The Securities Industry and Financial Markets Association (SIFMA), the Investment Company Institute (ICI), and The Depository Trust & Clearing Corporation (DTCC) last year published a report targeting the first half of 2024 to shorten the US securities settlement cycle from trade date plus 2 days (T+2) to trade date plus one day (T+1).
Perhaps this will be a first step toward broader coverage in other currencies, regions and exchanges. Proponents suggest that the immediate benefits of moving to a T+1 settlement cycle include reduced market risk and lower margin requirements, as well as significant cost savings.
A move to T+1 will certainly have its challenges: industry participants will have to align and implement the necessary operational and business changes. T+1 will pressurise the industry to get things right on trade date, which means more straight-through processing and less cumbersome or customised processes. In a T+1 settlement cycle, if a trade is executed today, the confirmation or affirmation process should occur on trade date – mostly at the close of business in the region - for the trade to settle the following day. There’s very little time for the firm to identify a mistake that could lead to failed trade settlement.
When industry executives consider T+1, a natural starting point for the conversation is from the US perspective. Most firms perceive the main challenges impacting asset managers based in the US, who are dealing directly with the DTCC locally. The truth is that the impacts of this truncation of the settlement cycle are actually far greater due to multiple factors stemming from the differences in time-zones for participants trading outside of the US. This article looks at some the operational problems of T+1 from outside of the US footprint.
Across the time zones
For a firm located outside the US, T+1 automatically becomes extremely difficult. For example, currently with a typical UK investment management firm its staff have ended their working day well before the markets close in the US. In a T+2 environment, many traders don’t complete the deal records until the morning of T+1. Occasionally they might log in at around 11pm to sweep up any unbooked trades, but if they don't match perfectly with a broker the trade will remain unmatched until the operational team returns the following morning.
Under T+2 that firm would have an entire day to correct and instruct the settlement of the trade, so there would be little or no issue, although if the counterparty is a US broker, it will be early afternoon in the UK before they can fix it. If we put this scenario into a T+1 context, the firm has effectively lost a day. While a trade is in an unmatched status, the parties can’t confirm the net settlement amount for the cash component of the trade, impacting funding processes.
Stock lending, custodians and FX
There are additional complications if a party is participating in stock lending. A custodian, for example, will not know about a requirement to recall stock until an asset manager sends the trade instruction to sell. If an asset manager sends an instruction after markets close, there is little or no chance to recall stock on the same day.
This scenario will have an impact on the number of failed trades because there's not enough time to facilitate settlement. The net result when the settlement cycle decreases will be that custodians may impose earlier instruction receipt deadlines. Furthermore, if stock is not readily available, then trades are going to fail. Service level agreements may also have to be revisited, as each party wants to protect their position and not be responsible for failed trade fees.
Many custodians allow UK-based asset managers to instruct on settlement day for US equities, but that's because the US market is still open when the UK market has closed. Deadlines for asset managers in Asia may become even tighter as their day is ending before the US market opens.
In India, T+1 has already been introduced and many UK firms already feel the pinch because the market there closes around 11am GMT and some custodians are looking for instructions by or before 9:30am. As this new trading lifecycle is established, many UK asset managers may struggle to meet these deadlines, resulting in pre-funding issues and foreign exchange challenges.
Similarly, there have been discussions on the impacts in the broader Euro markets of moving to T+1. From experience we often see that if the US markets introduce change, the tendency is that other regions follow suit. With new Central Securities Depository Regulation (CSDR) impacting processes, there are potentially going to be more failing trades, therefore more penalties incurred. All creating additional headaches for asset management firms.
Changing working practices
At this stage, many asset managers will be establishing forums or working groups to understand their custodians’ requirements under T+1, to then formulate internal procedures to support T+1 when it does go live in the US markets. This might involve testing their operational team presence in the local market time for executed trades, so perhaps trialling support in US market hours to see how that might work in practice. Team shift-work, accommodating a much longer working day may well be the necessary endgame.
Indeed, the imperative to adapt operating models is an interesting yet challenging area for discussion. Changing local working hours is an easy statement to make, but every firm has a finite number of resources in their operational teams. Getting an even split between staff members would be key so that the workload naturally flows, requiring careful analysis and staff commitment to change. For example, if US hours are typically 2pm to 11pm GMT, then there is likely to be a trade processing bottleneck around 4pm when all euro and UK trades are often still being booked. However, UK based asset managers are anticipating very low volume activities between 6pm and 10pm, adding to the challenges of balanced resourcing in a lengthy window of inactivity.
When firms look at a move to T+1, it is essential that they fully comprehend required changes to the post-trade environment. This is even more crucial for firms that have not re-engineered legacy systems.
As operational efficiency and regulations bring technology to the fore, now is the time to overhaul dated technology and systems and move away from practices like batch processing, which is still common in a great number of companies around the world.
The many operational problems associated with T+1 can be alleviated by corfinancial’s Salerio® software. Salerio deals with confirmation, matching and settlement instructions management, helping the middle office deal with high volumes of trades that must be processed on trade date. Salerio achieves this through complex matching automation leaving users to only deal with exceptions, thus enabling firms to process high volumes of transactions in the most time-efficient manner. Our software takes control, because as soon as the firm can send an instruction to a custodian, the custodian can issue notifications on the matching and settlement status of trades that Salerio centrally manages.
To read our Discussion Paper and find out more, please visit https://www.corfinancialgroup.com/download-t1-pdf/.
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