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The Brokerage Trade Cycle
Investors purchasing securities in their Cash brokerage account are generally given three business days before payment is required for the purchased securities. A business day is defined, as any day the exchanges are open for business. Similarly, brokerage firms also have three business days before payment to the investor is required for securities sold.
In theory, either the investor or the brokerage firm can make payment prior to the 3rd business day. However, in practice, the required payments are made on the third business day unless early or extended payment is both specified at the time of the trade and agreed to by both the buyer and seller.
The three-day brokerage cycle typically applies to Listed and OTC Equities, Corporate and Municipal Bonds, and Mutual Funds. Options, US Government Securities and Commodities typically require payment on the next business day after the trade is executed.
In addition to the movement of funds between the brokerage firm and its client, most securities transactions require the movement of both securities and funds between two broker dealers. The settlement of a securities trade between two brokerage firms follows the same settlement cycle as the trade between the brokerage firm and its client.
The Trade Cycle
The typical brokerage cycle for the vast majority of U.S. equities, corporate bonds and municipal bonds is a four-day cycle:
Trades that follow the regular 4 day cycle are referred to as Regular Way Trades.
The business day on which the trade is executed on a securities exchange or market is known as the Trade Date or simply as T. For the purposes of trade comparison and settlement, the majority of brokerage trades are submitted to the NSCC Clearing Corporation for matching and comparison on Trade Date.
It is important to note, that securities purchased (on Trade Date) are not considered to be owned by the investor – for the purposes of receiving dividends and other benefits of ownership – until the trade Settlement Date. Securities sold on Trade Date remain owned by the investor – for the purpose of benefit of ownership – until after Settlement Date as well.
Trade Date + 1
The business day immediately following Trade Date is known as Trade Date + 1 or T+1. On T+1 the brokerage firms receive back from the NSCC ‘Trade Contract’ reports that summarize the prior day’s (T) activity and highlight any transactions that were not successfully matched on Trade Date.
Trade Date + 2
The second business day following Trade Date is known as Trade Date + 2 or T+2. On T+2 the brokerage firm receives from the NSCC its preliminary settlement reports. The preliminary settlement reports identify the compared brokerage transactions (from T) for which the brokerage firm must deliver or receive securities and money on Settlement Date.
The business day on which the investor is required to pay for securities purchased – or receives payment for securities sold – is known as the Settlement Date or S or T+3. Settlement Date is also the day on which brokerage firms settle firm-to-firm trades – ie. Firm A sells 200 shares of XYZ Co. to Firm B.
Regular Way Trades
Brokerage trades executed for the normal trade settlement cycle are called Regular Way Trades. As mentioned previously, the normal trade settlement cycle is dependent on the type of investment security traded. For example, the majority of Equity, Mutual Fund, and Corporate and Municipal bond trades settle on the third business day following trade date. Options, US Government Securities and Commodities, on the other hand, settle on the next business day following trade date.
Regular Way Settlement applies to all securities trades unless otherwise specified at the time of the trade. Both the buyer and seller must agree to any special settlement cycles at the time the trade is executed.
Several non-Regular Way Settlement options are available to the securities investor. They are:
A Cash Trade is a securities transaction where both the trade execution and settlement are processed on the same business day. Certain cash investments follow a Cash settlement cycle. If the normal settlement cycle for the security traded is not cash settlement both the buyer and seller must agree to the terms before the trade is executed.
Next Day Trades
A Next Day Trade is any trade designated for settlement on the business day immediately following Trade Date – or on T+1. If the normal settlement cycle for the security traded is T+3, both parties must agree to the next day settlement at the time of the trade.
A Seller’s Option is a trade designated for settlement on the second business day after Trade date – or T+2. As with other atypical settlement cycles, both buyer and seller must agree on the Seller’s Option.
An Extended Settlement trade is any trade designated at the time of the trade to settle on any business day after the normal trade settlement date.
Why is there a Settlement Cycle?
The primary reason for the trade settlement cycle is to give both the brokerage firm and its clients sufficient time to both:
The brokerage industry is currently evaluating an industry wide objective to move the entire brokerage industry to a T+1 or Next Day settlement environment. The conversion to T+1 is expected in the year 2004 and is beyond the scope of this website. To obtain more information concerning the conversion to T+1 you can review the following document issued by the Securities Industry Association:
SIA T+1 White Paper