What it means
When you buy a share, the trade is agreed at once, but the exchange of money and ownership happens a little later. The gap between the two dates is the settlement cycle.
A regular way trade follows the normal cycle for the market, so no special arrangement is needed. The cycle is written as T plus a number, where T stands for the trade date.
Regulators have shortened it over the years, for example from three business days to two and, in the United States, later to one. The exact cycle depends on the market and the type of security, so a finance team should confirm it for each instrument.
Regular way is different from other settlement terms. A cash trade settles on the same day, and a next-day trade settles one business day after the trade date.
A seller's option trade lets the seller choose the delivery date within a range, and these variants are used when the parties want something different from the standard timing. The settlement date matters for cash management.
A company buying shares has to have cash available on the settlement date, and a seller will not receive proceeds until then. Dividends also depend on settlement, because the ex-dividend date is set so that buyers who settle in time are on the register at the record date.
Shorter cycles reduce risk, because the time during which one party could default before delivery is smaller. They also free up capital held to cover exposures.
The downside is less time to fix errors and arrange funding, particularly across time zones, so back-office teams need good processes. Regular way trading is important for the accuracy of records as well.
Treasury and accounting teams record a purchase on either the trade date or the settlement date, depending on their accounting policy and the standards they follow. Whichever they choose, they must use it consistently and understand the cut-off effects at period end.
In practice
Real-world examples.
Example
A fund manager buys 10,000 shares on a Thursday under the standard one-day cycle. The trade settles on the Friday, and the treasury team makes sure the cash for the purchase is available that morning.
Example
A company sells shares it holds as an investment on the last business day of the month. Its accountant notes that the trade date falls inside the period but the settlement date falls in the next period, so she checks the accounting policy to record the sale in the right month.
Example
An investor buys shares just before a dividend record date. His broker explains that the trade must settle in time for his name to be on the register by the record date, and that the ex-dividend date is set with the settlement cycle in mind.
Formula
Calculation
Settlement date = trade date + standard number of business days; cash due = number of shares x price per share
Suppose the standard cycle is one business day and a company buys 500 shares at $40 on a Monday. The cash due is 500 x 40 = $20,000. Settlement date = Monday + 1 business day = Tuesday, so the $20,000 must be in the account by then.Case study
Seen in the real world.
Winterbourne Treasury Services is an illustrative, fictional company that invests surplus cash in listed securities. When the settlement cycle in its main market was shortened by one day, the treasury team was caught out on the first Monday after the change.
A purchase of $750,000 was made on Thursday, and the team had planned to move the cash on Monday as before. The trade settled on Friday and the account was overdrawn for the weekend, costing interest and a letter from the bank.
The treasurer rewrote the cash calendar so that the settlement date was calculated by a formula that took the cycle as an input. The illustrative lesson is that a change in market rules is a cash management event, and any process built on the old timing needs to be reviewed.
Watch out
Common mistakes.
- Assuming that a trade settles on the day it is made, when the standard cycle usually adds a business day or more.
- Forgetting weekends and market holidays when counting business days to the settlement date.
- Using the same cycle for every instrument, when different securities and markets can follow different cycles.
Questions
People also ask.
What does regular way mean?
It means the trade settles within the normal period for that type of security, with no special agreement about timing.
What is T plus one?
It means settlement takes place one business day after the trade date, with T standing for the trade date.
Why are cycles getting shorter?
Shorter cycles reduce the time in which a counterparty could fail before delivery, and they cut the capital held to cover that risk.
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