Financial Markets Brace for a Swift Change to T+1

The financial industry is at the edge of a huge transition with the introduction of T+1 settlement.

This change, which shortens the settlement cycle from two days post-trade (T+2) to just one (T+1), is poised to enhance the efficiency and stability of securities markets.

Spearheaded by regulatory bodies in response to market volatility, T+1 aims to mitigate counterparty risk and streamline capital usage.

With India’s recent adoption and the US and Canada set to follow, the shift heralds a new era in trade processing, demanding meticulous preparation from market participants globally.

Benefits of T+1 Settlement

The shift to T+1 settlement is anticipated to bring a plethora of benefits to the securities industry. Foremost among these is the reduction of risk.

By decreasing the volume of unsettled trades and the time between trade and settlement, systemic, counterparty, and operational risks are significantly lowered, especially during periods of market volatility.

Additionally, the preservation of settlement netting at NSCC reduces the movement of securities and currency required on a trading day. Another advantage is the reduction in liquidity requirements. With diminished exposure over the settlement period, there is a corresponding decrease in margin requirements.

This allows broker-dealers to optimize capital and liquidity management. For investment funds, synchronizing the settlement cycle of mutual fund shares with portfolio securities enhances cash and liquidity management.

Moreover, capital and operational efficiencies are expected through infrastructure modernization and standardization of industry processes, leading to cost reductions.

Challenges and Concerns with T+1 Implementation

Despite the clear advantages, the transition to T+1 is not without its challenges and concerns.

One significant issue is the alignment with the T+2 FX settlement cycle. Market participants must ensure funding is available in time to settle U.S. trades at T+1, which may necessitate pre-funding FX trades or liquidating other assets.

This could lead to increased costs and deter trading due to the heightened collateral and liquidity risks.

Additionally, the rigid deadlines of the banking system and time zone differences pose substantial risks to timely settlement.

The need for rapid reallocation and recall of securities, particularly in securities lending, could result in increased settlement fails and penalties.

Furthermore, the compressed timeframe for trade affirmations and confirmations, coupled with asset servicing responsibilities like corporate actions, adds to the operational strain.

These factors underscore the necessity for enhanced automation and reevaluation of existing processes to accommodate the accelerated settlement cycle.

Impact on FX Settlement and International Coordination

The move to T+1 settlement has profound implications for FX settlement and international market coordination.

With FX transactions typically settling on a T+2 basis, the misalignment with the T+1 cycle for U.S. securities creates a conundrum for market participants.

Investors trading U.S. equities from different time zones, such as Asia-Pacific, must now execute FX transactions sooner, potentially leading to the need for pre-funding.

This misalignment also affects securities lending, as there is less time to recall loaned securities, increasing the likelihood of settlement fails.

The transition necessitates a re-examination of foreign banking deadlines and transaction processing cutoff times to ensure harmonization with the accelerated U.S. settlement framework.

To mitigate these challenges, the industry recommends that wholesale FX market participants conduct internal analyses and engage with central banks and industry groups to introduce T+1 settlement without disruption, particularly for non-U.S. based investors.

Preparing for T+1: Industry Recommendations and Actions

In preparation for T+1, the industry has outlined several recommendations and actions.

The advise for firms is to conduct thorough internal analyses of their global operating models and current processes to identify necessary changes for timely FX transactions.

Drawing on existing T+1 settlement processes for certain securities, such as U.S. Treasuries, can serve as potential models for expansion to other asset classes.

Engagement with the Federal Reserve, global Central Banks, market infrastructure providers, vendors, and industry groups is crucial to understand and reinforce behavioral changes.

Coordination among global FX market participants is essential to introduce T+1 settlement seamlessly.

Additionally, firms should adopt best practices such as same-day allocations and affirmations, and invest in automation to reduce the risk of settlement failure.

By taking these proactive steps, market participants can align their operations with the T+1 change and ensure compliance with the new settlement cycle.

Future Outlook

The transition to T+1 settlement is a transformative step for the securities industry, promising enhanced efficiency and reduced risk. As the global markets gear up for this change, the focus on meticulous preparation and industry-wide collaboration will be pivotal in navigating the challenges ahead.