T+2 Settlement Cycle
On September 5, 2017, the Securities and Exchange Commission (the “SEC”) adopted an amended rule to shorten the settlement cycle for most securities transactions, reducing the cycle to two business days (T+2), instead of three.
T+3 had been in place since 1995, after the SEC reduced the settlement cycle from T+5. This timing applies to the same securities transactions currently covered by the T+3 settlement cycle, including transactions for stocks, bonds, municipal securities, exchange-traded funds, certain mutual funds, and limited partnerships that trade on an exchange.
The move to shorten the settlement cycle to T+2 is intended to reduce systemic, counterparty and operational risk, and lower liquidity needs while aligning the United States with other T+2 settlement markets across the globe. The United States is one of the last countries to implement the T+2 settlement – Europe, Hong Kong, New Zealand and Australia have already made the move. Given the substantial volume of cross-border trading activity between Canada and the United States, Canada also switched to the T+2 settlement cycle on September 5, 2017.
The Depositary Trust and Clearing Corporation, which clears and settles actual trades in the United States, estimates that T+2 will reduce its average daily capital requirements by 25%, or about $1.4 billion.
For years, a large number of financial firms and other market participants have pushed for the shortened settlement cycle. The risk is reduced for brokers and investors alike when money moves more quickly between buyers and sellers. The global financial crisis nearly a decade ago heightened awareness of the need for a shorter settlement cycle.
Since then, the financial industry and regulators alike have aimed to reduce systemic risk within the financial system. Shortening the settlement period would reduce the risk when one party in a trade experiences financial distress and is unable to complete settlement obligations. It also means that investors will receive their money or shares faster after making a transaction.
How T+2 Affects Investors
With T+2, investors can buy and sell at a much faster pace. When an investor buys a stock on a Wednesday, the money is due in the account by Friday – a day earlier than any point during the past two decades. The same goes for when an investor sells a stock; the money is required to be delivered within two business days by the broker-dealer.
Another major difference is how this affects dividends. NYSE Rule 235 and Nasdaq Rule 11140(b)(1), have shortened the ex-dividend date cycle from two days to one day before the record date. Issuers with a record date on or after September 7, 2017, are required to follow the new one-day ex-dividend cycle. This is important for dividend investors because this shortens the timing of when a stock needs to be purchased for the holder to be eligible for the upcoming dividend.
For example, BlackRock Capital Investment Corporation (BKCC) has its next ex-dividend date on December 18, 2017. Prior to this change, the record date was supposed to be two business days after, or December 20, 2017. However, since the cycle has shortened to only one day, the new record date is December 19, 2017.
So an investor for the dividend would only be eligible if they purchased BKCC prior to December 18. This would also be applicable to investors that sold their BKCC shares prior to the ex-dividend date, as they sold their right to the upcoming dividend away.
A New Frontier
The move to T+2 settlement was inevitable – with the advent of technology, stock exchanges around the world and the financial services industry have grown tremendously. The shortened settlement cycle benefits capital markets because investors can trade faster and reduce their trading and margin costs.
Broker-dealers also benefit as they can manage their liquidity better and at the same time, reduce their overall risk. Thus far, the response to T+2 by market participants has been positive. The new challenge would be to further shorten the settlement cycle in the near future – to T+1 or T+0, maybe?