Settlement Date Meaning Examples How To Calculate

Settlement Date Meaning

Explanation

The gap between the date on which trade occurs and the date on which it settles is for completing the paperwork or the transfer process and providing the time for the transfer of payment, so even if it is an online trade, it takes a few days to reflect.

The standardized number of days is mentioned in the trade contract. However, the actual number of days is more than the specified number due to some errors that might occur or due to a public holiday. Traders are conveyed the same to avoid a situation of panic.

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Example

To bring more clarity to the concept, suppose a trader trades on security online on a Tuesday dated 5th June, so this is his trade date, but the security settles after two business days, so ideally, the settlement date should be 7th June i.e., a Thursday but due to some unforeseen circumstances, Thursday is declared as a public holiday, so the actual settlement is done on 8th June or Friday.

How to Calculate Settlement Date?

With effect from 5th September 2017, the Securities Exchange Commission or the SEC adopted the T+2 convention in which the securities trade would settle after two business days from the Trade date, which was earlier T+3, i.e., three business days. This was done because of improvement in technology and to increase the efficiency of trades and markets.Prior to this, with effect from 7th June 1995, the SEC adopted the T+3 convention, with a few exceptions, in which the securities trade would settle after three business days from the Trade date.In the case of most currency trades, the T+2 convention is followed, but there are a few currency pairs that are an exception to this rule and settle according to the T+1 convention.Historically, trades were settled in as long as days, and it was only from the 1970s onwards that this was first reduced to T+7, then followed by T+5 conventions to the currently used convention.

Risks

The time gap between the two dates causes the chances of default from either party to increase. The seller might not deliver the securities, or the buyer might not make the payment. This can impact the following trades undertaken by these traders because most times, the traders pledge the same securities or money for other transactions, so if they are not received in time, their other trades might get impacted. This risk is, at times, also known as the credit risk.

Further, it can lead to counterparty riskCounterparty RiskCounterparty risk refers to the risk of potential expected losses for one counterparty as a result of another counterparty defaulting on or before the maturity of the derivative contract.read more when one party fulfills his side of the trade, but the other party doesn’t fulfill his side of the trade, such as the security being transferred and payment not made.

Settlement Date vs. Trade Date

Meaning – Trade date is the date on which the traders executed the transaction, and therefore it is also known as the transaction date. While as explained before, the settlement date is the date on which securities and cash are exchanged, or the trade is netted out.Control – Traders only have their control over the trade date because it is their decision on when to buy or sell. However, the settlement date is prescribed to them by either the exchange or the security contract in which they have traded.Online Transaction – Even in online transactions, the trade date is when your holdings reflect the transaction, but the cash is deducted, and the securities are actually credited to your account on the settlement date by the broker.Taxation – For calculation of tax liability for the year, trade date is considered, so if a trade is executed on the last day of the year while it is settled in the following year, it is considered for the year just ended, and the tax benefits or losses are from this trade are considered in that year only.

Importance

Regulation – According to certain regulators, the trader who has bought security cannot resell it till the trade is settled, and the trader cannot use the funds he will receive from the sale of a security to buy another security till the time the trade has settled. Hence, the traders need to be mindful of such regulations. Violation of such a rule is often termed as ‘free-riding.’Accounting – When settlement date accounting is followed, the transaction is recorded in the trader’s balance sheet only once it is settled. Therefore, this might change the month in which the trade is recorded in comparison to the trade date based accounting. Settlement accounting, therefore, is more conservative, we can draw the analogy of accrual accountingAccrual AccountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. read more, and cash accountingCash AccountingCash Accounting is an accounting methodology that registers revenues when they are received & expenditures when they are paid in the given period, thereby aiming at cash inflows & outflows. read more wherein the cash flow statement is a better reflector of the cash position of the company; similarly, the settlement date accounting is a better indicator of the trader’s cash position.

Conclusion

The settlement date is when the assets are exchanged, payment is made, or trades are netted off. This date is generally after the Trade date, which is the date on which the businesses execute the transaction and is sometimes known as the transaction date too.

The gap between the trade date and the settlement date varies for different markets. Still, the most common convention that has been recently adopted by the SEC is the T+2 convention, which makes it two business days after the trade date. Settlement date accounting is considered analogous to the cash-based accounting system and is a more conservative approach that shows the exact cash position compared to the trade date accounting.