Quiver Quantitative - U.S. trading moves to a shorter settlement cycle on Tuesday, with regulators aiming to reduce risk and enhance efficiency in the world's largest financial market. This transition, however, may initially lead to an increase in transaction failures for investors. To comply with the U.S. Securities and Exchange Commission's (SEC) new rule, investors in equities, corporate and municipal bonds, and other securities must now settle transactions within one business day after a trade, instead of the previous two-day period.
The move, known as T+1, follows a similar change in Canada, Mexico, and Argentina, which reported a smooth transition. The UK is expected to follow suit in 2027, with Europe also considering the shift. The SEC's initiative is partly a response to the 2021 trading frenzy around "meme stock" GameStop (NYSE:GME) (GME), highlighting the need to mitigate counterparty risk and improve market liquidity. “Shortening the settlement cycle will help the markets because time is money and time is risk,” said SEC Chair Gary Gensler.
Market Overview:
- U.S. equity settlement moves to T+1 today, aiming to reduce risk and improve efficiency.
- Faster settlement reduces counterparty risk and improves liquidity, potentially lowering costs.
- Transition may lead to temporary rise in settlement failures due to tighter timelines.
- Foreign investors face challenges sourcing dollars for same-day settlement.
- Industry prepared for potential rise in settlement failures, with DTCC conducting pre-emptive tests.
- Long-term benefits of T+1 outweigh short-term challenges, reducing systemic risk.
- Market participants expect fail rates to rise initially, but return to normal quickly.
Despite the potential benefits, the transition carries risks. Firms now have less time to secure funds for stock purchases, recall shares on loan, or resolve transaction errors, which could lead to higher settlement failures and increased transaction costs. “Hopefully, we'll start to see the expected benefits like risk reduction and lower margin requirements without a significant impact on settlement rates,” said RJ Rondini, director of securities operations at the Investment Company Institute.
Market participants, including banks, custodians, asset managers, and regulators, worked over the weekend to ensure a smooth transition. A virtual command center with over 1,000 participants was set up to monitor the process. Despite extensive testing, a temporary rise in trade failures is anticipated, similar to the increase observed in 2017 when the U.S. moved from a three-day to a two-day settlement period. "It's perfectly normal to see some changes in settlement rates initially, but we expect them to return to normal quickly," Rondini added.
This article was originally published on Quiver Quantitative