Why ETF settlement happens on T+3?

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math22
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Why ETF settlement happens on T+3?

Post by math22 » Fri May 19, 2017 11:51 am

Why ETF (at least in my broker) settles on T+3 days?
Also, in general, do brokers allow you to sell your ETF before the settlement of the purchase of that same ETF?
I mean, for instance suppose I buy some ETF of 5/10 and it is supposed to settle on 5/13 but I want to sell it on 5/11 (for a profit), is this generally allowed?

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Re: Why ETF settlement happens on T+3?

Post by triceratop » Fri May 19, 2017 12:07 pm

Equities generally settle on T+3, not just ETFs. That might change: T+2 Settlement.

If you are in a Cash Account (please click that link, it is from the SEC and has all the details), you should be aware of Regulation T and avoid committing a "free-riding violation".
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Re: Why ETF settlement happens on T+3?

Post by David Jay » Fri May 19, 2017 6:21 pm

math22 wrote: ...for instance suppose I buy some ETF of 5/10 and it is supposed to settle on 5/13 but I want to sell it on 5/11 (for a profit)...
I wonder why Bogle isn't a big fan of ETFs?
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Re: Why ETF settlement happens on T+3?

Post by whodidntante » Fri May 19, 2017 6:32 pm

All stock exchanges are ran by a man with a donkey. When you issue your sell order, the man gets the money, then he loads it onto the donkey. Then he takes the money up the way to your broker's office. New York traffic being what it is, it can take a few days. I mean, have you tried merging onto a city street with a donkey? Also, sometimes the donkey gets tired or the man gets hungry.

Actually, this doesn't really explain why it takes so long. Maybe there are two donkeys involved.

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Re: Why ETF settlement happens on T+3?

Post by triceratop » Fri May 19, 2017 6:35 pm

David Jay wrote:
math22 wrote: ...for instance suppose I buy some ETF of 5/10 and it is supposed to settle on 5/13 but I want to sell it on 5/11 (for a profit)...
I wonder why Bogle isn't a big fan of ETFs?
This is exceedingly unlikely to be an issue for anyone investing with ETFs. I don't even think about the rule, because my trades are usually 30-60 days apart.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: Why ETF settlement happens on T+3?

Post by CppCoder » Fri May 19, 2017 8:05 pm

whodidntante wrote:All stock exchanges are ran by a man with a donkey. When you issue your sell order, the man gets the money, then he loads it onto the donkey. Then he takes the money up the way to your broker's office. New York traffic being what it is, it can take a few days. I mean, have you tried merging onto a city street with a donkey? Also, sometimes the donkey gets tired or the man gets hungry.

Actually, this doesn't really explain why it takes so long. Maybe there are two donkeys involved.
You forgot to mention the high frequency traders who have figured out to hang a carrot on a stick in front of the donkey :D.

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Re: Why ETF settlement happens on T+3?

Post by AlohaJoe » Fri May 19, 2017 9:07 pm

math22 wrote:Why ETF (at least in my broker) settles on T+3 days?
Because businesses usually do the bare legal minimum...which is T+3 execution. When the legal minimum changes to T+2 then they'll do that.

On a less cynical note: there's actually a surprising number of people involved -- custodians, central security depositories, and so on. All of them need to be notified and update their databases.
if you own stock, what you really have is an entry in your broker's database, and your broker in turn has an entry in DTC's database, and DTC (well, Cede) has an entry in the company's database of shareholders of record.
(For an example of how this complexity of keeping track of shares actually works out in real life -- and causes problems when things get complicated and the records get mixed up -- read what happened with Dole Food. They thought there were 36,793,758 shares but investors actually had 49,164,415 shares: https://www.bloomberg.com/view/articles ... any-shares)

The first step is that everything needs to be automated. My understanding is that, in the US, there are still a number of places with manual steps. This is one reason why the US scores poorly (compared to other nations) on settlement efficiency: http://www.omgeo.com/page/sda
Settlement efficiency in countries with SDA rates of over 90% – India, Taiwan, Hong Kong, Japan, Singapore and Korea – is 26% higher than in countries with SDA scores of less than 70% – Brazil, Italy, South Africa and the United States.
But even if everything is automated they might still have latency. For instance, imagine everything is automated by your custodian only updates records once a day at 9pm -- so everything would get "stuck" there until 9pm before it could get sent to the central security depository. And maybe at the central security depository they also only update once a day...so you've got another long wait there.

