The settlement period has undergone modifications throughout its history. Initially, the trade settlement period spanned five days. However, in 1993, the SEC decided to revise the settlement period for most securities transactions, reducing it from five to three business days. Nonetheless, the three-day duration appeared to be excessively prolonged. To address this, in March 2017, the SEC implemented a shortened settlement period, reducing it from T+3 to T+2 days. Continuing this trend, in February 2023, the SEC approved a further reduction in the settlement cycle for most securities, bringing it down to T+1 from the existing T+2. On February 15, 2023, the SEC adopted changes to shorten the standard settlement cycle for securities transactions to T+1 effective May 28, 2024. The standard settlement cycle for most broker-dealer transactions will be shortened from two business days (T+2) to one business day (T+1) after the trade date, unless the parties expressly agree to a different settlement date at the time of the transaction. Shortening the settlement cycle to T+1 will reduce market participants’ exposure to credit, market and liquidity risk arising from unsettled transactions. There are few challenges in adapting t+1 settlements which are articulated below :
- Market participants face increased operational complexity due to the shorter settlement cycle. This means that brokers, custodians, and clearinghouses need to efficiently manage and finalize trades, necessitating enhanced coordination and communication among different parties.
- The adoption of a T+1 settlement cycle introduces higher operational risk for market participants. With less time available for error detection and correction, potential losses may arise for those involved in the market.
- Potential difficulties may arise in settling trades if a bank or a major financial institution experiences downtimes. Additionally, heightened volatility in capital markets carries the risk of contagion, impacting the overall ecosystem.
- The limited timeframe for addressing exceptions is a result of overnight batch processing. Due to system constraints, trades executed during a T+1 settlement cycle may not be confirmed until the following day, thereby amplifying settlement risks. Furthermore, relying on outdated technologies and Excel macros to track settlement failures becomes unsustainable in the long run..
- Limited Time to Review Transactions: Previously, investment firms had a two-day window in T+2 settlements to thoroughly review transactions and detect any potential errors. However, the transition to T+1 settlement shortens this timeframe, requiring firms to promptly identify errors or risks on the same day the trade occurs, before the business day concludes. This condensed timeline increases the challenges associated with manually reviewing transactions, highlighting the imperative for technological advancements.
- Time Zone Complications: Although the T+1 settlement rule primarily applies to the United States, its impact extends globally. Firms and individual investors located outside the U.S. can be affected by T+1 settlements. Similar to the aforementioned challenges with transaction reviews, the abbreviated settlement timeframe leaves those operating in different time zones with limited time to catch up before settlements are due. To illustrate, consider a scenario where a business utilizes an asset manager and a custodian to manage its investment assets. The asset manager is based in the U.S., while the custodian operates outside the U.S. If the asset manager delays sending settlement instructions until the last minute, they may face difficulties accessing the market where the custodian is located
- Stock lending, custodians and FX : When engaging in stock lending, additional complexities arise. For instance, in the case of a custodian, they may not be aware of the need to recall stock until receiving a trade instruction to sell from an asset manager. If such an instruction is sent after the markets have closed, there is limited or no opportunity to recall the stock on the same day. Consequently, this situation significantly contributes to the occurrence of failed trades, as there is insufficient time to facilitate settlement. As the settlement cycle shortens, custodians may find it necessary to impose earlier deadlines for receiving instructions. Moreover, if the stock is not readily available, trades are more likely to fail. In order to safeguard their respective positions and avoid incurring fees for failed trades, each party involved may need to reevaluate their service level agreements.
Potential for Increased Volatility:?
- Some market participants have expressed concerns that the T+1 settlement cycle could increase market volatility. With trades settling faster, there is less time to react to market news or events, which could lead to increased volatility and price swings.
Legal and Regulatory Risk:?
- The adoption of a T+1 settlement cycle may pose increased legal and regulatory risks for market participants. Implementing this new settlement cycle requires modifications to existing contracts and legal agreements, which could potentially lead to disputes or legal challenges.
- Shifting to a shorter settlement cycle necessitates significant changes to the trading infrastructure for brokers, as well as obtaining the necessary approvals and completing procedures for foreign institutional investors operating in different countries and time zones.
- Global markets exhibit significant diversity in terms of their scale, technology, and complexity. For instance, settlement activities in Europe are distributed across 31 Central Securities Depositories (CSDs), while in the US, it is centralized in the Depository Trust & Clearing Corporation (DTCC). While other implementations may provide valuable insights, there is no one-size-fits-all approach, and each regulatory authority must analyze the specific benefits and potential costs of transitioning to T+1 based on their unique circumstances.
Forcing flows away from European trading hours:?
- Traders who participate in the European trading period presently enjoy the advantage of overlapping with the Asian markets at the beginning of the day and with the US markets towards the day's end. This enables them to engage with interest from both regions.
- However, transitioning to a T+1 settlement cycle could introduce challenges for cross-currency transactions since there is a reduced timeframe available to interact with US counterparties. This poses a particular issue for asset managers who need to wait until the end of the trading day to conduct their foreign exchange hedging, leaving them with insufficient time to execute trades in Europe.
Impact on Small Market Participants:?
- The move to T+1 settlement cycle could have a more significant impact on smaller market participants who may not have the same level of resources and infrastructure as larger firms. These firms may struggle to keep up with the faster settlement cycle and could face additional costs and operational complexity.
- The adoption of a T+1 settlement cycle necessitated substantial technological and infrastructural investments by market participants. Brokers, custodians, and clearinghouses had to enhance their systems and workflows to support the accelerated settlement cycle, resulting in additional expenses. However, the limitations of overnight batch processing reduce the time available for handling exceptions.
- System constraints mean that trades executed may not be confirmed until the following day when settlement is required in a T+1 environment, thereby amplifying settlement risks. Furthermore, relying on outdated technologies and Excel macros to track settlement failures becomes unsustainable in the long run.
Concluding mark is that moving to a T+1 settlement cycle presents both benefits and challenges. The benefits include reduced market risk, lower margin requirements, and significant cost savings. The challenges include increased costs, operational complexity, potential for increased volatility, operational risk, legal and regulatory risk, and impact on small market participants. Firms operating in a legacy environment and industry standards must act now to adapt to the new settlement cycle. Adapting to T+1 will require updating trade financing, technology infrastructure, and operational processes.
References
Transfer Officer| Senior Operations Analyst| Middle Office Specialist/Operations/Analyst | Trade Settlement Specialist, Pre-Matching, & Confirmation Expertise ????
11 个月Well explained about the challenges & benefits Custodians/Participants will face while transitioning to T+1. As per my understanding resources will play a vital role because at the end of the day only things which matters is how efficiently & fast trade Instructions will get matched and confirmed by Counterparties and how fast this will reach to custodian. The The Depository Trust & Clearing Corporation (DTCC) products are of great value here and who can invest in them will be in a winning situation. I am confused for Small firms who cannot afford these products, how are they planning to send Instructions fastly & efficiently? How are the getting trades matched & affirm? NIKHIL MOHITE can you please share your thoughts!