Buying or selling a stock is about to get a lot snappier starting next Tuesday. But that doesn't mean it'll get smoother, at least right away — and some financial firms are preparing to handle any possible bumpiness.
The current standard settlement cycle for broker-dealer transactions is "T+2." That means that it takes two business days from when you buy a stock to when that transaction "settles," or when the stock is officially transferred to the buyer's account and cash is delivered to the seller's account. That's been the norm since 2017.
Starting May 28, that cycle will take just one business day, or "T+1."
"For everyday investors who sell their stock on a Monday, shortening the settlement cycle will allow them to get their money on Tuesday," Gary Gensler, chair of the Securities and Exchange Commission, said in a press release. "It will make our market plumbing more resilient, timely and orderly."
These new rules will apply to stocks, bonds, municipal securities, exchange-traded funds, some mutual funds and limited partnerships that trade on an exchange. Broker-dealers and registered investment advisors will also have to follow new recordkeeping rules.
Some investors say that a shorter cycle should help free up more liquidity in the market and reduce volatility in margins — the collateral a trader has to show -- since it lowers the chance of default before the transaction goes through. Clearinghouses, which sit between buyers and sellers, collect the margins from traders as evidence that they can afford to make the transaction.
"Assuming everything goes well and we don't see any hiccups, the move towards T+1 will be an overall benefit to our ecosystem, institutional investors and retail [investors]," said Rich Lee, head of program trading and execution strategy at Baird.
Baird has had a T+1 committee in place since last summer to ensure such hiccups don't happen, Lee said. Employees have been in discussions with clients about how to assist them through the process. The company has also staffed up to handle their part in clearing trades with a shorter time frame.
The shortened settlement cycle is partly in response to the 2021 meme stock frenzy, when investors on Reddit sent shares of GameStop and AMC Entertainment soaring to eye-popping heights in a short span of time. (Meme stocks typically trade less on fundamentals and more on social media frenzy.)
Robinhood in 2021 temporarily suspended trading of GameStop, AMC and other stocks on its platform, blaming in part the T+2 rule that pushed up collateral requirements imposed on brokers like Robinhood. Investors were left waiting for their trades and brokers with their cash locked up until the settlement, unable to allow more purchasing to ensure they had enough funds to cover the trades.
"The existing two-day period to settle trades exposes investors and the industry to unnecessary risk and is ripe for change," Robinhood CEO Vlad Tenev said in a February 2021 release. "There is no reason why the greatest financial system the world has ever seen cannot settle trades in real time."
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