Summary
When stock exchanges were first established, the typical trade settlement period was 14 days. It wasn’t until the 1970s that required settlement times began shrinking, first dropping to 7 days, then 5 and then to 3 days till 1990s, then it lowered to 2 days in 2017. Now moving to T+1 involves reduction in risk, strengthen and modernizing securities settlement in the U.S. financial markets.
The move to T+1 settlement for US financial markets is a significant improvement over the current settlement system, bringing about reduced risk whilst also strengthening and modernizing securities settlement. This change, initiated under leadership of the Securities Industry and Financial Markets Association (SIFMA), the Investment Company Institute (ICI), and The Depository Trust & Clearing Corporation (DTCC), will likely start in the first half of 2024. The SEC has proposed an implementation date for T+1 of Q3,2024.
And there are costs associated with moving to T+1. The SEC has estimated that the change will cost the industry $3.5 billion to $4.95 billion to implement and it further estimates compliance costs of $5.5 million per institution.
The Depository Trust and Clearing Corporation (DTCC) estimates that a move to T+1 could reduce the $13.4 billion held by its members on average in margin each day by 41%
Following the February 2021 DTCC white paper outlining the need and timeline for moving to T+1, the U.S. financial services industry formed an Industry Steering Committee (ISC) and an Industry Working Group (IWG) with the intent of developing consensus for an accelerated settlement cycle transition; this was driven by a need to understand the impacts, evaluate the potential risks, and develop an implementation approach.
Primary Benefits:
- Compressing the settlement cycle to T+1 will demand that operational risk is mitigated as existing systems need to be able to support real-time processes due to time limitations. Batch processing simply won’t work. The use of application programming interfaces (APIs) will be crucial to enable data access and sharing in real time to resolve and understand any exceptions.
- Reduction of risk, particularly during periods of high volume and volatility: As both the volume of unsettled trades and the time between trade and settlement falls, there will be a reduction in systemic, counterparty, and operational risk across the settlement ecosystem, particularly in periods of market volatility. Furthermore, T+1 settlement preserves the benefits of settlement netting at the NSCC, thereby significantly reducing the volume of securities and currency required to be moved across markets on any given trading day.
- Reduction in liquidity requirements: With firms’ market and counterparty risk during the settlement period reduced, NSCC members will face lower margin requirements. This reduction will allow broker-dealers to better manage their capital and liquidity risks and better utilize their available capital. For investment funds, T+1 will align the settlement cycle of U.S. mutual fund shares with the portfolio securities settlement cycle, thus improving cash and liquidity management.
- Capital and operational efficiencies: Capital and operational efficiencies can be grouped into three categories: infrastructure modernization, standardization of industry processes and reduction in costs.
- Standardisation of technology: Using Standard SSIs process, whilst fully utilising available technology such as DTCC’s ITP ALERT Database and Custodians should leverage ITPs Global Custodian (GC) Direct Service in updating SSIs
Challenges:
- Since foreign exchange (FX) transactions traditionally settle on a T+2 basis, the process of purchasing US securities from abroad becomes more complex. They will either have to prefund the transaction with USD or arrange for a short-dated T+1 FX settlement. The effect of prefunding could potentially impact other investments, as clients need to sell a day earlier to have the USD available, resulting in an investment manager out of the market for 1 day.
- Corporate actions customarily have ex-date one day prior to the record date, enabling trades to settle in advance of the record date cut off. The US market change will mean that the ex & record dates will need to occur on the same day which will undoubtedly lead to more reconciliation issues and subsequent market claims.
- A market disconnect will emerge – whilst most markets will maintain T+2 settlement, the US market, which closes last amongst developed countries, will settle T+1. Any cross-border transactions will now be operating across two different settlement cycles resulting in further operational risk and staff pressure.
- A time constraint on securities lending will emerge; the lender will either need to obtain the original securities back from loan or substitute the lender with another party, bringing challenges in cases where the security has been sold late in the day on T+0 in order to effect settlement the following day.
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