Yahoo Finanza What Does The Upcoming T+1 Settlement Change Mean For Prop Traders?
In February, the Securities and Exchange Commission (SEC) announced the arrival of T+1, the new one-day securities trading settlement system. While the new system is still a few weeks away from implementation, traders could benefit from a settlement refresher and understanding of the violations that occur when trying to trade with unsettled funds.
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Settlement Rules And Consequences For Violations
Securities currently settle under T+2, which means two business days pass between the execution of a trade and the actual exchange of money and securities. For example, if you buy 100 shares of Nvidia Corp. (NASDAQ:NVDA) on Tuesday, the position will appear in your portfolio, but your broker won't deliver your cash to the seller until Thursday.
Settlement time has gradually decreased as trading technology has improved. Shares were once traded using pieces of paper, which required actual physical delivery for settlement. With paper shares, it made sense to have a time window between the transaction agreement and the exchange of assets. But this also presents an opportunity for improper activity, like buying an asset and using the funds to buy and sell a separate asset before settlement of the original trade.
What happens if you attempt to buy securities with unsettled funds? Three types of violations exist for trading with unsettled cash:
Good faith violation (GFV): Imagine you have 100 shares of stock in your account. If you sell your 100 shares, your account will show a cash balance for the transaction. This cash is unsettled because the trade won't settle for two days. If you buy and sell another stock the next day, you'll receive a good faith violation for trading with unsettled funds. Most securities brokers give a warning for the first GFV, but cash settlement restrictions will be administered for a second violation.
Freeriding violation: If you have $1,000 in your account and buy $2,000 worth of stock, you must supply the remaining $1,000 before settlement. You'll also need to hold the shares until the remaining cash is provided to avoid a freeriding violation. This violation is more severe and will result in a 90-day account freeze.
Liquidation violation: In a cash account, a liquidation violation occurs when shares of one stock are sold to meet the settlement requirements of a different stock. For margin accounts, a liquidation violation occurs when shares are sold to satisfy both maintenance and Fed margin calls. These consequences are the same as GFVs: first, a warning, then cash settlement restrictions. Note that margin accounts are required to trade certain securities like futures and forex contracts.
How Should Prop Traders Prepare For T+1?
The move to T+1 will benefit most prop traders. Reducing settlement time means traders can take advantage of more opportunities without waiting for funds to settle. Additionally, many settlement violations occur accidentally because of automated systems or a simple mistake. Moving to T+1 should decrease the number of unintentional violations applied to cash and margin accounts. Also, understand which securities settlement rules apply: Government bonds and options already operate on a T+1 schedule.
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