Introduction
The upcoming move to T+1 settlement in the United States represents a significant shift in the financial industry, with potential implications for market participants worldwide. The transition is aimed at promoting efficiency, reducing risk, and enhancing liquidity in the financial system. However, transitioning form a T+2 to a T+1 settlement environment is itself not without risk, and is likely to present numerous challenges for firms.
In this feature, we look at some of the implications of the upcoming shift to T+1, the challenges that the various stakeholders face, and the role of technology in facilitating a smoother transition.Background
On February 15, 2023, the US Securities and Exchange Commission (SEC) implemented rule amendments aimed at reducing the standard settlement cycle for the majority of securities transactions cleared and settled via the Depository Trust Company (DTC), from two business days after the trade date (T+2) to just one business day (T+1). This follows the 2017 transition from T+3 to T+2. And with the deadline for T+1 compliance set at May 28, 2024, firms now have just over a year to implement the changes necessary to ensure they are ready.
James Pike, Head of Business Development at Taskize, a provider of inter-company workflow solutions, provides some background as to why the SEC is instigating the change.
“A key driver is improving liquidity,” he explains. “Faster settlement reduces bottlenecks in the system, allowing assets to move more quickly through the economy. Another driver is reducing the cost of capital. Longer settlement cycles lead to higher costs for holding trades, and as interest rates rise, these costs increase.
“Risk management is also a crucial aspect,” he continues. “Longer settlement cycles increase risk because counterparties can go bankrupt or face other issues, as we saw with the recent SVB episode. By reducing the settlement cycle, the risk associated with pending trades is reduced.”
The influence of other markets, such as the cryptocurrency market, has also played a role in the SEC pushing for a shorter settlement cycle. Digital assets such as cryptocurrencies generally settle instantaneously (T+0) due to the blockchain technology that underpins them. This has highlighted the potential for traditional capital markets to adopt more efficient settlement processes.
How various stakeholders will be impacted
“The move to T+1 is welcomed as it could act as the silver bullet to improve settlement efficiency and modernise post-trade processes in the US,” says René Haag, Regional Head Securities Services America at SIX Group, the exchange and technology company. “However, it’s difficult to tell whether this transition will be as seamless as the move from T+3 to T+2 in 2017. Ultimately, it leaves virtually no room to resolve any exceptions during the settlement cycle, meaning that firms will need to urgently assess whether they’re truly ready.”
The transition will undoubtedly have a significant impact on various stakeholders across the securities industry. The buy side, responsible for initiating trades, will need to adapt to the new timelines, ensuring their instructions are sent promptly. The sell side, including banks, brokers, and dealers, will face increased pressure to efficiently manage settlements, and in many cases will require upgrades to their technology solutions and communication mechanisms with other parties. Custodians will also need to adapt their systems and processes to accommodate the shortened cycle, and to collaborate more closely with both buy and sell sides.
“The rules published in February indicate different requirements and impacts for each type of participant,” says Stanislas Beneteau, Head of FI & Corporate Client Line in the Americas for BNP Paribas’ Securities Services business. “US broker-dealers must enter into agreements with investors and maintain policies and procedures to ensure the completion of allocation, confirmation, and affirmation by the end of the trade date (i.e. T+0). Registered investment advisors, or investors, will have obligations to keep records of these allocations, confirmations, and affirmations. The third group directly mentioned in the rules are the clearing agencies, such as DTCC, which must have policies and procedures to facilitate straight-through processing (STP) and file an annual report on their progress towards that.”
While the rules for these three groups are quite clear, the knock-on impact on all other participants is also significant, says Beneteau. “Some categories will rely on their service providers to help them meet the rules, making it a substantial undertaking, especially considering there is just over 12 months before the go-live date.”
Time zone issues and operational hurdles
As firms adjust to the new timelines, many of their upcoming challenges will revolve around staffing, resourcing, internal processes and workflow. The requirement for buy-side firms to send allocations back on T+0 rather that T+1 is likely to be particularly problematic for those based in Asia, as it may require handing work off to their European or US offices in order to ensure everything is completed and settled by the T+1 deadline.
“40% of the US market consists of foreign investment, primarily from Europe and Asia,” says David Pearson, Product Manager at Torstone Technology, a provider of post-trade securities and derivatives processing. “Although there might be a late desk operating in London, dealing with asset managers in Hong Kong during their night-time hours to ensure every detail is correct for settlement is already challenging. If any discrepancies exist, the trade will fail. T+1 removes a significant amount of the time that was previously available to resolve such issues.”
With trade processing and asset servicing needing to occur on T+0 in order to meet T+1 settlement deadlines, managing time-sensitive tasks will no doubt be challenging for overseas participants. It is likely to necessitate the adoption of ‘follow the sun’ models, ensuring there is adequate operational coverage across different regions. For smaller players based predominantly in Asia, this could result in a significant change in working practice, as many such firms do not have the capabilities to pass work around in this way.
“There is concern amongst these firms that they will now have to work later hours or bring on additional coverage to ensure that their US trades settle properly,” says Christian Mendonca, Product Manager for Control for Buy-side Settlement at Gresham Technologies, a software company that helps financial firms reconcile and control their data. “They want to avoid walking in on T+1 with unallocated trades and having to scramble to resolve issues, settle transactions, or re-book trades.”
Technology challenges
Many legacy back-office systems rely on batch-driven processes run at the end of day. These will struggle to handle the compressed timelines required for T+1, suggests Pearson. Consequently, firms may need to invest in real-time solutions to facilitate faster settlement cycles.
