Deeper dive into T+2 and how stock trades are settled
Feb. 03, 2021 4:54 AM ETRobinhood Markets, Inc. (HOOD), SCHW, IBKR, MS, SQSCHW, MS, IBKR, SQ, HOODBy: Yoel Minkoff, SA News Editor34 Comments
- A topic that has gotten lots of attention on Wall Street over the last few days is a requirement that stocks be physically deposited in an account within two days of making a transaction - a process known as "T+2." During that time, brokers have to post collateral to the Depository Trust & Clearing Corp. because equity prices can fluctuate over those 48 hours, and the lag can make sure everything turns out alright. Some buyers are also using margin and sellers can be tapping borrowed shares, so the requirement could help prevent brokers from getting burned before the transactions settle.
- Backdrop: For many years, markets operated on a "T+5" settlement cycle, when security transactions were done manually. In the 1990s, the SEC shortened the settlement cycle to three business days, which reduced the amount of money that needs to be collected at any given time. It was only in 2017 that the commission moved to T+2, calling the previous standard an outdated "settlement cycle" due to improvements in technology, emerging new products and growing trading volumes.
- Latest argument: Given our current lightning-fast systems, many market participants say two days is too long to settle trades. "Moving the industry closer to T+1 settlement is good for everyone because the less risk we maintain in the system, the better off everyone is," said Shane Swanson, former director of equity market structure at Citadel Securities. Some are even calling for instant settlement, like Robinhood (RBNHD) CEO Vlad Tenev, who had to put up some big funds this week to cover the trading frenzy on his platform.
- "There is no reason why the greatest financial system the world has ever seen cannot settle trades in real time. Doing so would greatly mitigate the risk that such processing poses," Tenev wrote in a blog post. "Technology is the answer, not the oft-cited impediment. We believe it is important for all relevant stakeholders to convene in the near term to discuss the urgency and necessity of this issue."
- Related brokers: TD Ameritrade (NYSE:SCHW), Interactive Brokers (NASDAQ:IBKR), Charles Schwab (SCHW), E-Trade (NYSE:MS) and Cash App (NYSE:SQ).