Plus One—the Big Change to Market Plumbing You Shouldn’t Notice

An aspect of the stock market is set to speed up soon—and not everyone is jazzed about it.

No, we aren’t referring to actual trading, which is already lightning-fast. Starting next Tuesday, standard trades in the US will settle on the first business day after the trade (known as T+1), down from the second business day (T+2). This has been coming down the pike since late 2021, yet there is a lot of handwringing that the industry isn’t ready—particularly for overseas investors, where settlement times will remain T+2. Why the hubbub, and what do investors need to know? Read on.

Whenever you place a trade online, the process seems instantaneous. You click buy or sell, and the stock or cash shows up immediately, probably with an asterisk or some fine print that you don’t pay much mind to. But behind the scenes, there is a lot going on. This process is called settlement, and it takes time. The money doesn’t technically change hands until the trade is settled fully.

In olden days, it took a lot more time—around a full week. This was how long it took for brokers to orchestrate the physical exchange of money for stock certificates. It was a world of paperwork and oopsies. During the 1960s, a rapid increase in trade volumes drove the “Paperwork Crisis,” in which the NYSE closed on Wednesdays repeatedly to allow record-keepers to catch up. Not only did the increase in trading cause such delays and interruptions, all the mailing of physical certificates led to loss and theft. 

To solve the predictable problems that arose as retail investor participation broadened, the New York Stock Exchange created a central clearing house. All stock certificates lived there and money went through it, and you can think of it as tracking all the ins and outs in a central ledger. As the computer era dawned, it all went digital and increasingly automated.

In time, it cut the needed settlement time, too. As recently as 1992, standard securities settlement was T+5.^[i] The next year, it went to T+3—where it stood all the way through 2017. Then it shortened to T+2. That seemed to work fine for the most part. But in 2021, the meme stock craze seemingly revealed some flaws.

You might remember that: It is when a handful of stocks of beleaguered (and in some cases, bankrupt and mostly dead) retailers had giant price moves as people on Twitter and a Reddit forum hyped them. They used Internet slang and, according to most popular narratives, used COVID relief money to pump penny stocks in order to teach hedge funds with big short positions a lesson about the power of the proverbial little guy.

It was all fun and games—and anecdotes of wonderfully timed money-making trades—until there was so much trading activity that the online brokerage most of these folks used couldn’t keep up.

The clearing house system requires brokerages to post collateral to back their customers’ trades. This online brokerage, a venture-backed startup, didn’t have the clout of old Wall Street firms. When it got a collateral call, it took time to raise the money. During this window, trades got canceled. People couldn’t buy when they wanted to. People who wanted to sell couldn’t sell. Some folks’ paper profits went “poof.” There was a lot of talk about the system messing over the common man and woman.

So Congress, as it likes to do, held hearings to fact-find and brainstorm a fix. Regulators and industry participants weighed in. After much discussion, the SEC decided reducing settlement times to T+1 would help. (Some pushed for T+None, and maybe we will eventually get there. But not now.)

At the risk of oversimplifying, shorter settlement times reduce the likelihood that either counterparty to a trade would default. Hence, it would allow for lower collateral requirements. Lower collateral to post reduces the risk of a brokerage having to restrict trades while they scramble to meet a margin call. Nothing can make the risk go to zero, but most agreed it would help.

That was late in 2021. Everyone has known since then that May 2024 would be go-time. The industry, overall, is pretty well prepared. Cramming two days’ worth of processes into one isn’t a cinch, but brokerage firms staffed up and streamlined things. Many have already been operating at T+1 to identify potential kinks and iron them out well in advance. There is still a chance for operational errors. A shorter settlement process means less time to resolve them. But everyone seems up to the challenge.

Some coverage has portrayed the situation in a rather more alarmist manner. While they are mostly sanguine about US firms handling shorter settlement times, some are rather pessimistic about international transactions.

Here is why. In Europe and its ilk, stocks will still settle at T+2. But international institutions trading US stocks will have to comply with T+1. So if a hypothetical French investor named Pierre decides to sell a French stock listed in Paris and denominated in euros, using the proceeds to buy an American stock, there is a pickle: The money from his sale will be available in two days, but the American buy has to settle in one. This mismatch is causing some angst.

We don’t think it should. Here, too, nothing is sneaking up on brokerages in any country. They have worked hard to speed up foreign currency transactions (which underpin such cross-border stock trades) to ensure money gets where it needs to go on time. Currency markets operate 24/7, so brokerages have staffed up trading desks around the world to ensure more coverage during what Americans would consider off hours. They aren’t worry-free, but concerns center more on liquidity and not being able to obtain optimum pricing after-hours—not outright failure to execute a trade. A weekend Bloomberg piece, while pessimistic in tone, showed how prepared the industry is. ^[ii]

Don’t get us wrong. All investors big and small who invest in securities with varying settlement times will face some challenges to get everything coordinated. However: This is not new. Settlement time mismatches have always been a thing. Brokerages and investment managers know how to deal. The only thing changing is that they might have to deal a bit faster than they used to. But as the industry continues automating and streamlining back offices, it gets easier. This was in progress long before T+1 became the target, and it will continue as technology keeps advancing.

So if you are reading this as an investor with a US-based account who owns US stocks and foreign companies whose stocks trade here (known as American depositary receipts, or ADRs), you probably won’t notice anything beyond the aforementioned asterisks and fine print vanishing after one day instead of two.

And if you are an international investor who owns some US stocks, while headlines say you face more operational risk, we think it is overstated. This industry is adept at navigating and overcoming operational pickles. Brokerage firms know how to handle trades with a settlement mismatch. The likelihood trades start failing left and right and the industry throws up its hands in disgust looks about as close to zero as you can get.