All you need to know about T+1 Settlement
What is T+1 settlement
The introduction of a T+1 settlement cycle refers to the shortened time period between a trade execution and the settlement of the transaction. This T+1 settlement concept is now partially live in India, where market participants are able to settle their trades one business day after the trade has been executed, adhering to the T+1 settlement framework. This shift from the previous T+2 settlement cycle, where trades were settled two business days after execution, aims to enhance the efficiency and effectiveness of the securities market through the T+1 settlement change. The idea of implementing a T+1 settlement cycle is also actively being considered for the United States, with an estimated timeline of implementation set for around 2024.
Discussions and evaluations are currently underway to assess the feasibility and potential benefits of transitioning to a T+1 settlement cycle. This proposed T+1 settlement change is expected to bring numerous advantages, such as reducing counterparty risk, lowering capital requirements, and increasing market liquidity through the efficiency of T+1 settlement. Furthermore, early-stage discussions have begun in Europe regarding the possibility of adopting a T+1 settlement cycle. While specific details and timelines for the T+1 settlement adoption are yet to be determined, market participants and regulatory authorities are engaging in preliminary conversations to evaluate the potential impact and feasibility of such a T+1 settlement transition. This demonstrates a growing interest in aligning settlement practices across different regions to promote global harmonisation and streamline cross-border transactions with T+1 settlement. Overall, the introduction of a T+1 settlement cycle marks a significant shift in the securities industry, aiming to expedite the settlement process and enhance market efficiency. With India leading the way and the United States and Europe actively considering this T+1 settlement change, it is evident that the industry is moving towards shorter settlement cycles to optimise operational processes and facilitate smoother trading activities.
Why T+1 settlement
The market has been aiming to decrease the length of the settlement cycle for quite some time. The settlement cycle refers to the time it takes for a trade to be finalised and for the buyer to receive the securities they have purchased, while the seller receives the funds for the transaction. In the past, T+2 settlement was considered a significant progress towards achieving a shorter settlement cycle. T+2 means that the settlement occurs two business days after the trade date, but the new T+1 settlement aims to reduce this period even further. A shorter settlement cycle has several potential benefits. One of the primary advantages is investor protection. By reducing the time between trade execution and settlement, investors are less exposed to potential risks and uncertainties that may arise during this period. For example, market conditions or the financial health of the parties involved in the transaction could change, potentially causing losses or disruptions. A T+1 shorter settlement cycle minimises this exposure and provides investors with greater certainty and security.
Additionally, a reduced T+1 settlement cycle can lead to increased market efficiencies. With faster settlement, market participants can quickly reallocate their capital and engage in additional trades, facilitating liquidity and promoting a more dynamic market. This can also contribute to reducing market volatility and enhancing overall market stability. Furthermore, a shorter T+1 settlement cycle can help mitigate operational and counterparty risks. The longer the settlement cycle, the more time there is for errors or disputes to arise, potentially leading to failed trades or financial losses. By shortening the cycle to a T+1 settlement system, the likelihood of such incidents decreases, promoting smoother and more reliable settlement processes. In summary, the market has been striving to shorten the settlement cycle, with T+2 settlement seen as a significant step and T +1 settlement as the next logical progression. A shorter settlement cycle offers various advantages, including increased investor protection, enhanced market efficiencies, and reduced exposure to operational and counterparty risks.
What is the impact of T+1 settlement?
In order to achieve the current average equity settlement rate of 95% in the United States, a significant amount of manual investigation, review, and correction is required. This process involves thoroughly examining and verifying each equity transaction to ensure accuracy and compliance with regulations. The manual investigation entails carefully scrutinising the details of each trade, including the buyer and seller information, transaction price, and any special instructions or conditions. This step is crucial in identifying any discrepancies or errors that may have occurred during the trade execution or reporting process. Once potential issues are identified, a thorough review is conducted to determine the root cause of the problem. This may involve investigating discrepancies in trade confirmations, reconciling trade data across different systems, or analysing trade settlement instructions to ensure they align with the agreed-upon terms.
After the review process, appropriate corrections are made to rectify any identified errors. This can involve contacting the relevant parties involved in the trade, such as brokers, custodians, or clearinghouses, to resolve discrepancies and ensure accurate settlement.
This significant operational effort typically spans over two business days until the close of business on the day following the trade, known as T+1 settlement. This allows sufficient time for the manual investigation, review, and correction processes to be completed thoroughly. The need for such meticulous manual processes is driven by the importance of maintaining a high equity settlement rate. Accurate and timely settlement of equity transactions is crucial for maintaining investor confidence, market stability, and regulatory compliance.
Efforts are continuously made to streamline and automate these processes to reduce the reliance on manual intervention. However, due to the complexity and intricacies involved in equity settlement, a considerable amount of manual effort is still necessary to achieve the desired settlement rate.