By Vikas Srivastava, Chief Revenue Officer, Integral.
Tick-tock tick-tock, the clock is ticking down to one of the most pivotal moments in financial markets this decade. This coming May will mark the transition to T+1 settlement for equities and bonds transactions in North America. To add to the complexities, CLS confirmed last week it will not make any change to the FX settlement cut-off time. The rationale is logical – this would require a comprehensive risk assessment supported by detailed modelling and analysis, and it is not their responsibility to fix the problems that have been inadvertently caused in FX by the changes to market structure in securities. However, we are back to square one on the challenge of safely settling FX in line with T+1. With only seven weeks to go, this is set to have a significant impact on the operating models of financial institutions all over the world.
In the wake of recent market readiness reports, there is quite a lot of work to be done before May. According to data from Bloomberg Intelligence (BI), it is estimated the upcoming US transition to T+1 settlement could cost the industry over US$31bn a year. Moreover, the European Fund and Asset Management Association (EFAMA) sounded the alarm last month, urging global regulators to confront the looming impacts on FX settlement risk specifically. According to EFAMA, it is estimated 40% of daily FX flows will no longer be able to settle through the CLS platform. This transition, more than halving the current settlement cycle, will demand rapid adjustments from market participants. And one of the biggest risk and cost contributors – aside from an increase in settlement failures – is the heightened costs associated with the FX side of the trades.
For market participants, how FX trades are conducted to source the required US dollars to purchase US securities is a key consideration. Firms will be up against it under T+1 to confirm their equity trades and then execute the FX trade required to source dollars for equity settlement. The burden does largely fall on asset managers buying the US equities. But with this burden comes an opportunity for banks to play a greater supporting role for their asset management clients.The answer on both sides must be greater automation. It is essential there is tighter integration between equity and FX trading systems, with seamless data flow and minimal manual intervention to survive the shorter settlement window.
As an example of how this could work in practice, take the case of a UK investment manager buying a US stock. With automated buy-side systems, as soon as the stock trade is confirmed, FX OEMS will be notified of the exact US dollars to buy to pay for that stock purchase. The investment manager’s relationship banks can deliver their FX price discovery and execution services via APIs seamlessly embedded into the buy-side FX execution system, resulting in automated best execution of currency trades. For asset managers, the priority needs to be building up their automation capabilities. Relying on manual intervention increases the risk of mistakes, meaning a firm is unlikely to complete each part of the workflow in the shorter timeframe. Nothing changes in terms of how a trade settles, it is simply that firms have a much shorter amount of time to play with. However, there are current gaps on the buyside when it comes to having automated processes in place to be able to do their execution electronically. This is why the focus needs to be on implementing the right tech to do this.
While it is hard to think about winners at this stage, the firms who come out on top will be those who implement cloud-based technology to act as a bridge between buy and sell-side firms. With only two months to go, the EFAMA findings should really act as a wake-up call for the market. This is the latest piece of evidence pointing to the very real challenges for FX settlement posed by T+1, and the seeming lack of solutions to resolve the conundrum. Those that don’t prioritize this will find themselves faced with a very sticky situation this coming May.
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