Settlement Date

Settlement date is the date on which the cash and assets are exchanged or the trade is settled through netting out a process for a trade that took place a few days back, the gap between the trade and the settling of the same varies from security to security and from one exchange to another, and is specified in the security document, commonly for shares it is 2 business days after the trade.

It is specified in the security document, commonly for settlement date stock it is 2 business days after the trade. On the other hand, for government securities and options it is T+1 day, which is the day after the trade was made. The transfer of ownership, irrespective of the asset class is officially carried out only after the settlement.

• The settlement date refers to the date on which a financial transaction, such as a purchase or sale of securities, is finalized.
• The settlement date is crucial for ensuring the completion of financial transactions and the transfer of ownership or rights associated with the securities or assets being traded. It is the point at which the contractual obligations between the buyer and seller are fulfilled.
• The timeframe for settlement can vary depending on the type of transaction and the market in which it takes place. Standard settlement periods include T+1 (one business day after the trade), T+2, or T+3, indicating the number of business days after the trade date.
• The settlement date affects buyers' and sellers' cash flows and risk exposure. Buyers must have funds to settle the transaction, while sellers rely on timely payment.

The settlement date is when the assets are exchanged, payment is made, or trades are netted off. This date is generally after the Trade date, which is the date on which the businesses execute the transaction and is sometimes known as the transaction date too.

The gap between the trade date and the settlement date varies for different markets. As in the settlement date for the stock market might be different that the settlement date bonds. Still, the most common convention that has been recently adopted by the SEC is the T+2 convention, which makes it two business days after the trade date. Settlement date accounting is considered analogous to the cash-based accounting system and is a more conservative approach that shows the exact cash position compared to trade date accounting. The gap between the date on which the trade occurs and the date on which it settles is for completing the paperwork or the transfer process and providing the time for the transfer of payment, so even if it is an online trade, it takes a few days to reflect.

The standardized number of days is mentioned in the trade contract. However, the actual number of days is more than the specified number due to some errors that might occur or due to a public holiday. Traders are conveyed the same to avoid a situation of panic.

Let us understand the concept of settlement date stocks and other asset classes, let us take the help of a couple of examples. These examples will give us a practical understanding of the intricacies of the concept and its related implications.

Example #1

Thomas,a trader trades on security online on a Tuesday dated 5th June, so this is his trade date, but the security settles after two business days, so ideally, the settlement date should be 7th June i.e., a Thursday but due a public holiday the settlement is delayed. Therefore,  the actual settlement is done on the 8th of June or Friday. On Friday Thomas gets the shares in his portfolio and hence the transfer of ownership is also completed.

Example #2

The Indian stock market has gained prominence of not just Foreign Direct Investors (FDIs) and Foreign Institutional Investors (FIIs) but also within the country as the post-pandemic numbers of retail investors are at an all-time high.

However, the liquidity of the market was affected due to the T+2 settlement date and the regulatory authorities had decided to shorten the settlement period to T+1 days. India made the shift from T+3 to T+2 for similar reasons in April 2003. This allows investors to experience gains and dividends, if applicable from the day after the market closes on the trading date.

For different asset classes, the transfer of ownership takes different timelines. For settlement date bonds and stocks, the transfer happens within two days of the trading date. However, for other assets, it may vary. On a larger scheme of things, it may also vary from country to country. Therefore, let us try to understand how to calculate the date of settlement through the points below.

• With effect from 5th September 2017, the Securities Exchange Commission or the SEC adopted the T+2 convention in which the securities trade would settle after two business days from the Trade date, which was earlier T+3, i.e., three business days. This was done because of improvements in technology and to increase the efficiency of trades and markets.
• Prior to this, with effect from 7th June 1995, the SEC adopted the T+3 convention, with a few exceptions, in which the securities trade would settle after three business days from the Trade date.
• In the case of most currency trades, the T+2 convention is followed, but there are a few currency pairs that are an exception to this rule and settle according to the T+1 convention.
• Historically, trades were settled in as long as days, and it was only from the 1970s onwards that this was first reduced to T+7, then followed by T+5 conventions to the currently used convention.

Purchasing an asset on a particular date and having it delivered to the portfolio at a later date is a natural cause of concern for any investor. Let us discuss the risks of settlement date stocks and other asset classes through the explanation below. This will help us understand the concept in-depth.

The time gap between the two dates causes the chances of default from either party to increase. The seller might not deliver the securities, or the buyer might not make the payment. This can impact the following trades undertaken by these traders because most times, the traders pledge the same securities or money for other transactions, so if they are not received in time, their other trades might get impacted. This risk is, at times, also known as the credit risk.

Further, it can lead to counterparty risk when one party fulfills his side of the trade, but the other party doesn’t fulfill his side of the trade, such as the security being transferred and payment not made.

Let us understand the importance of a settlement date bond and other asset classes through the discussion below.

• Regulation - According to certain regulators, the trader who has bought security cannot resell it till the trade is settled, and the trader cannot use the funds he will receive from the sale of a security to buy another security till the time the trade has settled. Hence, the traders need to be mindful of such regulations. Violation of such a rule is often termed as ‘free-riding.’
• Accounting - When settlement date accounting is followed, the transaction is recorded in the trader’s balance sheet only once it is settled. Therefore, this might change the month in which the trade is recorded in comparison to the trade date-based accounting. Settlement accounting, therefore, is more conservative, we can draw the analogy of accrual accounting, and cash accounting wherein the cash flow statement is a better reflector of the cash position of the company; similarly, the settlement date accounting is a better indicator of the trader’s cash position.

Throughout this article and countless discussions about investments, we would often hear settlement date stocks and trading day in tandem. To fully understand the concept, it is vital for us to understand the differences and their significance in the market. Let us do so through the comparison below.

• Meaning - Trade date is the date on which the traders executed the transaction, and therefore it is also known as the transaction date. While as explained before, the settlement date is the date on which securities and cash are exchanged, or the trade is netted out.
• Control - Traders only have their control over the trade date because it is their decision on when to buy or sell. However, the settlement date is prescribed to them by either the exchange or the security contract in which they have traded.
• Online Transaction - Even in online transactions, the trade date is when your holdings reflect the transaction, but the cash is deducted, and the securities are actually credited to your account on the settlement date by the broker.
• Taxation - For calculation of tax liability for the year, trade date is considered, so if a trade is executed on the last day of the year while it is settled in the following year, it is considered for the year just ended, and the tax benefits or losses are from this trade are considered in that year only.

This has been a guide to what is Settlement Date. Here we explain its examples, risks, and importance, and compared it with trade date in detail. You may learn more about financing from the following articles –

• Cash Settlement
• Cash Settlement vs. Physical Settlement
• After Hours Trading
• Pairs Trading
• Box Spread