FXPA Publishes Buy-Side T+1 Guidance
Posted by Colin Lambert. Last updated: November 28, 2023
The Foreign Exchange Professionals Association (FXPA) has published a guidance paper to help buy side firms in their preparation for the transition to T+1 settlement in US and Canadian securities markets, set for the end of May 2024.
The paper, Buy-Side Guidance in Preparation for T+1 Settlement, is based upon feedback from buy-side attendees at a recent roundtable discussion FXPA jointly hosted with the GFMA’s Global Foreign Exchange Division. It lays out pre-trade and trading considerations, as well as, naturally, post-trade.
In the pre-trade space the guidance focuses on the onboarding process and the establishment of ISDA and/or CSA agreements. It also recommends that firms that STP orders into e-trading venues re-assess their pre-trade netting logic and include more focus on bank/custodian settlement abilities, as well as their geographic location and cut-off times.
It also warns that banks funding facilities could be reduced or withdrawn during busy periods and therefore buy-side firms should study what credit lines, banking (including overdraft) facilities and finding commitments they already have.
Tapping into a topic of discussion in Europe and Asia, the guidance also recommends a review of whether a night desk or physical North American presence would be beneficial if, for example, there were unexpected extensions to trading and settlement hours. Finally, the guidance recommends a review of back-up procedures in the event of an unexpected external event or third-party failure.
The trading recommendations focus on liquidity optimisation, especially for those firms that trade on a Market at Close basis in securities markets, warning that the likely trading window, 4-6pm EST, is when FX markets are at their thinnest and trading is likely to generate volatility and wider spreads. Programme trading firms may also need to assess whether these trades should be executed earlier in the day, the guidance adds.
Buy-side firms should also consider how best to process bulk transactions to mitigate settlement risk for T+1 FX trades, and the guidance suggests that possible approaches could be to transact a series of “sweep trades” throughout the day to clear most FX exposures more quickly; process one bulk FX trade on T+1, then a “trueup” trade on T+0 – most of which they could then settle via CLS, with any small balances booked outside of it – and pre-fund FX for T+1 transactions, something that avoids the need to try to locate liquidity and settle for T+1 value, although there are extra costs involved.
The guidance further observes that more consideration should be taken with trades executed at the 4pm London Fix and whether there is sufficient time to process these trades, and also warns that rollover trades may have to be executed earlier in the day to allow for reinvestment of P&L into the underlying securities markets on the same day.
While the introduction of T+1 in securities markets is not intended to increase FX settlement risk, that could be the unintended consequence if market participants are not fully prepared
Finally in trading, the FXPA guidance recommends that firm with public financial reporting deadlines consider whether the move to T+1 settlement (and the potential increase in market volatility at certain times) could impact their ability to ensure correct FX settlements and flows, including managing issues in a shorter window where key cut-offs can affect public financial reporting such as quarter ends.
In the critical post-trade space, where so much of the pressure of the T+1 switch will be felt, the FXPA guidance says that firms who trade on a “holding” account and then post-trade allocate (PTA) should determine whether they need to split transactions into those that need to be PTA’d earlier in the day (to accommodate counterparties/custodians that struggle to meet T+1 processing deadlines) and those that can be PTA’d later (with counterparties/custodians that have efficient T+1 processes).
It adds that firms should discuss with custodians their processing capabilities and cut-off times and identify any changes needed to adapt their existing fund settlement cycle to T+1 and ensure they have adequate funding in place to meet increased demand to settle T+0 trades outside of CLS.
It stresses that buy side firms should continue to engage in dialogues with their counterparties, custodians, and settlement and clearing service providers and that CLS participants should continue to monitor whether any extensions to the CLS Real-Time Gross Settlement operating hours are likely to be granted.
Finally, firms should review post-trade correction and cancellation processes through both their FX trading venues and their own internal Order Management Systems (OMS) to ensure that they are adequately prepared for mitigating potential T+1 issues.
In conclusion the FXPA notes that while the introduction of T+1 in securities markets is not intended to increase FX settlement risk, “that could be the unintended consequence if market participants are not fully prepared.”
It reiterates that FX traders should conduct a full review of the scale of the challenge of T+1 for their FX trading businesses, considering trading relationships, credit, operational processes, funding, and settlement. “Strategically, this may present an opportunity for firms to review the greater impact of an accelerating settlement cycle across asset classes,” FXPA notes in the guidance.