I have an old coworker who used to work a major bank in Sydney, Australia. He says the way that "online transfers" used to work in Australia was that every day the 4 banks would meet at midnight and swap hard drives -- and then everything would get processed the next day. That's why it took two days instead of being instantaneous like we'd expect.

I imagine there are a fair number of traders/brokers/whatever that would need to upgrade or replace systems ... or totally change their processes in order to meet faster execution deadlines.
I mean, for instance suppose I buy some ETF of 5/10 and it is supposed to settle on 5/13 but I want to sell it on 5/11 (for a profit), is this generally allowed?
Why don't you try it and find out?
Last edited by AlohaJoe on Fri May 19, 2017 9:34 pm, edited 1 time in total.

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Re: Why ETF settlement happens on T+3?

Post by grabiner » Fri May 19, 2017 9:32 pm

math22 wrote:Why ETF (at least in my broker) settles on T+3 days?
Also, in general, do brokers allow you to sell your ETF before the settlement of the purchase of that same ETF?
I mean, for instance suppose I buy some ETF of 5/10 and it is supposed to settle on 5/13 but I want to sell it on 5/11 (for a profit), is this generally allowed?
This is allowed in a cash account as long as you made the initial purchase with cash or settled funds.

It would not be allowed if you made the purchase with unsettled funds. Say you sold A on 5/10 and immediately bought B with the funds; this is OK because you will be able to pay for B on 5/13 when A settles. But if you now sell B on 5/11, that is a violation, as you have sold B before you paid for it.

See the SEC rules on freeriding for more details. While you aren't supposed to do this, you won't go to jail or pay a fine if you do it. Your account may be temporarily restricted so that you cannot buy anything with unsettled funds; if you sell something on 5/10, you will have to wait until 5/13 to use the proceeds to buy something else.
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Re: Why ETF settlement happens on T+3?

Post by navyitaly » Fri May 19, 2017 11:59 pm

If you have a margin account it's allowed (with sufficient credit available).

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Re: Why ETF settlement happens on T+3?

Post by Longtermgrowth » Sat May 20, 2017 12:26 am

navyitaly wrote:If you have a margin account it's allowed (with sufficient credit available).
Makes me wonder if I should have signed up for a margin account. What if I hold a bond and stock ETF, see stocks drop, and want to rebalance that day by selling the bond ETF to buy more stock ETF? An ACH transfer from external accounts would take days as well...

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Re: Why ETF settlement happens on T+3?

Post by triceratop » Sat May 20, 2017 1:56 pm

Longtermgrowth wrote:
navyitaly wrote:If you have a margin account it's allowed (with sufficient credit available).
Makes me wonder if I should have signed up for a margin account. What if I hold a bond and stock ETF, see stocks drop, and want to rebalance that day by selling the bond ETF to buy more stock ETF? An ACH transfer from external accounts would take days as well...
This is allowed and not a free riding violation for a cash account. You sell BND on 1/1, buy VTI on 1/1. Both settle on 1/4. A problem only arises if you sell VTI before 1/4. But if you're rebalancing is this really a problem?

Mutual funds sometimes have frequent trading restrictions too; ETF critics like to ignore this point.
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Re: Why ETF settlement happens on T+3?

Post by whodidntante » Sat May 20, 2017 2:03 pm

Longtermgrowth wrote:
navyitaly wrote:If you have a margin account it's allowed (with sufficient credit available).
Makes me wonder if I should have signed up for a margin account. What if I hold a bond and stock ETF, see stocks drop, and want to rebalance that day by selling the bond ETF to buy more stock ETF? An ACH transfer from external accounts would take days as well...
I typically sign up for a margin account, unless it's a broker that requires a hard credit pull and I plan to apply for credit elsewhere soon. There isn't a big disadvantage that I have found. You may occasionally incur a margin debit if you aren't careful or don't understand the policy for funds availability at your broker. Some brokers will take your marginable shares and lend them out to short sellers, which means the dividends will not be qualified. However, they compensate you for the increased tax burden by paying you more than the dividend amount. On the other hand, margin has advantages if you use it responsibly.

