What Is the Settlement Period?
In the securities industry, the trade settlement period refers to the time between the trade date—month, day, and year that an order is executed in the market—and the settlement date—when a trade is considered final. When shares of stock, or other securities, are bought or sold, both buyer and seller must fulfill their obligations to complete the transaction. During the settlement period, the buyer must pay for the shares, and the seller must deliver the shares. On the last day of the settlement period, the buyer becomes the holder of record of the security.
Key Takeaways
- The settlement period is the time between the trade date and the settlement date.
- TheSECcreated rules to govern the trading process, which includes outlines for the settlement date.
- In March 2017, the SEC shortened the trade settlement period to T+2.
- Trade settlement period will further reduce to T+1, or one business day after trade is placed, starting May 2024.
Understanding Settlement Periods
In 1975, Congress enacted Section 17A of the Securities Exchange Act of 1934, which directed the Securities and Exchange Commission (SEC) to establish a national clearance and settlement system to facilitate securities transactions. Thus, the SEC created rules to govern the process of trading securities, which included the concept of a trade settlement cycle. The SEC also determined the actual length of the settlement period. Originally, the settlement period gave both buyer and seller the time to do what was necessary—which used to mean hand-delivering stock certificates or money to the respective broker—to fulfill their part of the trade.
Today, money is transferred instantly but the settlement period remains in place—both as a rule and as a convenience for traders, brokers, and investors. Now, most online brokers require traders to have sufficientfunds in their accounts before buying stock. Also, the industry no longer issues paper stock certificates to represent ownership. Although some stock certificates still exist from the past, securities transactions today are recorded almost exclusively electronically using a process known asbook-entry; and electronic trades are backed up by account statements.
Settlement Period—The Details
The specific length of the settlement period has changed over time. For many years, the trade settlement period was five days. Then in 1993, the SEC changed the settlement period for most securities transactions from five to three business days—which is known as T+3. Under the T+3 regulation, if you sold shares of stock Monday, the transaction would settle Thursday.The three-day settlement period made sense when cash, checks, and physical stock certificates still were exchanged through the U.S. postal system.
T+2 Settlement Period
In the digital age, however, that three-day period seems unnecessarily long. In March 2017, the SEC shortened the settlement period from T+3 to T+2 days. The SEC's new rule amendmentreflects improvements in technology, increased trading volumes and changes in investment products and the trading landscape.Now, most securities transactions settle withintwo business daysof their trade date.So, if you sell shares of stock Monday, the transaction would settle Wednesday. In addition to being more aligned with current transaction speeds, T+2 could reduce credit and market risk, including the risk of default on the part of a trading counterparty.
Real World Example of Representative Settlement Dates
Listed below as a representative sample are the SEC's T+2 settlement dates for a number of securities. Consult your broker if you have questions about whether the T+2 settlement cycle covers a particular transaction. If you have a margin account you also should consult your broker to see how the new settlement cycle might affect your margin agreement.
T-2 settlement dates for:
- Certificates of deposit (CDs): Same day
- Commercial paper: Same day
- U.S. equities: Two business days
- Corporate bonds: Two business days
- Municipal bonds: Two business days
- Government securities: Next business day
- Options: Next business day
- Spot foreign exchange (FX): Two business days
Moving Towards T+1 Settlement
In February 2023, the SEC voted to further reduce the settlement cycle to T+1 from the prevailing T+2 for most securities. That means, trades placed on Monday should be settled by Tuesday.
The meme-stock buying frenzy in 2021, put pressure on brokers to increase deposits with clearinghouses while they waited for trades to settle in the T+2 cycle. That led to brokers, such as Robinhood, to restrict buying in some stocks. The shortened T+1 cycle, that goes into effect May 28, 2024, is intended to avoid such situations in future.
