The Uncertainty of T+1
Posted by Colin Lambert. Last updated: November 28, 2023
Today, (28 November) marks the six-month threshold for the headline act of the past six months in markets, the US SEC officially setting the date for the US (and Canada’s) transition to T+1 settlement for its securities markets. In FX markets the focus has very much been about the Hobson’s Choice for many between funding or settlement risk, but even in securities markets there is great unease over the impending change.
There is also a degree of frustration in markets at the SEC’s absolute intransigence when it comes to the changeover date. Several sources have told The Full FX that respected market associations lobbied the US regulator hard to have the actual changeover just over three months later at the beginning of September, rather than the end of May. “The US and Canada both have 2 September as a market holiday, that would give market participants a long weekend to effect what is an important change,” says one senior banker familiar with the process. “Instead, the SEC has – typically I might say – stood its ground and insisted on the end of May, when the US and Canadian holidays are one week apart. They’re not making it as easy as it could be.”
Interestingly, the recent Future of Finance report published by Swiss and Spanish exchange group SIX also found a bifurcation of views as to the benefits, or otherwise, of the move in securities markets themselves. The report found an “ambiguous” mood amongst surveyed executives over the shift, with 47% finding it provides an opportunity to automate processes, increase efficiency and reduce costs – a good thing – while 45% see nothing but greater operational complexity for participants with global operations.
The report does not appear to have asked those with positive views whether they were happy with the associated upfront costs of effecting greater automation, or indeed whether they had already automated, but anecdotally, a lot of market participants seem to behind the curve when it comes to automation for T+1 specifically.
Again, on the positive side of the ledger, 41% saw global alignment with “the rest of the main markets”, however this too was balanced by 43% fearing a higher rate of settlement fails – something that comes with financial penalties in many securities markets. It is not clear what the “main markets” represent, certainly it does not reflect the UK and EU, both of whom are only just starting a consultation process on potentially moving, nor would they seem to reflect many Asian markets, that also remain at T+2 and are likely to continue to be so.
With the deadline fast approaching, it’s time to finalise operational and technological enhancements and engage in end-to-end testing
There was also a split on opinion on something that very much impacts FX markets, with 39% of respondents to the SIX survey seeing a significant reduction in counterparty risk, but the same percentage fearing higher funding costs.
Overall, the sense is that even in the securities markets themselves there remain significant unease, something that could be read from a statement from key securities market utility DTCC marking today’s six-month deadline. “With only six months to go before the T+1 settlement implementation date in the US, we strongly encourage market participants to step up their preparations,” warns Val Wotton, general manager, institutional trade processing at DTCC. “A shorter settlement cycle will demand streamlined and efficient operational processes; the US T+1 regulatory mandate presents an opportunity to enhance efficiency and reduce risk by increasing post-trade automation as manual or outdated processes increase the likelihood of trade failure.
“The margin for error is much lower within a shortened settlement cycle so automation of post-trade processes is critical,” Wotton continues. “Focusing on areas such as trade allocation, confirmation, and affirmation and leveraging best practices like a Match to Instruct workflow helps facilitate timely settlement, making T+1 settlement achievable. Firms need to remember that T+1 will also have a significant impact on market participants trading US securities that are located in jurisdictions with different time zones.
“With the SEC’s May 28, 2024, deadline fast approaching, it’s time to finalise operational and technological enhancements and engage in end-to-end testing,” he adds. “DTCC’s suite of testing programmes, along with our post-trade and consulting services are available to support the industry’s transition to T+1.”
What About FX?
Counterparty risk and funding concerns are very much front and centre of thinking in FX markets – with the potential discarding of best execution policies thrown in for good measure. As reported by The Full FXpreviously, CLS, the main settlement infrastructure of FX markets, is surveying participants over a potential extension to its settlement window, which currently closes for next-day settlement just two hours after US securities markets finish at 6pm EST, meaning the large number of “trade at close” orders executed in securities markets have minimal time to be processed for FX netting and hedging.
This means participants have just two hours to agree and process their equity trades, organise their funding and cash positions, and execute and submit the FX hedge for processing. Even in an automated environment, that is a lot of work and processes than need to be connected and run very smoothly.
