Clearing and settling stock trades may not sound like probably the most exciting topic, however it is a crucial one. And something big is occurring this yr. The US stock market is moving to a shorter settlement cycle.
Starting May 28, trades in U.S. stocks will choose the day after the trade date (T+1). Currently the settlement cycle is 2 days after the trade date (T+2). Trading in U.S. corporate bonds and unit investment trusts will even move toward the shorter cycle, as will the national stock markets of Canada and Mexico.
As a result, the US stock market operates on a shorter settlement cycle than most other developed markets, which operate on a T+2 or T+3 cycle.
Faster settlement protects market participants by reducing systemic risk, operational risk, liquidity needs and counterparty risk. It also helps reduce margin requirements and allows investors to access the proceeds from a sell trade more quickly.
The faster conversion of securities into money corresponds to technological advances and should proceed to advance. If we are able to send money immediately – as most of us can now do through faster payment systems – then why cannot we also move the money related to our stock trades in real time?
The answer is that cash and securities move on different settlement tracks with different operational processes. Furthermore, we still operate in a world of national currencies and national securities markets. Transferring money between them will not be all the time smooth.
Why is that this vital for a worldwide index provider?
FTSE Russell’s role as a worldwide index provider is to supply an objective view of market behavior. This means creating and managing a wide selection of indices, data and analytics solutions to satisfy clients’ needs across all asset classes, styles and techniques.
It also means looking beyond the every day headlines of market movements and into how those markets work. Settlement cycles are vital to us because we cannot view a particular stock market in a vacuum – from the attitude of local traders and investors.
In fact, a U.S. trader or investor buying and selling Amazon or Microsoft stock probably won’t notice that much has modified at the tip of May. However, the brand new T+1 settlement cycle for US stocks creates complexities for foreign investors in US stocks.
For anyone outside the U.S. who buys or sells U.S. stocks, there’ll likely be an associated foreign exchange (FX) transaction. A foreign buyer of U.S. stocks may have to sell their currency to buy U.S. dollars to buy the shares. Likewise, a seller of U.S. stocks will likely wish to convert the dollars received into one other currency.
The convention within the foreign exchange market is T+2 settlement. After May twenty eighth, there can be a mismatch between FX and equity settlement periods.
Consequential effects
The shortening of the U.S. equity settlement cycle could have various knock-on effects for other financial market participants world wide. This may be exacerbated depending on the time zone by which an investor operates.
Index fund managers is also amongst those affected. The reproducibility of regional or global benchmarks may be tested, for instance, if the brand new settlement cut-off times usually are not achievable for a typical index-tracking portfolio. Importantly, US stocks currently make up greater than 60% of worldwide stock indices by weight.
Keep an eye fixed on the stock market structure
Changes to stock market operations are inevitable and ongoing. They are being watched closely by FTSE Russell via our country classification process for stocks. The quality of regulation, the trading landscape and the custody and settlement procedures in individual stock markets impact this process.
We conduct a proper annual country classification review throughout the FTSE global equity indices each September, using a comprehensive, transparent and consistent methodology, and an interim country classification review each March. We will publish the outcomes of every review shortly thereafter.
Over the last three many years, we now have seen a welcome shift towards smoother post-trade processes and reductions in settlement times. But the changes in market practices resulting from the looming shortening of the US equity settlement cycle is an area we can be monitoring closely.
Two resources to assist you familiarize yourself with this topic are: the market and index impact of the shorter US equity settlement cycle And The challenges and opportunities for US and Canadian foreign exchange shift to T+1.
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