April 2023

Capital markets: the implications of shortening settlement cycles to T+1

By James Maxfield, Head of Product and Solutions

The shift to a T+1 securities settlement life cycle in the United States and Canada is likely to have far-reaching implications across capital markets. Shortening the settlement cycle brings value in terms of risk and capital efficiency for market participants, but it is not without potentially negative consequences.

The shift was announced jointly by the U.S. Securities and Exchange Commission (SEC) and the Canada Capital Markets Association (CCMA).

Removing one day from the settlement process will require the acceleration of all post-trade activities that happen under current conventions. None of those steps will go away as a result of the change; it merely means they will have to happen faster. Adapting to T+1 settlement is a non-trivial exercise for both buy- and sell-side participants, as well as for the market infrastructure and service providers that support them.

Systems and processes that rely on batch processing (at the end-of-trade date) to feed exception management processes will have to be reengineered and the processes that rely on them redesigned. This impact is exacerbated by the global nature of capital and the important role played by North American markets – meaning traders and investors within Asia and Europe will have even less of a window to resolve issues once time-zone implications are factored in.

International considerations

This move by the SEC has turned heads in Europe. Given the widespread involvement of European participants in U.S. markets, firms on this side of the Atlantic will have to adjust to the SEC’s timetable.

It seems to be a matter of when, not if, European markets follow suit.

The Association for Financial Markets in Europe (AFME) announced a new industry group to assess the practicality of same-day settlement on the continent. It will not be as easy a shift, given the decentralised nature of European markets and the need for each financial centre – e.g. Paris, London, Amsterdam – to shift to single-day settlement simultaneously.

Proactive mobilisation

But with dates set and momentum created, industry focus must now move to understanding the change’s impact and mobilising accordingly. Here are some of the main considerations for market participants to consider as part of their impact analysis.

Data quality

The industry already has transaction matching processes – using either a vendor matching platform (affirmation/ confirmation and allocation) at one end of the spectrum versus emails and spreadsheets at the other end. Shrinking that window to ensure the process happens on the trade date will require a relentless focus on data quality.

For example, standard settlement instructions (SSI) data needs to be proactively kept in sync, as opposed to relying on the matching process to highlight exceptions. This shift will challenge traditional process constructs, where operating models are designed to be exception-driven – not data-driven – in the way they support settlement.

Business architecture redesign

A wordy way of saying systems and operating models will need to be assessed and re-drawn to support what will become an increasingly “intra-day” way of working. This might not sound significant, but the reality of offshored operating models, batch processes, and global clients will stress current architecture design.

The positive spin is that this creates an opportunity to look at the end-to-end process with fresh eyes, as regulatory form often becomes the only way to catalyse industry-wide change. But these enhancements will likely require investment and then prioritisation within a pool of typically scarce resources (both money and people).

Liquidity management

Liquidity in this context is a broad term. It effectively means, “do I have cash and/or securities available to support my settlement obligations?” A large part of the current settlement window is devoted to ensuring the positioning of currency balances, inventory positions, and collateral to lubricate the wheels of settlement.

This process will now become a lot harder, where the traditional focus on resource utilisation (keeping stock and cash balances as flat as possible) will conflict directly with the requirement to settle transactions in a timely fashion.

Maintaining buffers of cash and securities is inefficient and unpopular with chief financial officers and treasurers, but may become a necessary evil in some circumstances to avoid punitive failure costs. Liquidity mismatches could arise, for example, where out-of-currency foreign exchange settlement obligations cannot be aligned with the actual security settlement itself (linking the currency trade to the securities trade).

Such mismatches could also arise when loaned securities cannot be returned quickly enough to avoid a trading failure. Some market participants are already making noises about reducing borrowing and lending activity due to pressure created by the T+1 settlement window.

It is probably too early to call this yet, but the interconnections between liquidity management and securities settlement processes must be understood in detail to model their economic impact effectively.

Change management

Settlement conventions drive all sorts of things within a financial institution, from cost-of-carry (pricing impacts), cash management forecasting (settlement timing), and the actual settlement process (instruction of settlements). System and process changes will all need to be extensively tested internally, as well as externally in some cases with service providers (such as custodians, DTCC or NSCC) and vendors.

Adapting to T+1 will be a significant exercise, both in terms of testing new changes and regression-testing current functionality, which will require careful end-to-end coordination. It will also require proactive risk management of execution dependencies, issues, and risks.

With implementation scheduled for May 2024, time is short for market participants to conduct impact assessments and mobilise resources. The sheer size and scale of the U.S. equities market means that every participant globally will be affected by the change.

The clock is ticking.