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Building an Orchestrated Ecosystem: The Move to T+1 Settlement
Preparing for the May 2024 T+1 securities settlement cycle compression in the United States requires careful thought, especially for firms trading US stocks outside the US in a non-USD base currency. In this article, Northern Trust’s Kia Oboudiyat, Chief Strategy Officer, Global Foreign Exchange and Gerard Walsh, Global Head of Capital Markets Client Solutions, discuss trading and trade-related FX as part of the same solution.
and Gerard Walsh, