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The shorter settlement cycle in the US and Canada is due to be implemented in less than six months time and market participants expect a significant jump in settlement failures.
The standard settlement cycle for most US broker-dealer transactions in securities will be reduced from two business days after a trade, T+2, to T+1 on 28 May 2024 in the US and on the previous day in Canada. The US Securities and Exchange Commission said the aim is to reduce latency, lower risk and promote efficiency and greater liquidity but it requires streamlined and efficient operational processes, presenting an opportunity to increase post-trade automation.
Virginie O’Shea, founder of consultancy Firebrand Research, said in an email to Markets Media that the majority of large and mid-tier sell-side firms and large asset managers active in the US and Canada have examined how a shortening of the timeframe for trade affirmation and confirmation will impact their current processes.
“Nearly everyone I’ve spoken to expects a significant jump in settlement failures and most don’t know how long it will take for those to normalize post-May,” she added. “There’s a lot of apprehension overall because the industry is only as efficient as its slowest counterparties and clients, and inefficiencies will equal more costs in such a tight timeframe.”
Jesús Benito, head domestic custody and trade repositories ops., securities services at SIX said in an email that the majority of the asset managers, 59%, cited a higher rate of settlement failures as a main consequence of the impending T+1 deadline according to the Swiss financial market infrastructure’s latest annual Future of Finance report. The survey of 343 C-suite executives at global financial institutions also found that nearly half of investment banks, 47%, see T+1 as an opportunity to automate processes, increase efficiency and reduce costs.
The move to same day affirmation is a big change, especially for clients outside America, and O’Shea has seen firms physically move teams due to the number of manual processes required in a short timeframe to deal with, for example, exceptions management and securities recalls.
“The DTCC testing has yet to kick into full gear with the majority of industry participants, so the start of the year will be hectic from a preparation standpoint,” said O’Shea. “Moreover, I haven’t even mentioned the asset servicing and securities lending impacts that need to be better addressed by the majority of industry participants - especially those on the buy side.”
DTCC, the US post-trade infrastructure provider, formally started its testing program for T+1 on 14 August 2023 so market participants can fully evaluate their end-to-end processes before implementation. Firms can participate in as many of the 21 bi-weekly testing cycles as they choose before testing is scheduled to finish on 31 May 2024.
Val Wotton, managing director and general manager, DTCC institutional trade processing, has warned that market participants should step up their preparations for T+1 and focus on areas such as trade allocation, confirmation, affirmation and leveraging best practices like a Match to Instruct workflow will help make T+1 achievable.
Wotton said in a statement: “With the SEC's 28 May 2024 deadline fast approaching, it’s time to finalize operational and technological enhancements and engage in end-to-end testing.”
James Pike, ex- EMEA client operations chief at Morgan Stanley and now head of business development at Taskize, a Euroclear company that aims to reduce manual interventions both within and between financial services firms, said in an email that brokers, custodian banks and asset managers cannot afford to be disconnected from one another between now and the deadline. Pike continued that brokers do not typically use custodians in the US market as they are direct participants of the DTCC, but custodian banks are incredibly important for asset managers.
“The issue is they do not know who the custodian bank is for every fund that they are trading with, which means they are unable to reach out directly to the custodian bank because they have no contractual relationships with them,” added Pike. “Ultimately, this is why there needs to be more seamless real-time dispute/problem resolution occurring between the three counterparties between now and May 2024.”
Pike also warned that if Europe does not replicate the US shift to T+1, the flow of investment will continue to move from the continent into US equities and the continent’s markets will lag even further behind the US.
The move to T+1 also has an impact on how firms will approach foreign exchange execution and settlement due to the amount of overseas investment in US securities. For example, 50% of Asian cross-border settlements are for North American securities in the institutional space, ahead of the 45% that remains within Asia according to a paper from consultancy The ValueExchange and Digital Asset. The paper said: “More institutional trades from Asia leave Asia than remain in the region.”
Steve Carlin, VP product management at AutoRek, which automates reconciliation and financial control processes, said in an email that the knock-on effect on FX presents a significant headache to any overseas fund manager with a significant percentage of their portfolio tied up in US stocks.
“Due to the shortening of the settlement cycle, the fund manager in question will have to carry out what would have been tomorrow’s currency conversion task today,” said Carlin.
In November 2023 The Foreign Exchange Professionals Association (FXPA) published a a framework of voluntary, non-binding recommendations in a paper, “Buy Side Guidance in Preparation for T+1 Settlement”, that was developed by the association’s T+1 settlement and buy-side working groups.
“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,” said FXPA. “Strategically, this may present an opportunity for firms to review the greater impact of an accelerating settlement cycle across asset classes.”
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