Shorter Time to Settle Trades Not Expected to Hit ETFs Much

The SEC is requiring most brokers-dealers to settle trades in one day instead of two.

The Securities and Exchange Commission will require that brokers settle trades in one day instead of two, but the change may not have a big effect on ETF trading, at least for those who invest for the long term.  

In February, the SEC announced that most broker-dealers will need to shorten the time they take to settle trades to one day down from two. In Wall Street and regulatory jargon, the time frame, or settlement window, will go to "T + 1" from "T + 2." Most brokers will have until May 28, 2024, to comply with the regulation.  

According to the SEC, the rule change is meant to reduce trading risks. The agency is trying to prevent a repeat of the 2021 meme-stock crisis when shares of video-game retailer GameStop and other stocks that were heavily shorted by hedge funds rose rapidly.  

“Today’s adoption addresses one of the four areas the staff recommended the Commission address in response to the meme stock events of 2021," SEC Chairman Gary Gensler said in the February announcement. 

International Trades

A potential issue arising from this is that other markets, such as those in Europe, still use T+2 settlement. 

According to Aisha Hunt, principal at Kelley Hunt, a law firm that provides services to asset managers, a potential problem occurs when exchange-traded funds have only one day to get cash for redemptions, but the sale of foreign stocks won’t settle for two days.

That means authorized participants dealing with redemptions will have to borrow money to cover cash redemptions in the interim. Theoretically, that could drive up trading costs, as firms pass on the borrowing costs to investors.  

Precedent as a Guide

Investors can look to historical precedent as a guide to how that may play out. The SEC narrowed the settlement window to the current two days from three in 2017. According to data from FactSet, the average trading spreads of U.S. ETFs that held foreign stocks rose by 0.003% in the two weeks following the change. Average spreads of U.S. ETFs that held domestic stocks were unchanged. 

“You can't say there's no issue here. But I think you can contextualize the issue and say that most traders will not really notice a difference,” Elisabeth Kashner, director of global fund analytics at FactSet Research Systems, said in an interview. 

Kashner also said that trading costs are less important the longer an investor holds an investment and that short-term traders who trade frequently will be affected more. 

Contact Gabe Alpert at [email protected]