Settlement

Quick definition Settlement is the process of finalising a trade: transferring cash from the buyer to the seller and transferring securities from the seller to the buyer. What it is When you buy a stock, the trade executes immediately (T), but settlement happens 2 business days later (T+2). During these two days, the buyer and seller still owe each other the securities and cash. Settlement is handled by clearinghouses and depositories that ensure each side delivers what they owe. Why it matters Settlement risk is the risk that a counterparty fails to deliver securities or cash at settlement. Without proper settlement infrastructure, trades could fail and cause systemic risk. Settlement also creates financing costs. Cash sits idle for 2 days waiting for settlement. Traders must manage this "settlement float." T+2 settlement timeline - T (trade date): order executes - T+1: first business day after trade - T+2 (settlement date): cash and securities are transferred US stocks and many other securities use T+2. Some markets use T+1 or T+0 (immediate settlement). Clearing Clearing is the process of determining who owes what. A clearinghouse calculates net obligations and ensures they match. Settlement is executing the clearinghouse's instructions (transferring cash and securities). Depository A depository (like the Depository Trust Company, DTC) holds securities and facilitates transfers. When you buy a stock, the seller's securities are transferred from the seller's account at the depository to your account. Practical example You buy 1,000 shares at 100 dollars on Monday (T). The trade executes immediately. On Wednesday (T+2), settlement occurs. The seller transfers 1,000 shares from their account at the depository to your account. You transfer 100,000 dollars to the seller. Until settlement, you don't own the shares; you have a claim on them. Settlement failures Occasionally, a party fails to deliver. A stock may be hard to borrow, or cash may be unavailable. The clearinghouse manages failures and can force buy-ins. See also - Clearing - T+2 Settlement - Depository - Counterparty Risk