As the North American T+1 settlement deadlines fast approach – 28th May 2024 for all US securities settled through DTC and 27th May for Canadian securities – the industry has been ramping up in preparation. And although the shorter settlement cycle promises to increase settlement efficiency, improve liquidity, decrease counterparty risk and reduce overall trading costs, for many market participants the shift has required significant – and costly – adjustments to their post-trade systems and processes.Despite this disruption however, the general consensus is that the industry – for the most part – is now well-prepared for the transition. Certainly for the bigger US-domiciled firms, the major decisions have now largely been made and the appropriate actions taken; where changes to systems or processes have been required, they are either in progress or have been completed. Several firms in fact, confident in their current state of readiness, have now imposed a freeze on further system changes until the end of May, aiming to get through T+1 successfully, ensuring the majority of trades are allocated, confirmed, affirmed and settled within the necessary timeframe, and then refining additional processes gradually after this initial phase.
This is a topic that will be discussed in-depth at A-Team Group’s upcoming TradingTech Summit in London on February 29th, with experts including:
- Peter Tomlinson, Director, Head of Post Trade, AFME (Moderator)
- Linda Gibson, Head of Regulatory Change, BNY Mellon | Pershing
- Sachin Mohindra, Executive Director, Client & Market Solutions, Goldman Sachs
- Emma Johnson, Executive Director, Securities Services Global Custody Industry Development, JP Morgan
- Matt Johnson, Director, ITP Product Management and Industry Relations, DTCC
It’s free for financial institutions to attend so do be sure to book your place as it’s filling up fast.
Closing the gaps
“Although the industry generally completes major projects successfully, with firms making the required changes even at the expense of other priorities, the main worry is not about hitting deadlines,” says Robert Cioffi, Global Head of Equities Product Management at ION Markets, the trading, analytics, and risk management solutions vendor. “Rather, it’s the anticipated disruptions and the number of exceptions that could emerge that pose a significant concern.”
While the larger Tier 1 and 2 sell side firms seem to have their T+1 ducks in a row, can the same be said of smaller firms, particularly on the buy side. “Attention often centres on the average broker and bank, yet it’s crucial to consider the outliers, especially the smaller entities,” says David Pearson, Product Manager at post-trade processing provider Torstone Technology. “Contrary to what one might expect, it’s not the large institutions but the smaller players who face challenges. Firms such as small family offices and single fund managers often lack the IT infrastructure to handle electronic allocations, relying instead on email communication. Size should not dictate performance in this context. Both large and small firms are required to manage their allocations efficiently, as failure to do so could result in fines or penalties.”
Although core settlement process will remain largely unchanged under T+1, the pace at which tasks need to be completed will accelerate dramatically. This means that operations teams tasked with diagnosing and rectifying trade failures will need to rapidly review and analyse trade data to identify the root causes of such failures. “Many challenges that people will face will be around resolving trade exceptions,” says Vijay Mayadas, President of Capital Markets at Broadridge Financial Solutions. “Operations analysts often spend much of their day correlating different data sets to diagnose the cause of a trade failure and determine the appropriate remediation. This analysis is typically done using spreadsheets, where trade failures are examined individually to identify issues.”
“It’s the small gaps between systems such as post-trade processing platforms, order management systems and execution management tools that tend to result in the majority of operational challenges,” adds John Joseph, Head of North American Sales Engineering at Xceptor, the data automation platform provider. “These seemingly minor disconnects, which might only represent about 20% of the post-trade environment, can cause up to 80% of the difficulties within a firm. Therefore, it’s critical to closely examine these gaps and to focus on automating this 20% to achieve better Straight Through Processing (STP).”
The importance of intraday allocations
Key to achieving T+1 settlement success is the need to process allocations, confirmations and affirmations on a timely basis. Under the new regime, this should all be completed by the DTC cut-off time of 9:00 PM ET on the trade date itself. However, according to a recent DTCC report, as of December 2023, only 69% of all trades were affirmed by this cut-off time, meaning that there is still work to do.
“At DTCC, we’ve seen a buy-side trend where significant portions of allocations are being submitted after the U.S. close and concentrated in a 2-hour window,” says Val Wotton, Managing Director and General Manager of DTCC Institutional Trade Processing. “The new compressed timeframe will result in a very small window of time to handle and resolve trade exceptions. It is therefore recommended, wherever feasible, that firms move to an intraday allocation model, as they have done historically, for a smoother transition to T+1 settlement.”
Automating these processes as much as possible, so that transactions are matched and agreed upon on the day of the trade, will give firms a much better likelihood of settling within the accelerated T+1 timeframe. However, not all firms are geared up for this, says Xceptor’s John Joseph. “Some operations teams will find themselves struggling, particularly where they aren’t sending their allocations intraday – either in real time or near real time – instead, choosing to wait until the end of the day to finalise their allocations,” he says. “This approach creates a bottleneck because the information needs to be sent to prime brokers, custodians, administrators and dealers. And in situations involving multi-custodian or multi-prime allocations, there’s even more urgency to send those allocations, and broker dealers need to be equipped to receive these allocations and process them without delay.”