“In order to manage the allocation, confirmation workflow, and post-trade settlement instructions, it’s essential to have real-time processing of trades,” he says. “The market may close at four o’clock, but executions for clients can occur at any time during market opening hours. Therefore, it’s crucial not to wait until 6pm to allocate; instead, firms should complete their allocations as soon as orders are booked. However, many historic legacy systems in the US are batch-based. Consequently, technology changes are needed to transition to at least some kind of intraday – if not real-time – processing.”
Pearson also highlights issues that may arise when firms need to borrow stock. “The stock loan/borrow market provides liquidity for many stocks,” he says. “But moving from T+2 to T+1 will make it difficult for market makers who are short and need to borrow, as there isn’t enough time on the trade date itself to find the borrow. Whereas in today’s T+2 environment, there is more time to search for available stocks to borrow the following morning. Additionally, if those with assets to loan become hesitant to do so, fearing they won’t be able to recall the assets, the stock loan/borrow market could tighten, leading to a potential liquidity crunch, wider spreads, and declining portfolio performance,” he cautions.
Automation and STP are critical components for T+1 to be successful, says James Pike. “STP is essential for T+1, but it’s important to realise that legacy technology can be a barrier to achieving that. In order to identify and resolve exceptions, it’s necessary to have near-real-time exception handling rather than running batch processes. Over-reliance on batch processes, whether those are internal or industry utility-driven processes, will be a significant hurdle for any firm dealing with this issue.”
Workflow optimisation
As with any significant change to market structure, the T+1 transition does offer opportunities to market participants – and particularly solution vendors – who are able to help address the challenges. Workflow improvement is a key area of focus, as firms will certainly be seeking to streamline their processes and enhance efficiency. Technology vendors stand to benefit by providing innovative solutions that can accelerate issue resolution and optimise workflows for buy-side, sell-side, and custodian firms.
“Firms should focus on technology modernisation and re-evaluate their current workflows to identify optimisation opportunities,” says Christian Mendonca. “Allocating and matching with brokers on an intraday basis instead of waiting for the end of the day or the following day may be a significant undertaking, but with the right technology, it can be done. The sooner you can start that clock on T+0, the better off you are, with a higher likelihood of settling on time and reducing exposure to any sort of trade failures.”
Enhancing connectivity and communication is another crucial aspect of the T+1 transition, says Pike. “Much of the real work that needs to be done falls on the sell side, which includes banks, brokers, and dealers. Although the buy side drives the process by initiating trades and their corresponding instructions, there is often a lack of connectivity between the buy side, sell side, and custodians. If there is a problem between the broker and the buy side organisation, the issue moves from the buy side down to the custodian and then back up, resulting in a very bilateral process. These processes can take time, sometimes days or even weeks. It’s therefore crucial to create a process that facilitates the flow of information between all three parties almost simultaneously. This currently doesn’t happen, so it will be a significant shift and a considerable change.”
The International Perspective
Although the rule changes to T+1 settlement are specific to the US (with Canada moving to T+1 settlement in sync with the US on May 28th, 2024), the transition will certainly have a global impact, not just for overseas firms trading US and Canadian securities, but across the wider market. It could potentially influence the UK and European regulators to consider similar transitions, as they aim to keep up with the evolving global landscape. However, differences in market structure, regulations, and clearing and settlement practices across regions will likely affect the speed and ease of adopting such changes.
“The UK is seriously considering moving to T+1 to keep up with the US market,” says David Pearson. “The last thing the UK wants is to lag behind the US. Also, it could differentiate the UK from Europe. It’s much harder for the EU to move to T+1 because they have multiple Central Securities Depositories (CSDs) and multiple currencies. One of the underlying principles of the EU is harmonisation, so countries like France and Germany might consider aligning with the UK or even adopting T+1 themselves.”
In December 2022, the UK HM Treasury launched the Accelerated Settlement Taskforce to explore the potential for faster settlement of financial trades in the UK. The Taskforce is due to publish its initial findings by December 2023, with a full report and recommendations made by December 2024. As yet, there does not seem to be any equivalent initiative coming out of EU, although in autumn 2022, AFME (Association for Financial Markets in Europe) proposed establishing a similar task force to conduct a detailed assessment of the benefits, costs, and challenges of T+1 adoption in the EU.
Conclusion
In conclusion, understanding the implications of the transition to T+1 settlement is crucial for market participants across the globe. As the securities industry moves towards a more efficient and risk-reduced environment, it is now vital for all stakeholders to adapt and evolve with the new settlement cycle. The T+1 era presents both challenges and opportunities that require investment in technology and collaboration among industry players. Legacy systems, over-reliance on manual processes, and operational coverage across time zones are key areas that need attention to ensure a seamless transition.
“Firms have plenty of solutions available to get there,” says René Haag. “At the most basic level, banks and brokers need to start investing into their technology and operations. This will involve embracing automation, like APIs, as this will make it easier for market participants to undertake trade confirmations, allocations and affirmations.”
It’s clear that technology vendors have an opportunity to help firms embrace automation and STP to enhance their workflows, to improve connectivity and communication between market participants, and to address areas such as stock borrowing and lending with innovative solutions.
By adapting to – and evolving with – the T+1 settlement cycle, will the industry unlock a more efficient, liquid, and risk-managed future, fostering continued growth and innovation in the global financial markets? Time will tell.
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