Hedging securities trades individually, even in a fully-automated world, is a huge number of line items, that could stress systems
Eyes are definitely being cast at CLS to help alleviate the issue, but even if the utility’s survey does provide a majority verdict for change – by no means certain according to market sources – there are still questions over whether the settlement system, which operates under tight regulatory scrutiny as a vital infrastructure and needs approval for major changes, can actually get anything done in time?
The thinking inside CLS is that it can certainly effect an extended window, however the real challenge comes from outside the utility – can market participants change their CLS-related processes and solve the funding requirements, specifically do they have the time to find the funding their trades, including “Out” legs in In-Out trades on the system.
It does seem as though a significant minority of asset managers are not ready for the change, meaning they could be pushed towards executing with their custodian on a trade-by-trade basis. At a recent panel at The Full FX London conference, it was noted that such a shift in behaviour throws out best execution requirements due to the lack of competition for the trades. Equally, managers using their custodians could find they miss out on the netting benefits – as one execution desk manager observes, “Hedging securities trades individually, even in a fully-automated world, is a huge number of line items, that could stress systems.”
If a manager is to hedge on a more granular basis, then not only will automation be vitally important – probably critical – but their cross-market systems will have to be able to talk to each other. “To make this a reality, automation of the trading process is needed with very tight integration between the equity OMS, equity EMS, back-office confirmation of equity trade to then flow into the FX EMS,” observes Vikas Srivastava, chief revenue officer at Integral. “All this needs to happen very quickly and with no mistakes. Manual processes will not be able to handle this process and will lead to higher trade fails. The spectre of T+1 should be a wakeup call for market participants to work with their technology providers to install highly automated trading technology.
“Given the time pressure to deliver the infrastructure there are significant benefits of going with a cloud-based system which has a much faster time to market than in-house tech builds,” he adds.
Alex Knight, head of EMEA at Baton Systems, points out the change “is exposing some of the cracks in a system that has been adequate, but definitely sub-optimal, for many years.” Acknowledging managers will struggle with best execution, he sees an environment in which costs, inevitably, rise. It is not clear from the SIX survey whether those citing fears of higher costs included FX in their calculations, but there seems little doubt that for some, the increased cost could come from at least two directions.
“Much has been said of the potential for higher settlement risk in FX trades. Ultimately, liquidity and bilateral credit lines will be materially strained if firms are unable to meet the CLS cut-off window,” Knight suggests. “We know that technology – in the form of DLT – exists to support a long-term solution that allows for better intraday management of FX liquidity and credit lines, along with a reduction in settlement risk. However, there is an unfounded view among many that DLT-based solutions for PvP settlement and netting are years off, when in fact a solution powered by DLT is live and proven, operating in production at Tier 1 banks today for currencies both eligible and ineligible at CLS.
We are going to need some patience if we are to help solve this issue
“With today’s technology there really isn’t any justification for firms having no option but to experience the disadvantage of needing to settle gross and take on settlement risk simply because they submit the trade after midnight CET on value data,” he argues. “Proven solutions allow a full PvP settlement process, with netting, to be completed on demand and within minutes, enabling the settling parties to benefit from the instantaneous exchange of ownership, including for same-day settlement.”
Perhaps the biggest concern for the FX markets is that even in the core markets being traded, there are genuine worries over firms’ ability to cope – this will only be exacerbated in FX, a market many firms look at as part of the administrative, and not performance, process.
In a nightmare scenario, firms struggle to meet the changes in securities markets, prompting chaos there and what would likely be a severe reduction in activity, albeit for a relatively short period. If that happens, then the feed through to FX markets will also be reduced and major banks and liquidity providers could find desks dedicated to the asset manager community sitting around twiddling their thumbs metaphorically, waiting for trades that will not emerge.
“We are concerned that too many participants won’t be ready for the securities change, and that could feed through to FX,” warns the head of FX sales at a bank in London. “Even if CLS changes, there is no guarantee the trades will be calculated in sufficient time. I suspect we are going to need some patience if we are to help solve this issue – as banks we can handle the trades, and I think CLS will be able to do its bit – but this is a ‘lowest common denominator’ problem, success will only be achieved when all players are working effectively.”