The securities industry’s plan to cut the standard securities settlement period from two days to one is a positive for firms, investors and the broader industry, says Moody’s Investors Service in a new report.
Last week, the U.S. Securities and Exchange Commission issued its final rules for reducing the settlement cycle to T+1 on May 28, 2024.
The Canadian Capital Markets Association said the Canadian industry will transition to a shorter settlement period at the same time, in sync with the U.S. market.
The rating agency said this move to a shorter settlement cycle is credit positive for the financial services industry, U.S. clearing agency National Securities Clearing Corp. (NSCC), and the firms that participate in the central clearing process.
“The shorter T+1 settlement period will reduce counterparty risk for NSCC,” it said, adding that it will reduce margin requirements for the firms that are clearing trades.
“Because a move to T+1 would generally lower NSCC member margin requirements, it would reduce their liquidity risk related to large margin calls and would benefit the safety and soundness of the overall financial system,” the report said.
One of the underlying justifications for reducing the settlement cycle was the “meme stock” episode of early 2021, which generated a surge in retail trading and heightened market volatility.
“In periods of stress, intraday margin calls can result in a pro-cyclical effect that ultimately strains market participants’ liquidity,” the report noted. Shortening the settlement cycle would reduce those potential stresses.
Additionally, the move will benefit retail brokers for self-directed clients, Moody’s said, “since gains and losses on these clients’ trades are exposed to a potential retail broker default during the settlement period.”
At the same time, the report also noted that reducing the settlement cycle is a “complex undertaking” for the industry, which poses “extensive operational challenges.”
In anticipation of the substantial work involved, both the U.S. and Canadian securities industries have already begun preparing for the move to T+1.