The longer it takes for a trade to settle, the greater the counterparty and market risk that transaction poses. For this reason, regulators in the US, Canada and India are shortening their trade settlement cycles from two days (T+2) to one day (T+1), a move which is expected to put pressure on asset owners and managers in the year ahead.
David Petiteville, Director, Regulatory Solutions, Product at RBC I&TS, shares his insights into the current status of the T+1 transition, and how it will impact institutional investors.
First India, the US and Canada, and now, the rest of the world
Whereas India slowly phased in a T+1 settlement cycle for listed blue chip securities in an ascending order based on their market capitalization, the US and Canada are opting for a big bang approach instead. The US Securities and Exchange Commission (SEC) has just confirmed that T+1 will be introduced for all listed equities on May 28, 2024,1 prompting Canada to announce the same.2 Given how interwoven Canada's market is with that of the US, few expected either country to deviate on T+1 timings.
Whereas India slowly phased in a T+1 settlement cycle, the US and Canada are opting for a big bang approach instead
“The majority of market participants would have preferred the US switch to T+1 to happen during the three-day Labour Day weekend for both US and Canada, but it remains essential that both markets align considering how interconnected they are” said Petiteville. The May deadline does pose challenges for Canada in particular, as the May date is not a long weekend in Canada and because the Canadian Depository for Securities (CDS), the country's central securities depository (CSD), is currently undertaking a major system upgrade and modernizing, which will take resources away from T+1 planning.3
Irrespective, given the tight deadlines, financial institutions are now accelerating their efforts to become T+1 compliant.
Other T+2 markets are also consulting on adopting T+1, including the UK, the EU, Switzerland, Mexico, Peru and some Asian countries. Implementation of T+1 could be less straightforward for certain markets versus others. “The EU is a challenging market for T+1 given the higher volume of fail trades, which is expected to come down thanks to the Central Securities Depositories Regulation (CSDR),” said Petiteville.
There are other impediments facing the EU too. In contrast to the US and Canada – which have one CSD each – there are over 30 CSDs in the EU-27, and this could complicate any eventual move to T+1. “Greater standardization in the EU will be needed if T+1 is to become reality,” he added. Similarly, the lack of a shared currency in the EU-27 versus Canada and the US is also a barrier to T+1.
T+1 could unlock plenty of opportunities
Asset owners and managers stand to benefit from wider T+1 adoption. Firstly, faster settlements will mean counterparties have less exposure to each other during the post-trade process, so their risk levels are much reduced. This will translate into efficiency gains because financial institutions – including asset managers and asset owners - will not need to post as much collateral (i.e. cash or high-grade government bonds) to central counterparty clearing houses (CCPs), facilitating cash optimization and deeper liquidity.
Eased margin rules
could save the
industry billions of
dollars each year
The Depository Trust & Clearing Corporation (DTCC), which is one of the architects pushing for T+1, estimates these eased margin rules could save the industry billions of dollars each year.4 The DTCC also adds that the “alignment of portfolio shares with mutual funds that currently settle at T+1 will help with cash management.”5
The T+1 transition will not be entirely plain sailing
Although T+1 could help mitigate some risks, its implementation will likely create complications elsewhere.
“FX transactions traditionally settle on a T+2 basis. For international participants wanting to buy US securities, prefunding the transaction with USD or arranging for a short-dated T+1 FX settlement will be required. The effect of prefunding could potentially impact other investments, as investors need to sell a day earlier to have the USD available, resulting in an investment manager (being) out of the market for one day,” according to S&P Global.6
Investors operating in distant time zones to the US (i.e. Singapore, Hong Kong, Sydney, etc.) will be the ones most affected in this instance.
Settlement fails
could also increase
under T+1
S&P Global continued that other activities - including securities lending and corporate actions - could face disruption because of the T+1 transition. “Settlement fails could also increase under T+1 due to the time constraints being imposed on post-trade processing. Additionally, the move to T+1 means there will be a global settlement mismatch, as a number of markets are sticking with T+2 for the moment,” said Petiteville.
Although T+1’s introduction will throw up various problems, they are not insurmountable. “These changes will require the industry as a whole to embrace straight-through-processing (STP) and better automation, generating efficiencies in the medium to long term. The use of more modern systems and processes in a T+1 environment should be welcomed,” commented Petiteville.
Waiting for T+0 to arrive
The SEC has made it no secret that it eventually wants US equities to settle on an end-of-day basis, otherwise known as T+0. Petiteville said the industry is still digesting the implications of T+1, adding that discussions about moving to T+0 are premature at this time.
“To achieve T+0, financial institutions would need to invest heavily in new technologies, such as distributed ledger technology (DLT). Any move to T+0 would pose more challenges to the industry than T+1,” highlighted Petiteville.