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Re: Why ETF settlement happens on T+3?

Post by whodidntante » Sat May 20, 2017 2:05 pm

triceratop wrote: Mutual funds sometimes have frequent trading restrictions too; ETF critics like to ignore this point.
That's a good point. T. Rowe Price and I are currently fighting because they don't like my recent trading activity.

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Re: Why ETF settlement happens on T+3?

Post by CppCoder » Sat May 20, 2017 6:33 pm

Longtermgrowth wrote:
Makes me wonder if I should have signed up for a margin account. What if I hold a bond and stock ETF, see stocks drop, and want to rebalance that day by selling the bond ETF to buy more stock ETF? An ACH transfer from external accounts would take days as well...
I have a cash account at Fidelity. If I initiate an ACH transfer at Fidelity to pull from my bank during or before trading hours on a trading day, they credit the cash immediately, and I can trade immediately. The money actually arrives either at the end of the day or the next day depending on when I initiated the transfer.

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Re: Why ETF settlement happens on T+3?

Post by btenny » Sat May 20, 2017 7:16 pm

Trading is different depending on account type. Cash accounts use margin and are taxable. These are called brokerage accounts. You can buy and sell stuff simultaneously in these accounts. You can take cash in or out of these accounts as it is after tax money. These accounts can have positive or negative cash on hand. The margin is a revolving loan that allows the account to have negative cash value covered by the margin loan. So they pay you interest if there is positive cash balance and you pay them interest if there is a negative cash balance. So the brokerage lets you use borrowing to facilitate buying etfs or stocks or other things quickly and adjusts the cash account accordingly. So you can sell something for $X today and buy something else for $X a few minutes later. Then the brokerage will charge you margin interest on $X for 3 days while the sell order is completed and cash is put back in your account. Or you can just buy more stock than you have cash available. These margin trades are allowed for up to 30% to 50% of your account value. All profits and losses in these accounts are tracked by the company and reported to the IRS.

Tax free accounts like IRA or Roth IRA or 401Ks cannot use margin. They are tax free accounts and have lots of extra rules for trading. They only allow purchases if the cash is available in the account. So if I sell one etf today I need to wait for 3 days until that trade settles and the cash is available to buy something else. These trades are not taxed so any losses or profits are tax free.

So what you want to do depends on what account you plan to use for the trades.

Good Luck.

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Re: Why ETF settlement happens on T+3?

Post by grabiner » Sat May 20, 2017 10:38 pm

btenny wrote:Trading is different depending on account type. Cash accounts use margin and are taxable. These are called brokerage accounts. You can buy and sell stuff simultaneously in these accounts.
Brokerage accounts can be cash accounts or margin accounts; your account is only a margin account if you arrange to do so with your broker.

But even in a cash account, you can buy and sell simultaneously, as long as you don't violate Regulation T. If you sell A and buy B on 5/22, both trades settle on 5/25, so you have the cash to pay on the day the payment is due. (See links elsewhere in the thread for the SEC rules on trading with unsettled funds.)
Tax free accounts like IRA or Roth IRA or 401Ks cannot use margin. They are tax free accounts and have lots of extra rules for trading. They only allow purchases if the cash is available in the account.
While you cannot use margin in an IRA, you still have the same settlement rules which allow buying and selling on the same day. You may have other restrictions from your brokerage; for example, if you have sold a stock or ETF in your brokerage account, you might not be allowed to buy a mutual fund until the ETF purchase has settled.
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Re: Why ETF settlement happens on T+3?

Post by Valuethinker » Sun May 21, 2017 6:15 am

Many of us are old enough to know that the stock market closed 1 day a week during the 1960s, because it could not handle the volume of trades. The manual processes just could not keep up. Read John Brooks, The Go Go Years, or Adam Smith's Money Game, for more information on same.

One should understand that the USA has one of the world's oldest stock markets. My Goodness, there is still a physical floor to its Stock Exchange-- an anachronism that London did away with in the 1980s.

Amsterdam is older. I think London is older. It is easier to have 24 hour settlement (Hong Kong) if you have a smaller, newer market. Australia and Singapore are way out in front.

