Stock Trades Will Soon Settle 1-Day Sooner
The time frame between when you buy or sell a security and when the trade is settled is about to shrink. Currently, the US operates on a 3-day settlement cycle.
Effective Tuesday, 5 September 2017, the US will switch to a 2-day settlement cycle, know as T+2, which stands for trade date plus 2 days.
A trade executed on 5 September 2017, will be settled on 7 September 2017. Thereafter, executed orders to buy and sell will be settled on a 2-day cycle.
This shortened cycle will apply to stocks, corporate bonds, municipal bonds, unit investment trusts and financial instruments composed of these security types.
Most, but possibly not all, mutual funds will shift to a two-day settlement cycle on 5 September.
ETFs (exchange-traded funds) and closed-end funds, which trade like stocks will also make the shift to T+2.
The T2 Settlement website has a full list of the investment products moving to a 2-day settlement.
The EU, Hong Kong and SKorea have already moved to T+2.
Canada, Mexico and Peru will join the US on the T+2 Tuesday.
The change is a big deal for the financial industry. Shortening the settlement cycle will significantly reduce the amount of capital that clearing firms, the entities who ensure trades are processed, are required to hold.
The Depository Trust & Clearing Corporation (DTCC) estimates the change will reduce daily average capital requirements for its equity clearing fund by 25%, or $1.36-B. The change will also give various financial firms and institutional investors more flexibility.
The T+2 switch will also have implications for individual investors, they are as follows:
- Proceeds from a sell transaction will be eligible for withdrawal two days following the execution date instead of 3 days. In other words, you will be able to access any cash freed up from the sale of a security or a fund sooner.
- The shift to T+2 impacts whether or not you will be recognized as being eligible to receive dividends, distributions or shares in a spin-off or cash for an acquisition. Typically, eligibility is determined by the record date. The record date is the day as of which an investor must be listed in the company’s books as being a shareholder. Using dividends as an example, to be recognized as a shareholder, you must already own the stock on the ex-dividend date. Up until 5 September, the ex-dividend date has been 2 days prior to the record date. Effective on September 5, the ex-dividend date will be 1-day prior to the record date.
- Note: Companies typically do not list the ex-dividend date in their dividend announcement, so you will have to determine what it is.
1-day may not seem like much, but in the case of dividends, it does matter from a tax standpoint. To be eligible for the reduced 15% tax rate, 20% for high-income earners on qualified dividends, you must hold a stock for at least 61 consecutive calendar days during a 121-day window. The 121-day window starts 60 days before the ex-dividend date. Since the ex-dividend date will be a day closer to the record date under T+2, the window starts a day later as well.
Have a terrific holiday weekend.