For decades, Wall Street has been processing trades faster and faster, and on May 28 the industry will hit a new benchmark when it moves from the T+2 to T+1 settlement cycle.
This means whenever an investor buys or sells a stock, corporate bond, ETF or municipal security, their transaction will be processed in one business day instead of two. But with this structural change, a new question arises: can markets move even faster?
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Also read: The SEC’s T+1 settlement rule will transform stock trading: Here’s what you need to know.
Settlement involves the transferring of money and securities between a buyer and seller. Whenever someone buys or sells a stock, there are two important dates to keep in mind. The first is the transaction date (or T), which is when the order is confirmed. The second is the settlement date, when the buyer gets the securities they purchased in their account, and the seller gets the proceeds of that sale.
The wide-held belief in financial markets is that the less time between these two dates, the better. That’s because time equals risk, and the more time there is, the greater the chance of something going wrong.
That’s why U.S. markets moved from T+5, to T+3, to T+2 and now T+1. But will we ever see T+0—or in other words, same-day settlement?
Some industry groups warn against T+0 because they see “diminishing returns” and believe it will create additional risks. For T+0 to work, some systems my have to be redesigned, like the way market participants do ETF processing, options and margin investing, and securities lending.
But systems had to be changed for the transition to T+1 from T+2. This was possible because brokerages and clearinghouses knew the change was coming and had years to prepare.
Shaving the time frame beyond that fromT+1 to T+0 still removes an element of timing risk.
“It removes all the overnight risk from the system, which I think is a good thing,” Dave Lauer, CEO of Urvin Finance, told MarketWatch. In addition to leading Urvin, Lauer also advocates for market structure reforms to benefit retail investors.
“I think it makes it harder for things like abusive short selling, harder to not deliver securities, and harder to take advantage of loopholes.”
Lauer thinks that shorter settlement cycles could prevent certain forms of market manipulation that hurt individual investors. On top of that, he believes it creates a more natural experience for investors, who want to place a trade and then get the result of that transaction the same day.
Some markets already operate under a T+0 settlement cycle. Cryptocurrency trades settle in T+0 because of how the blockchain ledger works. Doing this requires prefunding trades so both money and crypto assets are transferred smoothly. Prefunding U.S. securities markets would be a bigger lift, but it’s not necessarily impossible.
T+0 settlement isn’t limited to crypto either. Earlier this year the Indian stock market transitioned to a same-day settlement cycle, making it one of the first countries to do so. While other countries like the U.S., Canada, the U.K. and Mexico plan their transition to T+1, they may be looking at India to see what’s next.
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