By Sandeep Sabnani, Head of Equities Product Strategy and Growth at ION Markets.
The shift to T+1 settlement over the past few years has occupied the minds of front office and trading desks across equity markets globally. Earlier this year, India became the first major economy to fully introduce T+1, following a phased approach, while the EU’s capital markets regulator ESMA in October called for feedback on a potential move to T+1 in the region.
With results emerging from industry testing in the US ahead of next year’s implementation date there, market participants appear to agree that the move to T+1 should prove to be as frictionless as T+2. But as equities trading has become more complex in recent decades under increased regulatory scrutiny and rulemaking, is the industry underestimating the impact of the shift to T+1?
The evolution of T+1
The 1989 stock market crash set in motion the process of settlement-cycle shortening that has culminated in the proposed T+1 regime. Moving from the current standard of two business days (T+2) to one is intended to further reduce multiple risks, from the amount of open exposure over the settlement period to potential counterparty, market, and credit risk.
However, the playbook applied for previous settlement window reductions will not necessarily apply for T+1. Throwing manpower at functions that require manual execution is no longer enough given many buy-side firms will be unable do so in the required window. Internal processes must become faster and more efficient to allow for next-day settlement, which means investment in automation will be key to an effective transition.
From exceptions to global currency implications
Questions are arising around what happens when a trade doesn’t settle on time and whether this will lead to more firms being penalised. Settlement fails will ultimately increase the cost of trading and impact trading desk profitability. This is especially true for firms that use legacy systems, which will struggle to cope with the increased settlement volumes in a T+1 environment.
Originating firms who want to liquidate positions to buy others will likely need an extended T+1 cycle, resulting in penalties. These will likely have to be priced in by trading desks and communicated to the originating firms, leading to more pre-trade communication.
And how will the institutions interact with their clearing providers when settlement exceptions occur? This is particularly pertinent in trades that settle in a different currency than the trading currency and which traditionally have longer application times.
For international investors, completing settlement within a single working day puts additional pressure on back-office processes, particularly for teams working across multiple time zones. Traders will need to work closely with the operations teams to ensure the accuracy of trade data, and therefore data mismatches and fat-finger errors will need to be caught with a high degree of precision.
The move has implications for stakeholders in Europe, with brokers concerned the move to T+1 in the US could force flows away from European trading hours, making cross-currency transactions more difficult. There will inevitably be a shorter window in which to finalize currency exchange trades for customer accounts that only hold local currency but trade in USD. There are also challenges of trading ETFs in a T+1 environment where the ETFs are composed of international stocks, some of which may continue to clear at T+2.
Finally, there will likely be an increase in complexity for traders managing cash positions to ensure their clients don’t overdraw or build up excessive cash where there are multiple settlement environments involved (i.e., T+1 and T+2).
Moving towards instant settlement
Increased use of automation for back-office processes will be key to managing the T+1 transition effectively, as well as towards T+0 in the future. From trading itself, through to confirmation and reconciliation, manual processes need to be identified and automated to free up time and resources for tasks that require a personal touch – particularly where customers are concerned.
Faster settlement also requires different systems to work together effectively to achieve true interoperability. For example, counterparty trading platforms need to interface seamlessly with central clearing systems. In fact, all post-trade (middle office and back office) interfaces must be adjusted to achieve true straight-through processing (STP) from execution to settlement.
Market institutions are working to deliver the efficiencies required to achieve seamless T+1 settlement. The US Depository Trust & Clearing Corporation (DTCC), for instance, has introduced a new ‘match to instruct’ (M2i) workflow. This enables automatic trade affirmation for member counterparties and accelerates their post-trade processes. Such collaboration between firms, institutions and vendors can smoothen the path towards same-day settlement.
To avoid underestimating the impact of the T+1 shift, it is critical that organisations educate as early as possible of the potential challenges. This will allow them to plan and manage an orderly transition to the new status quo to minimise downtime and potential regulatory infractions.
Given the trend towards efficiency and the need to “do more with less”, technology providers have been delivering solutions that provide greater automation to operations, including post-trade processing. In most cases, streamlining and automating internal workflows will go a long way in addressing the upcoming challenges.
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