How T+1 settlement transforms securities transactions

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Settlement is no longer a paperwork problem.

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The financial markets have adopted T+1 settlement, reducing the number of days it takes to complete a trade to one business day (from two), effective May 28, 2024. T+1 settlement applies to stocks, bonds, municipal securities, exchange-traded funds (ETFs), some mutual funds, and any limited partnerships that trade on an exchange.

After a market order clears, some time is needed to transfer the money between buyer and seller and then change the securities’ registration. The process used to take more than a week. Even after dramatic technological improvements, the process is not instantaneous, but it takes much less time than it used to. T+1 settlement (that is, the trade date plus one business day) is another step in that direction—one that’s now required by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).

The stock market is a market like any other. But when you go to a bookstore, for example, if you find a book you want to purchase, you take it to the checkout counter. The clerk takes your payment and, in turn, gives you the book (perhaps in a fancy bag).

Unlike a sale at a brick-and-mortar store, a securities transaction doesn’t take place in person. The buyer and seller normally don’t meet; instead, a broker-dealer—an intermediary—completes the transaction. Further, the security being traded is actually an electronic ledger entry, so someone needs to change it to reflect the new ownership. That work takes place through a clearing agency, with the assistance of the brokerage firms’ back-office operations staff.

The system works because buyers receive their securities and sellers get their money, instilling confidence that a basic function of the financial markets works. No one wonders whether they’ll get their money or the shares they purchased.

Over the decades, the time it takes to settle a trade has shortened to one business day from five. Under T+1 stock settlement, buyers must have enough money to cover their trades on the day of purchase, and sellers must present the securities to be transferred at the end of the day. In most cases, it takes even less time because the industry has embraced automation.

Settlement cycles change with technology and market conditions. T+1 replaced T+2, under which participants had two business days to take care of their funds and securities. The faster settlement reduces friction in the market, giving sellers access to their cash and buyers access to their securities a day sooner. A trade you make Monday will now settle Tuesday, when the new securities will show up in your account.

For most customers, the quicker settlement time is beneficial, although it may require you to arrange for bank Automated Clearing House (ACH) transfers sooner to ensure the funds are in your account for settlement. If any paper certificates are involved (for example, if you are settling an estate), you must ensure the broker receives them in time to settle the trades.

If you buy shares of mutual funds through your employer’s 401(k) plan, you won’t see a change. Stocks and exchange-traded funds (ETFs), which used to settle in two days, will now settle in one. You’ll need to have the funds for purchases ready in your account sooner than before, but you’ll see the securities and the proceeds of any sales a day sooner.

At one time, clerks waited to receive checks and paper certificates and then filled out forms to make the transfers happen. Five business days were allowed for settlement of funds, but it didn’t always happen in time. Mistakes were made, and the exchanges’ floors were covered in paper. Many Wall Street firms couldn’t keep up with the paperwork, and some even failed because they were unable to settle trades within the five business days required.

In 1968 the situation was so bad that the New York Stock Exchange (NYSE) and the U.S. Securities and Exchange Commission (SEC) stepped in. From June to December, the exchanges were allowed to close every Wednesday so that paperwork from Monday and Tuesday’s trading could be completed. Paperwork from Thursday and Friday was completed Saturday. Eventually, the exchanges and member firms invested in automation and beefed up their back-office capabilities.

History shows the importance of settling trades on time, and technology has made it easier for investors and traders to buy, sell, and trade securities in fewer days. T+1 is another step in that direction, and it is now required by the SEC and FINRA.

If you’re used to setting up a bank transfer after you place a buy order, you may have to rethink that habit. Regardless of how good a customer you are, regulation now requires that trades settle in one day, and the money has to be in your account for that to happen.