What is Settlement Period?
In the securities industry, the trade settlement period refers to the time between the trade date — month, day and year that an order is executed in the market — and the settlement date — when a trade is considered final. When shares of stock, or other securities, are bought or sold, both buyer and seller must fulfill their obligations in order to complete the transaction. During the settlement period the buyer must pay for the shares, and the seller must deliver the shares. On the last day of the settlement period, the buyer becomes the holder of record of the security.
Settlement Period — Brief History
In 1975, Congress enacted Section 17A of the Securities Exchange Act of 1934, which directed the Securities and Exchange Commission (SEC) to establish a national clearance and settlement system in order to facilitate securities transactions. Thus, the SEC created a set rules to govern the process of trading securities, which included the concept of a settlement cycle. The SEC also determined the actual length of the settlement period. Originally, the settlement period gave both buyer and seller the time to do what was necessary — which used to mean actually delivering stock certificates or money to the respective broker — to effect their part of the trade.
Today, money is transferred instantly but the settlement period remains in place — both as law, and as a convenience for traders, brokers and investors. Now, most online brokers require traders to have sufficient funds in their accounts before buying stock. In addition, the industry no longer issues paper stock certificates to represent ownership. Although a small number of stock certificates still exist from the past, securities transactions today are recorded almost exclusively electronically using a process known as book-entry; and electronic trades are backed up by account statements.
Settlement Period —The Details
The specific length of the settlement period has changed over time. For many years, the settlement period was five days. Then in 1993, the SEC changed the settlement period for most securities transactions from five to three business days — which is known as T+3. Under the T+3 regulation, if you sold shares of stock on Monday, the transaction would settle on Thursday. The three-day settlement period made sense when cash, checks and physical stock certificates still were exchanged through the U.S. postal system.
New SEC Settlement Mandate — T-2
In the digital age, however, that three-day period seems unnecessarily long. In March 2017, the SEC shortened the settlement period from T+3 to T+2 days. The SEC's new rule amendment reflects improvements in technology, increased trading volumes and changes in investment products and the trading landscape. Now, most securities transactions settle within two business days of their trade date. So, if you sell shares of stock on Monday, the transaction would settle on Wednesday. In addition to being more aligned with current transaction speeds, T+2 could reduce credit and market risk, including the risk of default on the part of a trading counterparty.
Listed below as a representative sample are the SEC's T-2 settlement dates for a number of securities. Consult your broker if you have questions about whether the T+2 settlement cycle covers a particular transaction. If you have a margin account you also should consult your broker to see how the new settlement cycle might affect your margin agreement.