The Securities and Exchange Commission’s target of reducing the US settlement cycle by 28 May 2024 has caused concerns for overseas investors that it will lead to increased trade failures and higher costs, leading to less liquidity.
The standard settlement cycle for most US broker-dealer transactions in securities will be reduced from two business days after a trade, T+2, by one day to T+1. In February this year the SEC set an implementation of 28 May 2024 for the move, which is earlier than anticipated. The regulator said the change will reduce latency, lower risk, promote efficiency and greater liquidity in the markets.
Market participants at the FIX EMEA Trading Conference in London on 9 March said the deadline of May had “caught everyone on the hop.” As a result there is little time to implement new technology and tactical patches are likely to be required to be put in place.
Although the move seems like a change for US markets, there are extraterritorial implications. Overseas investors own global baskets of ETFs which include US components, with for example, wo-thirds of the MSCI World Index being made up of US stocks.
In addition, approximately 40% of investment in US markets comes from overseas investors. Trades will fail if any errors are not resolved on the day of the tradeDue to time zone differences. As a result buy-side firms may need to build up their US operational teams or outsource settlement functions, which will be difficult for smaller asset managers.
Investors whose base currency is not the US dollar will also need to carry out foreign exchange transactions, so there are funding concerns if the settlement cycle is shortened. Funding trades also present a potential regulatory risk as European UCITS funds have constraints on the level of cash they are allowed to hold. Therefore, it may not be possible to settle US trades without breaching regulations. There are similar issues with UCITS mutual funds.
One panellist said: “The SEC believes no man should be left behind – as long as they are American.”
Custodians may fund shortfalls for larger asset managers to allow trades to settle, but smaller buy-side firms are unlikely to be offered the same facility, which could lead to liquidity challenges.
One fund manager said: “The buy side is allergic to paying costs but maybe the tide will turn. Either costs will be shared or there will be massive consolidation.”
FIX has a T+1 working group to discuss the many interconnected parts of the market that will be impacted. For example, if managers become less willing to lend securities because they are worried about getting them back in time, this could result in a liquidity crunch, wider spreads and increased costs for end investors. Therefore the working group is looking at how to electronify workflow in this part of the market.
The demand for data harmonization has increased in order to effectively implement T+1. FIX will focus on open data standards in order to reduce the cost of implementation for the industry. For example, FIX already owns the Market Model Typology (MMT).
FIX will also liaise with other trade associations whose role it will be to raise the issue of funding challenges for overseas investors with the SEC.