In finance, settlement refers to the final step in the transfer of ownership of securities for payment. Through the settlement process, the buyer and the seller exchange payment for a set quantity of securities at an agreed upon price, therefore fulfilling their contractual obligations. After settlement, all parties’ obligations are discharged, and the transaction is considered complete.
In simpler terms, it’s like the closing of a deal where what was promised is exchanged — stocks for money, for example — and everyone walks away with their part of the agreement fulfilled.
Within Canada, the standard settlement time for most exchange-traded securities, such as stocks and bonds, is trade date plus two business days, which is usually referred as T+2. This means that, if a security was purchased on Wednesday, May 15 (T), for example, it would settle on Friday, May 17 (T+2).
But that will change soon. Effective May 27, 2024, the markets in Canada and Mexico will shorten the settlement cycle for most securities from two business days after a trade (T+2) to one business day following a trade (T+1). U.S. markets will move to T+1 settlement on May 28, 2024.
This is part of a long history of modernization in the North American financial markets. The settlement cycle has been shortened twice before, from T+5 to T+3 in 1995, and from T+3 to T+2 in 2017. These changes have provided many benefits to the financial markets and its participants, including:
• Increased overall efficiency.
• Better use of capital.
• Reduction of risk, especially during period of high volatility.
The change to T+1 settlement means that investors will need to have funds available in their accounts one business day following a securities purchase. When selling a security, the move to T+1 will mean that funds will be available to investors one day earlier.
Other settlement terms
Although this change will affect the vast majority of securities traded in the North American financial markets, it’s good to remember that there are other settlement cycles that will remain unaffected by this change.Some securities can take a lot longer to settle, for example. This is more commonly found in structured products like private equity funds, which can take one week, one month, or even one quarter to settle.
This is very important information to have before moving ahead with an investment. If a private equity fund, for example, is only valued once a month, and it has one-month settlement, it can take almost two months to receive the proceeds of the sale of such fund. During this time, the funds cannot be used for other good investment opportunities or withdrawn if needed.
This is one of the many reasons why we avoid structured products or invest in highly illiquid securities. This is also why we stress the importance of understanding the settlement terms prior to investing.
It should be noted that while other countries around the world have announced their intentions to move to T + 1 settlement, the change in settlement on May 27 and May 28 only applies to North American markets (Canada, U.S., and Mexico).
Other Resources
In 2022, we wrote an article about the key terms that you can find on your online banking or investment statements. In this article, Know your settlement terms, we also go over the concept of settlement.
Kevin Greenard CPA CA FMA CFP CIM is a Senior Wealth Advisor and Portfolio Manager, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250.389.2138, email [email protected], or visit greenardgroup.com.
