Preparing for next phase of ETF trading as “T+1” starts on May 28

The U.S. financial industry’s plan to shorten the standard settlement cycle of U.S. securities trades to one day (T+1) from two days (T+2) takes effect on May 28, 2024. It marks the continuation of a years-long process to help limit risks of securities trading, enhance liquidity, and improve ETF market efficiency.

The T+1 settlement change is good news for investors in that it will make ETF trading and the settlement of trades smoother, as ETF adoption continues to expand. We believe this change is likely to make capital markets more efficient because all U.S.-listed securities, including underlying stocks and bonds held by ETFs, will have T+1 settlements. This change will also help keep domestic trading costs low and ETF shares liquid.

More narrowly, a shorter settlement window can improve advisor operations and smoothen model portfolio trading as model managers and advisors, in general, will have to wait less time for trades to settle before making their next move.

Some challenges remain, such as trading U.S.-listed international ETFs, but following best trading practices can go a long way toward controlling remaining risks. There will also be cases where expedited settlement—or T+0—will sometimes be necessary for issuers to coordinate with players in the primary market.

If you have any questions, call our ETF Capital Markets Desk to help you more decisively address possible issues.

Faster and faster

It’s worth comparing the T+1 shift with e-commerce to understand the significance of the changes.

Despite the efficiencies that buying online represent, you often must wait two days to receive packages. Similarly, when an investor buys a stock, bond, or shares of an ETF, they don’t take possession of it instantly. The upcoming changes represent the latest move to speed things up, a bit like overnight delivery.

Shortening settlement periods reduces counterparty risk and makes trading quicker, cutting collateral requirements and adding overall efficiency to capital markets. Longer settlement periods present counterparty risk—the risk that one side of the transaction fails to settle correctly, which is a worthy concern in a world where so much is becoming faster and faster.

Benefits of T+1 settlement

Reduce counterparty risk

Shortening trade settlement time reduces the exposure to a potential default by the other party involved in the trade.

A shorter settlement cycle also means there’s less time for market volatility or adverse events to impact completion of the trade. Think of the short squeeze in January 2021 with “meme stock” shares. Shorter settlement times would likely have reduced the collateral requirements during that episode, potentially clearing some of the chaos that flared up.  

Improve capital market efficiency

Shorter settlement times also mean that capital is tied up for less time, making it more attractive for investors looking for quick access to their funds or to transfer between investment vehicles without missing out on market exposure.

Cutting settlement time means cutting collateral requirements for market makers and authorized participants (APs) whose hedging strategies and balance sheet usage can leave them financially exposed until trades settle. Depository Trust & Clearing Corp. (DTCC) estimates the volatility component of margin requirements will fall 41% due to the shift to T+1, potentially saving billions of dollars.

Challenges of T+2 for international securities

Certain underlying international securities held within U.S.-listed ETFs that will conform with the new T+1 settlement rules will still have T+2 settlement after May 28¹. This may present ongoing challenges for investors keen on integrating foreign stocks and bonds into their portfolios.

The good news is that around 95% of all international ETF trading volume occurs in the secondary market, which means in such trading there’s no need for APs to create or redeem shares. Therefore, most investors should not incur additional costs.

Vigilance in the international arena will be advisable, particularly for more thinly traded ETFs where AP's may rely more heavily on the primary market to create and redeem ETF shares.

Given that U.S.-listed international ETF shares will be settling earlier than some of the underlying international securities, the AP will need to post collateral, typically cash, until those securities settle.

This added cost could be passed down through slightly higher premium/discount volatility or wider spreads—but, again, only with trades that require access to the ETF's primary market liquidity or for more thinly traded ETFs that rely more heavily on creations and redemptions.

Our Capital Markets Desk is here to help

The Vanguard ETF Capital Markets Desk is available to help you with any questions you may have and clarify how this change may affect your clients whose ETF use is significant and growing.

Legal notices

For more information about Vanguard funds or Vanguard ETFs, visit advisors.vanguard.com or call 800-997-2798 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

All investing is subject to risk, including possible loss of principal. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of a client's account. There is no guarantee that any particular asset allocation or mix of funds will meet a client's investment objectives or provide the client with a given level of income. Diversification does not ensure a profit or protect against a loss.

Bond funds are subject to interest rate risk, which is the chance bond prices overall will decline because of rising interest rates, and credit risk, which is the chance a bond issuer will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.

Vanguard is owned by its funds, which are owned by Vanguard’s fund shareholder clients.