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Capital markets across the globe are gearing up for a seismic change in the post-trade settlement period, as the United States transitions to a shortened ‘T+1’ securities trading settlement period. The new settlement period will become effective on 28 May 2024. ‘T+1’ trade settlement means that securities trading settlements must be completed within one day of the transaction date. All financial firms who participate in or facilitate the trading of US-listed securities, irrespective of global location, must comply with this accelerated trade settlement rule when it goes live. This poses significant financial and structural challenges for in-scope financial firms. In this article GreySpark Partners describes what firms need to consider as this deadline draws closer.

By GreySpark’s Elliott Playle, Research Analyst and Rachel Lindstrom, Senior Manager

The switch to T+1 trade settlement in the US is the culmination of progressive post-trade structural transformations that have been in play since the last decade of the twentieth century, and which were necessitated by the increasingly dynamic and technologically advanced capital markets landscape. Before the era of electronic trading, when physical stock certificates were delivered by mail, the Securities and Exchange Commission (SEC) allowed five business days for securities transactions to settle. Five days became three in 1993 as electronic trading started to gain traction which facilitated greater trading efficiencies and opportunities for quicker settlement. In 2017, the SEC further shortened the US trade settlement period to two days (T+2), which has remained in force since.

The new rule stipulates that all broker-dealer transactions of US securities that settle through the Depository Trust Company (DTC) globally must be settled between counterparties within one day of the transaction taking place. These counterparties could include domestic and international financial firms, such as investment managers, custodians and broker-dealers. The US securities in scope for the new trade settlement period include equities, corporate bonds, ADRs, unit investment trusts, mutual funds, exchange-traded funds, equity options and private-label mortgage-backed securities.

While the move to T+1 trade settlement in the US has been a long time coming, its implementation has been spurred by two watershed moments – the increased market volatility at the outbreak of the Covid pandemic in 2020, and the surging interest in meme stocks such as GameStop, which infamously saw a community of retail traders squeeze hedge funds out of their GameStop short positions in 2021, undermining market confidence. Collectively, both incidents exposed investors to counterparty risks that US policy makers believed could be reduced by shortening the securities trading settlement period.

Benefits of T+1 Trade Settlement

A shortened securities trading settlement period means market participants are exposed to that credit risk for a shorter duration (see Figure 1). Each day that a purchaser of a security owes the seller money, the seller is exposed to the credit risk of the purchaser. During volatile market periods, this risk is exacerbated, which increases the likelihood of default. A shortening of the settlement cycle would expose the seller to the credit risk of the purchaser for a shorter period. Shortening the duration to which firms are subject to credit risk would mean that there is a reduction in the total margin required to cover potential losses. This would leave firms with more capital at their disposal, improving capital allocation and efficiency, while also increasing market liquidity. According to a recent report, the move to T+1 by the US has the potential both to reduce margin requirements by roughly 25% for US equity market participants, and to enable investors to gain access to their funds more quickly following a trade.

Figure 1: Trade Settlement Period with a) T+2 Settlement and b) T+1 Settlement for US Counterparties in Eastern Standard Time (EST)
Source: GreySpark Partners

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A shorter trade settlement period is likely to encourage market participants to automate and modernise workflows, as they will be left with little choice but to transition away from cumbersome legacy technology stacks and move towards slicker, more efficient trading infrastructures and workflows. T+1 settlement readiness requires firms to break down siloed data walls to consolidate data, applications and processes. T+1 could lead to more efficient capital and technology utilisation and drive down costs in the long run.

Foreseen Impacts on the Buyside, Sellside and Financial Technology Vendors

The prospect of a shorter trade settlement period in the US is causing both excitement and apprehension for in-scope firms. With the EU and UK jurisdictions still operating on T+2 trade settlement, there is some concern that the new US T+1 settlement period will create misalignment across the world’s most critical capital markets. There are already differences in settlement periods across various regulatory jurisdictions, however. China, Hong Kong and Singapore operate using a T+0, T+2 and T+2 settlement timeline, respectively, and Latin American (LatAm) markets predominantly use a T+2 settlement period.

