John M Lund Photography Inc
Markets are only a week away from a new settlement cycle as the Securities and Exchange Commission (SEC) and the Depository Trust & Clearing Corporation (DTCC) move the industry to "T+1." Currently, market players are required to physically deposit stock in an account within two days of making a transaction, in a process known as "T+2."
During that time, brokers have to post collateral to the DTCC because equity prices can fluctuate over those 48 hours and some buyers/sellers are using margin/borrowed shares, so the lag can make sure everything turns out all right.
Backdrop: For many years, markets operated on a "T+5" settlement cycle, when security transactions were done manually. In the 1990s, the SEC shortened the settlement cycle to three business days, which reduced the amount of money that needs to be collected at any given time. It was only in 2017 that the commission moved to T+2, calling the previous standard an outdated "settlement cycle" due to improvements in technology, emerging new products and growing trading volumes. Note: The move to T+1 will also impact ETFs, certain mutual funds, REITS and MLPs.
One of the biggest catalysts to speed up the clearing timeframe was the meme stock trading frenzy of 2021, which ironically, just resurfaced. Brokers were forced to post collateral during the settlement period and eventually had to restrict trading to ensure they had enough margin in the funds held by the DTCC. Some have even called for real-time settlement, like Robinhood (NASDAQ:HOOD) CEO Vlad Tenev, who came away from the GameStop (NYSE:GME) saga with condemnations from the retail crowd given the platform's slogan to "democratize finance for all."
Is it a possibility? The benefits of an even shorter settlement cycle are controversial. This could eventually fail to protect market participants by not giving enough time to detect failed trades, correct settlement instructions or deal with compliance issues. Instant settlement (T+0) would also require expensive updates to almost all market infrastructure, and could do away with benefits like settlement netting, strain dealer resources, or weigh on important trading tools like margin purchases of stock. Other alternatives are also being explored, including T+0.5 or T+evening, where market trades would be settled the same day.
Related brokers: Robinhood (HOOD), Interactive Brokers (NASDAQ:IBKR), Charles Schwab (NYSE:SCHW), E-Trade (NYSE:MS) and Cash App (NYSE:SQ).
Wall Street Breakfast survey: For most investors, the shift to T+1 will have little impact on their trading decisions. The bigger question is whether it can prevent another crisis, like the GameStop short squeeze, from occurring again. As meme stocks make a comeback in 2024, do you see a scenario where brokerages will restrict trading again? Take the poll and share your thoughts about it in the comments section.
Related to this story
- Robinhood to become first brokerage offering overnight stock trading
- Should Wall Street move to a four-day trading week?
- SEC adopts final rules to shorten settlement of trades
- T+1 Is Wrong-Headed. Market Safety Is An Attitude, Not A Cost
- 2021 meme stock frenzy posed bigger threat to Robinhood than company revealed