These processes were put in place because of the number of manual processes, and how long it took to move the money, securities etc.

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Re: Why ETF settlement happens on T+3?

Post by Valuethinker » Sun May 21, 2017 6:18 am

AlohaJoe wrote:
math22 wrote:Why ETF (at least in my broker) settles on T+3 days?
Because businesses usually do the bare legal minimum...which is T+3 execution. When the legal minimum changes to T+2 then they'll do that.

On a less cynical note: there's actually a surprising number of people involved -- custodians, central security depositories, and so on. All of them need to be notified and update their databases.
if you own stock, what you really have is an entry in your broker's database, and your broker in turn has an entry in DTC's database, and DTC (well, Cede) has an entry in the company's database of shareholders of record.
(For an example of how this complexity of keeping track of shares actually works out in real life -- and causes problems when things get complicated and the records get mixed up -- read what happened with Dole Food. They thought there were 36,793,758 shares but investors actually had 49,164,415 shares: https://www.bloomberg.com/view/articles ... any-shares)

The first step is that everything needs to be automated. My understanding is that, in the US, there are still a number of places with manual steps. This is one reason why the US scores poorly (compared to other nations) on settlement efficiency: http://www.omgeo.com/page/sda
Settlement efficiency in countries with SDA rates of over 90% – India, Taiwan, Hong Kong, Japan, Singapore and Korea – is 26% higher than in countries with SDA scores of less than 70% – Brazil, Italy, South Africa and the United States.
But even if everything is automated they might still have latency. For instance, imagine everything is automated by your custodian only updates records once a day at 9pm -- so everything would get "stuck" there until 9pm before it could get sent to the central security depository. And maybe at the central security depository they also only update once a day...so you've got another long wait there.

I have an old coworker who used to work a major bank in Sydney, Australia. He says the way that "online transfers" used to work in Australia was that every day the 4 banks would meet at midnight and swap hard drives -- and then everything would get processed the next day. That's why it took two days instead of being instantaneous like we'd expect.

I imagine there are a fair number of traders/brokers/whatever that would need to upgrade or replace systems ... or totally change their processes in order to meet faster execution deadlines.
I mean, for instance suppose I buy some ETF of 5/10 and it is supposed to settle on 5/13 but I want to sell it on 5/11 (for a profit), is this generally allowed?
Why don't you try it and find out?
As ever, a fact filled and interesting post-- didn't know re Dole Foods! Thank you.

Sydney is actually one of the more automated exchanges.

Blythe Masters (ex JP Morgan CFO, one of the people who invented the CDS) is heading up a startup using Blockchain (Bitcoin technology) to do settlement-- the pioneering markets they are working with are Singapore and Sydney. Morgan Stanley published a piece about it which was available online.


linkback.morganstanley.com/.../7ts1o97g-3pg7-g000-a67d-005056012000

Google is giving me grief on pdf links, but if you google Blythe Masters Morgan Stanley Blockchain you should get the link to the pdf.

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Re: Why ETF settlement happens on T+3?

Post by AlohaJoe » Sun May 21, 2017 10:15 am

Valuethinker wrote:Sydney is actually one of the more automated exchanges.
And yet Australia also has T+3 settlement :oops: though ASIC is talking about moving to T+2 next year, I think. At least Australian electronic funds transfer (which takes 1 day) doesn't take the ridiculous amount of time American ACH (which usually takes 2-3 days) does...but Vietnamese electronic funds transfer is the fastest of the ones I've experienced...usually it is in the destination account in under 60 minutes.

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Re: Why ETF settlement happens on T+3?

Post by btenny » Sun May 21, 2017 11:55 am

Grabiner. Thanks the data about rule T. I had it explained to me the way I said above. If you do trades my way it always works. So a person does not need to try to remember the variations.

The Dole case is wild. I read most of that report and am floored how the numbers of shares got all goofed up. I am more concerned than ever about a MAJOR cyber attack hurting our stock market or a major broker very bad. Think about how bad ownership things would be if one of the big brokers lost 30% or more of their data base due to some cyber event. The multiple players situation is so convoluted it would never get fixed. WOW!!!!!!

Good Luck.

