, less time to deal with trading entities that are suddenly confronting massive and unexpected trading losses within the settlement cycle timeframe.

There is also less time for regulators to identify and freeze the potential proceeds from potential frauds, such as, insider trading and market manipulation, before those proceeds exit the jurisdiction.

Industry's say on move to T+1

The Investment Company Institute (ICI), a leading association representing regulated investment funds, has said that the move to accelerate trade settlement from two business days after trade execution (T+2) to one business day (T+1), is a logical step.

Global market participants benefit from shortened settlement periods, as such moves can reduce counterparty exposure, improve liquidity, decrease collateral obligations, and expedite cash and security deliveries to retail investors.

Securities Industry and Financial Markets Association (Sifma), earlier in February 2023 when the SEC was finalizing the transition rule, said that the industry strongly supports the transition of securities settlement from T+2 to T+1, and in fact has been working on the project since 2020.

However, it had asked the SEC to give them until September 2024 to make the transition.

“We appreciate the Commission finalizing its rule to provide certainty, but we strongly disagree with the implementation date of May 2024," it said in a statement issued last year.

"It is the industry, and not the regulators, who will do the work to shorten the cycle and rushing the implementation for no apparent reason will only add risk when the underlying goal is to mitigate risk," Sifma said.

Pakistan's transition to T+1

Pakistan is also gearing up to transition to T+1, with its pilot run starting April 15, 2024, said the National Clearing Company of Pakistan Limited (NCCPL).

NCCPL has said that this proposed change in the settlement cycle will add significantly towards further enhancing the efficiency of the securities market operations and lead to its alignment with the best practices adopted and implemented by reputed securities exchanges in the world.

It will also demonstrate its strong commitment and capability to adapt ever transforming global service benchmarks to foreign investors and securities markets.

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