Banking Category Banking: the easy, simple banking guide

What is a trade settlement?

Trade settlement refers to the day money is exchanged by the buyer and seller in a transaction. Trade settlement does not confer risk; that is assumed at the time of the trade. Trade settlement allows time for paperwork between the exchange, the brokers and the investor to be completed so title is properly registered. Trade transfers are handled by 'back office operations' offices that employ pretrade and posttrade operators to quickly process transactions.

Trade Date and Settlement Date

On the day a trade occurs it is considered that the risk of the trade immediately transfers. This is called the trade date. Depending on the type of security traded the transfer of monies may occur at the same day or at a later date. This is the case with futures trading which transfers funds almost immediately or stocks which generally transfer three days later.

Settlement Date and Dividend Dates

Stock buyers seeking to capture an announced stock dividend must be the owner of the stock on the day of record. The day of record is the last trade day by which ownership can be established before the dividend is paid. Thus the settlement date must occur on or before the ex-dividend date in order for the investor to receive the dividend.

When Issued Settlement Dates for Bonds

Fixed income securities, particularly corporate and municipal bonds that are newly issued, may have deferred settlement dates. It is not unusual for settlement dates to be set 30 to 60 days in the future. Ordinary bond settlements in the secondary market occur on a five day basis. However, in addition to monies being exchanged for the principal amounts of bonds monies are also due for accrued interest. Accrued interest is the daily prorated amount of interest paid to the holder of the bonds.

Electronic Transfers on Settlement Date

Until the mid 1980s, settlement date required the creation and exchange of physical securities. With the advent of electronic settlement, customer securities are held in the electronic records of the broker involved in the trade. The purchaser can then request a physical certificate acknowledging ownership of the underlying security. Electronic transfers greatly reduce recording errors and allow quick retrading and day trading of securities in a short period of time.

Trade Settlement Is an Important Part of Short Trading

Pretrade settlement involves having all the documentation ready for the quick and efficient exchange of business interests. There must be a trained staff and the proper equipment to complete all the exchange processes. When securities are shorted, however, the trader is selling securities the trader does not own. It is up to the back office to borrow securities at a nominal interest rate and use those securities to deliver against the short sale. Failure to deliver securities can result in severe penalties and exchange suspensions.

About the Author

After an 18-year career on Wall Street as a trader of municipal and mortgage backed securities, Carmelo Montalbano developed a very large desktop trading application that managed more than 30 institutional portfolios. Technology and small business acquisitions continue to be his primary interest.

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