One-day stock trade clearing launches in Canada

Investors might never notice, but the way Canadian capital markets function fundamentally changed this week after a process that began nearly 30 years ago was finally completed.

Settlements, the complex undertaking that ensures money and securities properly change hands every time stocks or bonds are bought or sold, previously had to be completed within two business days of the trade itself. As of Monday, however, settlements now have a single business day to be completed.

While the shift from what was known as T+2 to the new T+1 regime might seem insignificant or even irrelevant for retail investors, experts argue the opposite is true. Sale proceeds will hit investment accounts faster as trades start settling more quickly and interest charges on any money borrowed to buy securities will kick in one business day earlier than before.

Ultimately, the move to T+1 will increase market efficiency and lower risks of trades failing to settle because of market volatility, which should allow for lower trading fees.

“Even though direct investors aren’t directly involved in those processes, their agents are, and by making the ecosystem less risky and more efficient, where cash can be better utilized through settlement, that drives positive benefits downstream to the end investor,” said Kevin Sampson, president of the Canadian Depository for Securities Ltd.

CDS, which is owned by Toronto Stock Exchange operator TMX Group Ltd., provides settlement and clearing services for all Canadian-listed equities, debt, fixed income and money market securities that trade on every marketplace in the country.

“Our systems were already T+1 compatible but, given our role in the market, we are all hands on deck to make sure it is a smooth transition,” Mr. Sampson said.

Part of the reason T+1 leads to lower market risk is because the longer it takes for a trade to settle, the more likely that trade will result in what is known as a failure to deliver. That occurs in situations in which either the buyer lacks the funds to acquire the security or the seller does not actually own the correct number of securities.

Addressing failure to deliver risk has been a key part of the reason why experts have spent decades calling for a T+1 regime to be implemented.

“A longer settlement period may have a particularly adverse effect in times of a steep market decline,” reads an excerpt from a 23-year-old Canadian Capital Markets Association report that advocated for a T+1 regime to be adopted. “Indeed, the earlier shortening of the settlement period from T+5 to T+3 was in part a response to the 1987 market decline.”

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After moving from a post-trade settlement deadline of five business days to three business days in 1995, the now-former T+2 regime was adopted in 2017. While the consequences of moving to T+1 are expected to be broadly positive, there are some potential drawbacks.

Settlement failure rates, which refer to the proportion of trades that are not completed before the settlement deadline and can therefore result in additional fees, are expected to spike. They are seen as much less detrimental than failures to deliver because those trades are usually still settled and cleared later, and might incur a fee related to the delay, whereas failures to deliver more often result in trades being cancelled outright.

According to a January, 2024, survey conducted by market research firm ValueExchange, the fail rate is expected to rise above 4 per cent shortly after T+1 is implemented from roughly 2 per cent before. Failure rates among small to mid-sized investment firms are expected to grow by 36 per cent, the survey found.

“The compressed time period to process those settlements, given it is a day less, we expected those fails to go higher,” Mr. Sampson said. “We will be monitoring that extremely closely to see if that materializes, and then the question is for how long.”

“It is a question of whether it is on a temporary basis until the market adjusts and optimizes the process around the new settlement regime, or whether that persists,” he said.

International trading will also be made slightly more complicated by the move to T+1, as thus far only Canada, the United States, Mexico and Argentina have implemented the new regime. Markets in Europe, Asia and Britain will continue to settle on a T+2 basis, raising the potential for mismatched settlement dates and increased costs related to either money or securities not being delivered when expected.

Eventually, Mr. Sampson expects other markets to adopt a T+1 settlement regime.

“We know the U.K. has initiated a process to start examining a move to T+1 and a debate that has taken place at the EU level as well,” he said “So I think there is still more to come in other markets.”