T+1, T+2, T+3 Settlement Explained

In the world of finance, the settlement period of securities transactions is a critical aspect that affects the efficiency and risk management of financial markets. The terms T+1, T+2, and T+3 refer to the number of days it takes for a security transaction to settle, which is the date when the ownership of the security is transferred and the cash is exchanged. Here, we delve into the latest figures and data to explain these settlement periods.

What is T+1 Settlement?

The T+1 settlement cycle, which stands for "trade date plus one," is the most recent and widely adopted settlement period. This cycle was successfully implemented in the United States and has been gaining traction globally. The transition to T+1 aims to reduce the time between the trade date and the settlement date, thereby minimizing the risk associated with unsettled securities trades. For instance, if a stock market transaction occurs on a Monday, it must settle by Tuesday under the T+1 cycle.

Benefits of T+1 Settlement

The shift to T+1 has several benefits. It reduces the pre-settlement risk, which in turn improves liquidity. For example, the National Securities Clearing Corporation (NSCC) Clearing Fund has seen a decrease in its size due to the reduced risk associated with shorter settlement periods. Additionally, the cost of settling transactions on T+1 is significantly less expensive than settling on T+2 or T+3, as incentivized by the DTCC's pricing policy.

Challenges with T+1 Settlement

While the transition to T+1 has been successful in some regions, it poses challenges in others. For instance, in the Asia Pacific region, markets like Australia are still discussing the feasibility of adopting T+1 due to geographical time zone challenges and the ongoing CHESS replacement project. India has successfully moved to T+1 at the start of 2023, but offshore investments remain pinned to the T+1 settlement regime due to funding requirements.

T+2 Settlement

The T+2 settlement cycle, which stands for "trade date plus two," is still widely used for most stock market and mutual fund transactions. This cycle means that if a stock transaction occurs on a Monday, it must settle by Wednesday. While this period is longer than T+1, it provides more time for market participants to recall securities out on loan to settle trades, thereby reducing the risk of settlement failures.

T+3 Settlement

The T+3 settlement cycle, which stands for "trade date plus three," is less common but still used for certain types of securities like bonds and some money market funds. This cycle means that if a stock transaction occurs on a Monday, it must settle by Thursday. This longer settlement period increases the risk of counterparty default and market risks associated with unsettled securities trades.

Conclusion

The transition to T+1 has been a significant step towards reducing risks and improving efficiency in financial markets. While challenges remain in implementing T+1 globally, the benefits of shorter settlement periods are clear.