The new US trade settlement period is set to have a huge impact on global capital markets, with banks, buyside firms, vendors and counterparties in the US and abroad affected. One impact felt by all in-scope firms is the significant overhaul required of existing technology infrastructure, potentially incurring high up-front costs. According to a recent report, the T+1 transition could cost a financial firm engaging in the trading or custody of US equities between USD 6 and USD 10 million over the coming years. In-depth reviews of technology infrastructure are likely to be necessary in order to identify gaps and inefficiencies. All aspects of the trade life cycle, including communications, connectivity, execution, operations, settlement, clearing and reconciliation will need to be re-optimised in light of the transition. Many firms are likely to embrace automation to achieve this objective. The use of APIs and cloud technologies to facilitate straight-through processing and reduce reliance on manual trade management workflows and legacy infrastructures is a likely outcome. Infrastructure must be resilient enough to withstand the processing of high transaction volumes in a compressed settlement period, yet still maintain operational integrity and security. Granular monitoring will be needed to iron out issues in the new architectures.

The technological impact of T+1 will inevitably vary from firm to firm. Larger firms may already have compliant infrastructure in place and, if not, they will have the funds to adopt automated technologies from third-party vendors. Firms may need to start preparing for system replacements if their existing technology is unable to support the new settlement deadlines. Contractual obligations with existing vendors will place time constraints that may need to be considered, however. Smaller firms with tighter budgets may have to make budget cuts to finance the technology expenditure that is required to facilitate the firm’s compliance.

Generally speaking, buyside firms’ technology will need to become nimbler and operate closer to real time. For example, due to T+1, the buyside will need technology that supplies prime brokers with real-time trade details as trades are matched between the buyside firm and executing broker. Typically, buyside firms deliver trade data to executing brokers and prime brokers separately in order to outline any data discrepancies between them ahead of trade confirmation. Sellside firms will require something close to a real-time view of cash flows and inventories across the organisation. According to one vendor working in this space, most firms currently do not have a holistic, real-time overview of their inventories, with positions spread between multiple Depository Trust & Clearing Corporation (DTCC) accounts across multiple business lines and jurisdictions. From a vendor perspective, the new settlement period could provide fresh opportunities for business with buyside and sellside clients, as they seek to embrace automation and efficiencies in order to streamline trade flows. However, it may also require self-evaluation and refinement of service offerings to ensure they are fit for T+1 trade settlement in the US. Failure to bring appropriately enhanced trading platforms to meet these new requirements could lead to loss of business for vendors at the end of their contracts.

Figure 2: The Impact of T+1 Settlement on Buyside Firms
Source: GreySpark analysis

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The adjustment to the T+1 settlement period is not only an upheaval facing post-trade divisions in firms, but rather, one facing the entire firm. Critical business areas, ranging from front-office trading desks to accounting and reconciliations teams, will have to increase the speed at which they undertake their responsibilities. The back office will need to define a process whereby they can more swiftly update and manage account information for the front office. Some middle office teams will have to re-paper client agreements. Given the increased time pressure, and high workload, errors could be made, especially if personnel do not have sufficient skills to use the new technologies. Generally, the shift to T+1 settlement will require financial firms to institute a new culture, wherein there is an appreciation for automation, and a reluctance to continue inefficient activities. Softer skills such as cross-department education and communication will be of paramount importance.

The impact felt by financial firms of the new settlement period depends on the size and location of their core business. Smaller financial firms may find the reduced settlement period harder to deal with than larger financial firms. Smaller firms with less staff will struggle more than their larger counterparts to absorb the pressures resulting from the shorter settlement period, and smaller firms may find both the initial costs and the resourcing and training needed for the new technologies challenging to meet. Indeed, it may be necessary for headcounts at small firms to be increased as they take on automating technologies.

International Implications of the US T+1 Settlement Rules

Intuitively, one could imagine that moving from T+2 to T+1 settlement might halve the post-trade settlement time, but this is not necessarily the case when it comes to cross-regional trading. Due to time zone constraints, European/UK firms’ settlement window will reduce by far more after the switch to US T+1 settlement, as Figure 3 shows.

Figure 3: The Impact of T+1 Settlement on Cross Regional Trading
Source: GreySpark analysis

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As shown in Figure 3, a halving of the US settlement period will reduce the time a European/UK buyside firm has to submit allocations by a greater amount than a firm in the US (US buyside from 26 to 9.5 hours – a reduction of 63%, European/UK buyside from 32.5 to 16 hours – a reduction of 51% ) This constriction of the available time for allocations will inevitably heap pressure on post-trade divisions and, in particular, leave less time to source and execute corresponding foreign exchange (FX) transactions. Essentially, the window after market close on the trade date will take on greater importance. Cash management processes will also have to be compressed into a shorter period to ensure that correct funding is in place for settlement. Collectively, these issues could lead to more processing errors and settlement fails.

