Modernising the Front to Back Trading Workflow: Getting Ready for T+1 SEC Settlement

With less than three months to go before the North American securities markets transition from T+2 settlement to T+1, firms have faced numerous operational challenges in adapting to the shortened settlement cycle, and have been making comprehensive preparations to modify their existing processes to comply.

A distinguished panel of industry experts came together at A-Team Group’s recent TradingTech Summit London, to discuss these questions. Peter Tomlinson, Director, Head of Post Trade at AFME moderated the panel, and was joined by Linda Gibson, Director, Head of Regulatory Change at BNY Mellon | Pershing; Sachin Mohindra, Executive Director, Client & Market Solutions at Goldman Sachs; Emma Johnson, Executive Director, Securities Services Global Custody Industry Development at JP Morgan; Matt Johnson, Director, ITP Product Management and Industry Relations at DTCC; and Karan Kapoor, Executive Director – Global Head of Regulatory Solutions at Delta Capita.

Why T+1?

The panel provided a quick summary of how we’ve got to this point, describing how the industry had long debated the feasibility of moving to T+1 or even T+0 settlement, discussions that failed to gain significant momentum until the meme stock events of early 2021, which exerted significant pressure on market infrastructure and intermediaries, particularly clearing brokers. The issue came to a head when significant margin calls compromised the ability of some clearing firms to trade, effectively barring their clients from reversing positions or conducting further transactions in the affected stocks. Consequently, the SEC committed to the date of 28th May 2024 to transition all US securities cleared and settled via DTC to a T+1 settlement cycle, aiming to reduce the costs and risks stemming from the two-day time lag between trading and settlement, to improve liquidity, and to bring more stability to the markets.

The importance of affirmations

In the run-up to T+1, the term “affirmation” has become a significant buzzword, said one panelist. The DTCC recently releasing a report outlining the importance of the affirmation process, pointing out how – unlike with a simple “fire and forget” approach, where trades are indiscriminately sent to the CSD without any assurance of their completion – once a transaction is affirmed, the likelihood of its settlement significantly increases. The DTCC report offers several clear recommendations, a key one being that 90% of all trades should be affirmed by 9pm Eastern Time on T+0. Currently however, only 73% of transactions processed through the DTC’s architecture meet this deadline, so there is a substantial gap that needs to be bridged.

However, even for the most proficient operational teams equipped with the best technology stacks, this timeline presents a challenge, agreed panelists. The securities post-trade environment relies on a sequence of actions, including various handoffs between teams and systems, all of which will need to be accelerated to achieve affirmation by 9pm. Importantly, allocations will need to be completed by 7pm, a considerable time compression compared to current standards. Therefore, it is crucial to ensure that trades are booked accurately, with all necessary reference data, from the outset.

International implications

A significant proportion of US stocks are held by non-US investors, with around 40% of such investment originating from the UK and Europe. Consequently, the impact of T+1 in the US and Canada will be felt globally. One panelist noted that the larger international banks and brokers  probably already operate ‘follow the sun’ models for trading, which should serve as a ‘wake-up call’ for middle and back offices to align with those global working standards. As a result, some firms have started reassigning staff to different time zones or altering working hours. The panel agreed that there is clearly an imperative for increased automation, given that manual processes will come under much greater strain in a T+1 settlement environment.

Panelists also noted that the shift to T+1 introduces a degree of misalignment, due to the fact that not all jurisdictions are transitioning simultaneously. Although North American markets are moving in May this year, the UK and the EU are yet to initiate such a change. This misalignment is expected to create friction, particularly in the case of ETFs containing global underlyings, where the ETF will settle on T+1, but the underlying securities will settle on T+2. A similar situation will arise with ADRs, bringing about settlement complexities that did not previously exist. The industry has yet to work out how to make these processes more efficient.

When asked about the likelihood and timing of the UK and EU moving to T+1 settlement, one panelist felt that it was very much a case of when, not if. ESMA are now consulting on when the EU should move, and recently undertook a call for evidence to collect stakeholder views. In the UK, the Accelerated Settlement Taskforce is looking at the technical details of trades being settled on T+1.  And panelists agreed that a recent industry round table attended not only by EU and UK regulators, but also the SEC, was an encouraging demonstration of global bodies working together.

Changing behaviours?

One panelist highlighted how achieving long-term, sustainable transformation in the financial markets industry hinges on two critical elements. Firstly, the establishment of appropriate infrastructure and technology is essential. Secondly – and perhaps more importantly – there must be a shift in behaviour. The presence of technology is futile if it is not utilised to its full potential. T+1 settlement, therefore, necessitates a fundamental behavioural change. The technology involved is not novel, said the panelist; the transition involves moving from batch processing to real-time operations and improving the quality of reference data. It therefore doesn’t entail a radical overhaul of market structures or technologies, rather it instigates a shift in behavioural patterns, forcing a re-evaluation of how market participants consider taking a more integrated approach, taking into account issues such as disparate time zones, aligning securities lending more closely with cash transactions, FX elements, and how to service clients across multiple jurisdictions, for example.

With regard to how vendors and service providers are working with market participants, Karan Kapoor, Executive Director – Global Head of Regulatory Solutions at Delta Capita, commented: “People are eager to stay ahead of the curve and are taking numerous steps to enhance their efficiency levels. We are collaborating on various initiatives with our clients to increase automation across key trade lifecycle processes, including confirmations, affirmations, and allocations. Additionally, we are focusing on enhancing reference data like SSIs and inventory management, as well as refining operating models. The development of communication and workflow tools is also a priority, as there is an increasing need for more optimized channels in these areas. Concurrently, we are engaging with several firms to explore long-term strategic solutions, considering how technologies like blockchain and artificial intelligence can further advance client’s objectives in a T+1 environment and beyond.”

Stock borrowing and lending

A question came from the audience as to whether short selling liquidity will be impacted by less stock being available for borrowing in the T+1 environment. A panelist responded that the transition will certainly compress the time frame for stock borrowing and lending decisions, as participants will need to determine their net buying or selling position and whether they need to borrow stock, are able to lend stock, or need to recall loaned stock, by the end of the trading day. This compression is likely to lead to some initial turbulence, with lenders potentially increasing their buffers and reducing the volume of their lending to mitigate risks. This may, in the short term, affect market liquidity. However, the panelist was optimistic that the markets will adapt to these structural changes over time, and T+1 will eventually become standard practice, with market operations smoothly adapting to the new timeline.