Starting Tuesday, U.S. trading will shift to a shorter settlement period, a move regulators believe will reduce risk and enhance efficiency in the world’s largest financial markets. However, this transition is expected to initially increase transaction failures for investors.
To comply with a rule change adopted by the U.S. Securities and Exchange Commission (SEC) in February, trades in U.S. equities, corporate and municipal bonds, and other securities must now settle within one business day after the trade (T+1), down from the previous two days (T+2). This change will take effect on May 28. Canada, Mexico, and Argentina will transition to T+1 a day earlier. The UK plans to implement this change in 2027, and Europe is considering it. The new standard aims to reduce counterparty risk and improve capital efficiency and liquidity, prompted by the 2021 GameStop trading frenzy.
“Shortening the settlement cycle will benefit markets by reducing both time and risk,” said SEC Chair Gary Gensler, adding that it will strengthen market infrastructure. However, the compressed timeframe could increase settlement failures and transaction costs, as firms have less time to secure funds, recall loaned shares, or resolve transaction errors.
Implications for Market Participants
Settlement failures occur when a buyer or seller does not meet their obligations by the settlement date, potentially leading to losses, penalties, and reputational damage. RJ Rondini, Director of Securities Operations at the Investment Company Institute, expressed cautious optimism: “We hope to see reduced risk, lower margin or collateral requirements, and minimal impact on settlement rates.”
Settlement, the process of transferring securities or funds after a trade is agreed upon, is managed by the Depository Trust Company (DTC), a subsidiary of the Depository Trust and Clearing Corporation (DTCC). The U.S. will follow India and China, where faster settlement cycles are already in place.
Weekend Preparations and Anticipated Challenges
Banks, custodians, asset managers, and regulators will work over the weekend to ensure a smooth transition. The Securities Industry and Financial Markets Association (SIFMA) has organized a virtual command center with over 1,000 participants to coordinate the change. On Monday, a U.S. holiday, the market’s focus will be on the transition in Canada, Mexico, and Argentina. Any issues there could affect the U.S., warned Christos Ekonomidis, T+1 Program Director at BNY Mellon.
Wednesday will be a significant test, as trades executed on Friday (T+2) and Tuesday (T+1) will settle, likely increasing volume and potential failures. Despite extensive testing by DTCC and market participants, an increase in settlement failures is expected, similar to the transition from T+3 to T+2 in 2017.
A survey by research firm ValueExchange predicts the fail rate will rise to 4.1% from the current 2.9% post-implementation. However, SIFMA expects the increase to be minimal, and the SEC anticipates a short-term uptick. Brian Steele, President of Clearing and Securities Services at DTCC, emphasized the industry’s readiness, noting significant participation in the transition process.
Risk and Reward Analysis
The shift to T+1 is designed to mitigate systemic risk by reducing counterparty exposure, improving liquidity, and decreasing margin and collateral requirements. However, some market participants worry that the change might transfer risks to other areas of the capital markets, such as foreign exchanges and securities lending.
Foreign investors, who hold nearly $27 trillion in U.S. stocks and bonds, must adapt to the shorter settlement cycle, potentially increasing the need for overnight funding markets to bridge liquidity gaps. Natsumi Matsuba, Head of FX Trading and Portfolio Management at Russell Investments, noted the firm’s proactive approach by testing market liquidity during off-hours.
Gerard Walsh, leader of Northern Trust’s Global Capital Markets Client Solutions group, advised managers to be aware of the potential solutions available for these new challenges, stating, “The full impact won’t be clear immediately, but preparation is key.”
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