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The Shortened Settlement Cycle
On September 5, 2017 the U.S. moved to a T+2 settlement cycle moving from the standard T+3 cycle. Firstly, let me explain what that means-literally it is the trade date plus 2 days. If that’s still Greek, then when you buy a stock, for example on Tuesday, October 10th, that is the trade date. However, the trade is not settled, (meaning the ownership is transferred and money changes hands) until three days later on October 13th- hence the trade date + three days or (T+3). Now, the U.S. has switched this to T+2, so instead of getting your money three days after the trade date, you will be getting it early at two days after-assuming you are selling the asset.
Who does this affect?
In a nutshell, it affects any investors doing bond trades or stock trades in the U.S. market. Now everything will be “settled” sooner. This is actually a good thing in some ways. In general, the sooner money changes hands, the safer it is for the parties involved, as you would have seen in your own lives. It also applies in the world of finance, where it reduces the risk for investors by having the transaction settle one day earlier.
The other benefit is that the change will align the U.S. with the current European cycle. This of course makes for seamless transactions across the regions. In fact, Canada switched to the shortened cycle on the same date as the U.S. The Japan Securities Dealers Association (JSDA) will shorten the settlement cycle of Japanese Government Bonds (JGBs) from T+2 to T+1 on 1 May 2018. As it stands, many countries in the Asia Pacific have already adopted the T+2 settlement cycle. Managers of global funds are likely to benefit from a consistent and streamlined cash flow approach.
Interestingly enough, it is a huge benefit for mutual funds in the U.S., as the majority of them pay out investors on a T+1 (trade date +1 day) settlement which means that the investors get paid before the fund can receive money from the sale of securities in the portfolio. This will reduce the liquidity risk for those mutual funds, although there will still be a lag of one day.
Not positive for everyone!
This change will not benefit everyone, as investors who are purchasing stocks will have to fund the accounts in a shorter time period. Those brokers who “short” securities, i.e. they borrow stocks to sell them and have to cover the position at some point, will find themselves having to fork up the money sooner to cover their short positions.
The Way Forward
Successful implementation of the T+2(trade date plus 2 days) cycle will lead to a further reduction, as it is thought that if the transition is a smooth one, the industry will then suggest a move to a T+1 settlement which would be ideal for mutual funds and would benefit individual investors-who routinely ask for shortened settlement cycles so as to get their money faster. Of course, this has huge benefits for clearing houses, who many times have an obligation to fund accounts for brokers, and undergo risks every day. The shorter the cycle, the lower the risk and most players in the industry would jump at the chance to lower their everyday risk.
Yanique Leiba-Ebanks, CFA, FRM is the AVP, Pensions & Portfolio Investments at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: firstname.lastname@example.org
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