The T+1 settlement period in the US may also lead to an indeterminate period of higher-than-average settlement failures and, as a consequence, increased costs. More settlement failures could lead to a contagion of counterparty risk spreading through the capital markets ecosystem – for example, if a participant is expected to receive securities or cash on a particular date and does not because of a counterparty failing to settle, then there is a risk that the affected party will be unable to meet their own obligations with other counterparties on the same date. To mitigate the increased risk of settlement failure, additional operational expenses to support overnight funding may be required. Settlement failures may be especially acute and complex for pooled investments, such as overseas-listed funds (from a US perspective) containing US equity or bonds, which settle on a T+2 basis. These trades will now have to settle on a T+1 basis, increasing the complexity of the settlement process.

Paradoxically, the reduced T+1 settlement period in the US could actually lead to capital markets facing more short-term risk, rather than less risk as intended, because of the strain this complexity and time pressure puts on technology and business processes. The difference in time zones between the US and APAC means that operations teams there only have a one- or two-hour window to process trades, which likely has to take place during market hours and not after close of business (see Figure 5). In effect, areas such as Australia and New Zealand must settle on T+0. Trades on a Friday will pose a particular challenge to APAC firms because they will need to complete post-trade processing on a Saturday unless they can pass the work to colleagues in a different time zone. In this scenario, investors face the possibility of settlement failures and huge backlogs of trade settlements that may disrupt operations.

Figure 4: The APAC Advantage When Trading US Securities After 2pm (Tokyo time)
Source: GreySpark analysis

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Under the current T+2 settlement period, APAC firms dealing in US securities at 2pm in Tokyo have 35.5 hours to allocate and affirm trades before the deadline because the start of the trade date in New York is at 2pm in Tokyo. Under the new T+1 settlement period, APAC firms trading during their market open but after 2pm will have up to 21 hours to allocate and affirm trades before the new deadlines. However, this shortened time allowance for allocation and affirmation falls largely during the night for APAC firms, effectively meaning they will have to perform same-day affirmation and allocations. This will inevitably put huge pressure on settlement teams in APAC firms. As such, they are likely to need to relocate processes and staff or modify working hours in order to adjust to the US T+1 settlement period.

Figure 5: The APAC Disadvantage When Trading US Securities Before 2pm (Tokyo time)
Source: GreySpark analysis

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GreySpark observes a disadvantage for APAC firms trading in US securities before 2pm Japan Standard Time (JST) because this effectively shifts T+0 a calendar day earlier. For example, trading at 10am JST would cause a firm to miss the 7pm allocations deadline in the US by one hour, because this falls at 8pm EST. As such, APAC firms may refrain from trading in US securities before 2pm JST. Trading after 2pm coincides with the start of the trading date in the US, outlined above, giving APAC firms up to 21 hours to allocate and affirm trades. 

The T+1 settlement period also creates a significant FX issue for APAC investment firms. Many firms are concerned about receiving unfavourable FX rates from their agent banks, especially when the base currency is weaker than the US dollar. Time constraints could mean that there is not enough time to shop around for the best deal or to interact with US-based counterparties. Following the US T+1 transition, APAC firms will effectively face immediate settlement failure if an FX mistake is made. This could leave them with little option but to outsource their FX business to a custodian bank, or alternatively, to pre-fund FX transactions.

Preparing for US T+1 Settlement

Financial firms making the transition to the US T+1 trade settlement period should consider several factors ahead of the May 2024 implementation date. With the deadline only four months away, time is of the essence. Figure 6 shows key points that GreySpark believes financial firms should consider.

Figure 6: Considerations for Firms in Preparation for US T+1 Trade Settlement 
Source: GreySpark analysis

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The Importance of Adequately Preparing for T+1 Trade Settlement in US

Failure to meet the new US T+1 trade settlement requirements could have significant financial and reputational implications for in-scope firms. These include higher costs resulting from trade inefficiencies, heightened interdependency risks and breakdown in client relationships. Ultimately, not meeting the T+1 settlement requirements could leave firms at risk of being cut adrift from a critical financial market, as clients will take their business to other parties that can settle their transactions more efficiently. Additionally, not performing relevant system upgrades that US T+1 trade settlement requires may leave firms at a competitive disadvantage to those employing cutting-edge, automated technologies. 

The new T+1 trade settlement period in the US promises to bring a heady mix of excitement, confusion and uncertainty. It presents a huge opportunity for financial firms to streamline and rejuvenate their workflows and create a more efficient trading ecosystem. Equally, though, it is likely to bring teething problems that will include operational difficulties and bottlenecks if the transition process is not executed correctly, which could have negative financial and reputational consequences. Given the encroaching deadline, it is critical that in-scope firms prepare for the inevitable financial, technological and operational impact.