EFAMA: T+1 FX Change “Costlier and Riskier” for Fund Managers
Posted by Colin Lambert. Last updated: April 10, 2024
With The Full FX View
A new policy paper from the European Fund and Asset Management Association (EFAMA) calls for US and European authorities to be more assertive in driving an extended CLS window in response to the T+1 changeover in US securities markets, arguing that a failure to deliver a later cut-off time “does not represent an absolute reduction of risk in the system”.
Research from EFAMA estimates that 40% of daily asset manager FX flows are at increased risk due to the changeover, and while the paper praises the success of CLS in mitigating Herstatt Risk, and that the settlement service is “critical” during periods of market stress, it also warns that when T+1 comes into being on 28 May 2024 fund managers in Europe will have “a very ljmited ability to access CLS” for their USD trades.
“The reason is simple,” the paper points out. “Asset managers trade throughout the US trading day, with a significant part of trading coming on market close (4pm Eastern Standard Time). By the time an asset manager has confirmed the trade and is ready to execute the FX, there is little time, if any, to submit the FX trade to CLS, which has a cut off of 6pm EST.
“Under these circumstances, CLS access is significantly reduced, if available at all,” it continues. “When US securities still settled on T+2, the issue of PvP netted FX settlement did not arise as there was an additional day in which to submit trades for settlement on the CLS platform.”
The Full FX View
This would seem, at face value, a very late and important intervention from EFAMA, one that heightens the pressure on CLS to deliver an extension to its current settlement times.
CLS has surveyed the industry and the word is that the feedback was less than unanimous in backing an extended settlement window. More notably, CLS itself has said even if it does change, it will be unlikely to deliver the change in time for the 28 May changeover.
It will be interesting to see the response of custodians and other service providers to this report, because rather than someone in authority, this is their customers speaking – a group we purport to listen to intently.
There is also an element of irony about this, in that yet again, a group representing the buy side, is not only calling for its service providers to deliver a solution – which is fair enough, they pay their fees after all – but doing so at such a late date. It is fair to ask the question, ‘what took them so long?” Publishing what is a pretty punchy paper at such a late stage of the transition, risks giving the impression that it is designed more to cover the association’s members from their own customers, than it is to drive actual change. After all, how realistic is the type of change being discussed here in a three-month window?
In reality, the solution to the T+1 changeover in FX markets is multi-faceted – it is not just about CLS changing how it operates, or new providers entering the market. The buy side has to accept some responsibility and invest in systems that at least give it a chance of speeding up the process of reconciliation and hedging. There is the suspicion in the FX industry that for many managers, even if CLS did extend by 90 minutes, they still would not be able to meet the daily deadline.
Service providers can also, to a degree, offer more choice around how they handle the clients’ trades. At the moment, too many people are thinking merely of hedging underlying transactions on a trade-by-trade basis – perhaps we need more “batch” offerings?
The one thing that is guaranteed in this whole process, of course, is that the foreign exchange market can provide a price for a T+1 trade. If the rest of the workflow chain can work out their issues, then there will at least be the ability to execute. Not all markets can say that.
It is good that EFAMA has published a paper that clearly and unequivocally states their members’ position and requirements. The association is quick to urge central banks and regulators to take a more pro-active role in solving the issue, but it should be noted that this paper would have been infinitely more valuable had it been published six months ago.
EFAMA argues that the inability to use CLS “pushes asset managers into costlier and riskier alternatives”, such as prefunding (i.e. holding USD cash buffers) which are an inefficient use of capital; operationally complex FX on trade day with a ‘true-up’ required the next day against the confirmed trade; and bilateral settlement with the counterparty bypassing CLS altogether.
The paper is based upon a survey of EFAMA members which sought to determine the percentage of FX trades (with the dollar on one side) which would not be eligible for CLS settlement due to the inability to meet a custodian deadline, which itself is set against the official CLS cut-off.
“The results were in line with what this industry has feared since the US T+1 move was announced,” EFAMA states. “Well over 1/3 of FX trades (38.5%) would have to settle outside CLS according to estimates by fund managers, based on their trading patterns and their custodial relationships.”
EFAMA says that custodians displayed a wide range of cut-offs, with two major time clusters where cut-offs were applied, either around 6pm CET (indicating a European business day-imposed cut-off and well ahead of CLS’s cut-off which comes at midnight CET or 6pm EST), and around 10.30pm CET (4.30pm EST), but again with variations around that time. “There is no doubt that custodians could be more aligned in their cut-off times, and the industry average should ideally be much closer to the CLS cut-off,” EFAMA urges.
CLS has previously estimated that around $65 billion of daily FX volume is vulnerable due to the changeover, and this is reinforced by the EFAMA paper, which says $50-70 billion is at risk, although it is “easily double that figure on active trading days”. Putting this much flow at risk, “should be a significant concern”, the association argues.
The paper also observes CLS itself refers to its business as the ‘unglamorous plumbing’ which provides the backbone of the financial system, ensuring that money and other assets flow smoothly, safely and efficiently. It also points out that SEC chair Gary Gensler, has often referred to the US move to a shortened settlement cycle as an upgrade to the most efficient and reliable pipes on the market.
“European asset managers would beg to differ,” EFAMA state. “With 40% of our daily FX flows unable to settle safely and efficiently, we see a major hole in the proverbial pipes, even before the valves are turned on.
‘Without necessary adjustments to make the CLS platform accessible (this will require changes to cut-off times both by CLS and custodians’ own internal deadlines), the asset management industry cannot agree that T+1 will make the system ‘safer for everyone’,” it continues. “T+1 implementation today does not represent an absolute reduction of risk in the system. From where asset managers sit, it looks more like a shift away from credit and market risk to an increase in operational and settlement risk.
“We hope that the SEC and NY Federal Reserve, as well as the ECB, can take a more active role in understanding impacts on settlement risk and to take mitigating measures,” it adds.