Wotton explains how DTCC’s Central Trade Matching (CTM) platform and Match to Instruct (M2i) workflow helps automate post-trade processes to enable firms to meet the necessary deadlines. “DTCC’s CTM provides seamless automated connectivity from trade execution to settlement, enabling accelerated settlement,” he says. “Once a trade has been matched between an investment manager and executing broker, CTM will send status updates to both counterparties. If no match is found for a trade, an exception occurs, in which case each counterparty is automatically updated on a change in the trade status and given the possibility to amend the trade. This allows counterparties to catch trade exceptions prior to settlement, saving valuable time – critical in a T+1 environment.”
He continues: “CTM also provides a Match to Instruct (M2i) workflow which automatically triggers trade affirmation and the delivery of instructions for DTC-eligible securities directly to the DTC for settlement when a trade match occurs between an investment manager and executing broker. This level of post trade automation maximises the chances of hitting DTC’s 9:00 pm trade-date cut-off for T+1.”
Exception handling and the power of AI
Cioffi suggests that one aspect that has yet to receive widespread attention is the handling of exceptions. “Currently, issues can be resolved within a T+2 timeframe, but the question arises: what happens if trades cannot be sorted out in time under the new schedule. This could lead to significant operational challenges. It’s an area to monitor closely, particularly as firms may face fines for delayed processing, although that will likely expedite the resolution of such problems.
“This situation could also drive changes within the industry,” he continues. “Clearing firms with superior technology and exception handling capabilities may gain an edge over those that struggle in this area. Consequently, buy-side firms, in their duty to their clients, might demand further changes from the clearing firms to meet their obligations effectively.”
One area of technology that is generating interest in this regard is AI, particularly the use of Large Language Models (LLMs) such as GPT. “The introduction of a chat-based interface, powered by a GPT model that interprets chats and translates them into queries across various databases, holds great promise for enhancing productivity,” says Mayadas. “This technology allows operations personnel to use a simple language-based chat interface to navigate complex and diverse trade databases. It aids in identifying the reasons for trade failures and suggests remediation strategies. What’s particularly interesting is the ability of these models to engage in deeper reasoning, assisting users in the thought process required to resolve an exception. Over time, these models can also be trained to guide analysts on which questions to ask next, the top remediation actions to take, and strategies to prevent future occurrences.”
Another advantage of GPT-type technologies is their inherent multilingual capabilities, says Mayadas. “Complex queries can be translated into multiple languages and back again, retaining the original meaning. This feature is likely to be incredibly beneficial for firms in the Asia-Pacific region trading in U.S. markets, where the time constraints are even more acute when dealing with exceptions in a T+1 environment,” he says.
For overseas firms, automation is particularly important, says Wotton. “For firms operating outside the U.S. time zone and conducting cross-border transactions with a requirement to settle U.S. securities, there is a greater need to implement post-trade automation as T+1 will compress the settlement window available to them,” he says. “Firms impacted by the move to T+1 based outside the U.S. should also be aware of post-trade processes which are unique to the U.S., such as trade affirmation which enables institutions to affirm broker confirmations. Here, the executing broker submits a trade confirmation, with either the investment manager or its custodian affirming the trade. Within the T+1 settlement cycle, this process will need to be completed by 9pm ET.”
What of ETFs?
The shift to T+1 settlement is also expected to significantly affect the global ETF market, because of the risk of settlement mismatches stemming from timing differences between the settlement of ETF shares and their underlying assets, as well as between primary and secondary markets. Some observers believe these variances in settlement timings could lead to both a rise in failed trades and to wider trading spreads in the secondary markets.
“The ETF landscape presents an interesting dynamic,” says Jeff O’Connor, Head of Market Structure at Liquidnet, the technology-driven agency execution specialist. “The market for ETFs, now almost seven trillion dollars in assets under management, continues to expand at a record pace. ETF trades often vary in structure across different regions, particularly in settlement procedures and currency market components, which might trade and settle in T+2. So challenges arise when a currency translation is required. Although I believe the industry will eventually adapt, ETFs that have both domestic and international exposure may initially face uncertainties in settling under the new regulations. And given the substantial size of the ETF market, it may be necessary for regulators to re-evaluate their approach to these types of assets.”
New opportunities for tech vendors
So what are the key takeaways, given that there are now less than four months to go before T+1 goes live.
“There’s no room for manual allocations anymore, and reliance on outdated methods could lead to significant financial repercussions,” says O’Connor. “My advice is for asset managers to maintain constant communication with their broker-dealers and to have a comprehensive understanding of the entire process, from clearing to custodial services. While it appears that larger asset managers are well-prepared for these changes, there is a concern regarding the readiness of smaller and even mid-sized managers, who may not yet be fully equipped to handle these requirements.”
Will brokers stop dealing with clients who fail to adopt electronic processing. And might this open up a market for technology providers who can offer affordable solutions. Torstone’s Pearson thinks so. “If brokers are penalised due to their clients’ inability to handle these processes, they may eventually refuse to execute transactions for them,” he says. “The cost of adopting necessary technology can be daunting and prohibitive for these smaller entities, and it remains uncertain whether all small family offices and asset managers fully recognise the need to transition towards some form of electronic processing. However, the electronification of this workflow is critical. This situation presents a significant opportunity for technology providers, particularly those who can offer managed services at a lower cost point to accommodate these firms.”
Come and join us at the TradingTech Summit to hear from Pershing, Goldman Sachs, JP Morgan and the DTCC about how to modernise your front to back trading workflow in preparation for the SEC’s T+1 settlement.
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