What is a Settlement Period?

The settlement period is the period of time between the time of a transaction and the time that the terms of that transaction are fulfilled. In financial transactions, this refers to the amount of time it takes for payment to be proffered to the seller and the security being sold to be transferred to the buyer. Depending on the security being sold, the amount of time in the settlement period may differ. Settlement periods are represented in terms of T, which refers to the date of the transaction, plus the number of days of the period, such as T+3 for the three-day period for settlement of a stock transaction in the United States.

When it was the practice of traders to actually own stock certificates after a transaction, the three-day settlement period was common. Although the three-day period still nominally exists, it is common for traders to buy and sell the same stock in less time. The practice known as day trading, buying and selling a stock on the same day. This is represented as T+0, although that practice is banished in some countries because of the volatile effect it has on the stock market.

While the standard settlement period of a stock transaction is T+3, other transactions have a different amount of time attached to them. For example, in the United States, mutual funds must be settled within one day, or T+1. Forex transactions with the U.S. Treasury are conducted in a period of 2 days, or T+2.

Some settlement periods can be extended over a much longer period of time, yielding more flexibility in transactions. Within the real estate industry, it's not uncommon for the period of settlement to be extended over weeks and even months. The terms of the settlement period are usually worked out prior to the transaction and can be dependent upon a number of variables, such as the financing arrangement of the buyer and how long it will take for the selling party to move out of the property.

In any exchange, settlement risk must be considered. This refers to the risk that one of the two parties involved in the transaction defaults on meeting their terms of the agreement, leaving the other party to possibly suffer significant losses. As a result, many countries have adopted longer settlement periods or allow for extensions of the predetermined settlement period, a practice known as extended settlements, to try and eliminate the risk of such defaults from taking place in any type of transaction.