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Re: Why ETF settlement happens on T+3?

Post by jhfenton » Sun May 21, 2017 3:00 pm

math22 wrote:Why ETF (at least in my broker) settles on T+3 days?
Also, in general, do brokers allow you to sell your ETF before the settlement of the purchase of that same ETF?
I mean, for instance suppose I buy some ETF of 5/10 and it is supposed to settle on 5/13 but I want to sell it on 5/11 (for a profit), is this generally allowed?
You should read the SEC page that triceratop linked, but the short answer is that you can sell an ETF (or other equity) as soon as you have paid for it with settled cash.

So, examples…

(1) if you have $10,000 in your settlement fund, you can buy $10,000 of ETFX today and sell ETFX today.

(2) If you buy $10,000 of ETFX today and sell $10,000 of Mutual Fund (T+1) to pay for it, you can sell ETFX tomorrow (when the mutual fund sale has settled).

(3) If you buy $10,000 of ETFX today and sell $10,000 of ETFY (T+3) to pay for it, you can sell ETFX on the third business day from today.

(4) If you sold $10,000 of ETFY yestday and buy $10,000 of ETFX today, you can sell ETFX in two business days from today (when the sale of ETFY settles).

As an aside, Vanguard graciously allows the purchase of Vanguard mutual funds using the unsettled proceeds of equity sales in cash accounts. This means that you can sell ETFX and immediately use the proceeds to purchase a Vanguard mutual fund. This is a courtesy extended by Vanguard. They are not required to allow it. (If you do this in a margin account, you will be charged two days' margin interest on the difference in settlement period.)

The only time this is ever remotely relevant for me is during flash crashes or events like Brexit. I mostly hold Admiral shares, but if a fund drops say >5% intraday, I might buy some ETF shares to rebalance. If it fully recovers two days later, I might want to sell it to rebalance back. In that case, I could run afoul of the rules if I funded my initial purchase with an ETF sale. But since I hold my bond funds as Admiral shares, not ETFs, two-day rebalancing wouldn't be a problem.

And T+2 settlement is definitely supposed to happen on September 5, 2017 in both the US and Canada as you can read at triceratop's other link: UST2
AlohaJoe wrote:
Valuethinker wrote:Sydney is actually one of the more automated exchanges.
And yet Australia also has T+3 settlement :oops: though ASIC is talking about moving to T+2 next year, I think. At least Australian electronic funds transfer (which takes 1 day) doesn't take the ridiculous amount of time American ACH (which usually takes 2-3 days) does...but Vietnamese electronic funds transfer is the fastest of the ones I've experienced...usually it is in the destination account in under 60 minutes.
Every institution I use now has at least overnight ACH. Starting this year, my credit union even shows them as pending on the same day. My paychecks, FSA reimbursements, tax refunds, transfers to Vanguard (pulls), credit card ACH payments (pulls), all show up as pending on the day initiated.

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Re: Why ETF settlement happens on T+3?

Post by livesoft » Mon May 22, 2017 12:50 pm

I've been told that this T+3 is likely historical because it applied to stocks back in the day. One could call their broker (or more likely a broker would call you) and place a trade. One could have no money in their cash account (did money market funds even exist?) and needed time to get the money to the broker to pay for the trade. There was no internet ... things were done by phone. One couldn't see their checking account online nor their brokerage account online. (If you don't believe me, go watch the movie Hidden Figures). You wrote a check and mailed it to cover your trade. Did ACH even exist?

I remember that one could call up a mutual fund company and place an order to buy shares that would be executed at the end of the day. The MF company just asked that you mail them a check to cover the purchase. I even had a broker fedex me a pre-paid fedex envelope to get a check to them quickly.

So maybe this T+3 was just for convenience of the brokers? But you wouldn't know the amount of the check to send either (if buying by number of shares) until the purchase was complete, so it was for your convenience, too.
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Re: Why ETF settlement happens on T+3?

Post by hmof » Thu May 25, 2017 3:35 am

AlohaJoe wrote:
Valuethinker wrote:Sydney is actually one of the more automated exchanges.
And yet Australia also has T+3 settlement :oops:
Not any more, since March 2016: http://www.asx.com.au/services/t2.htm

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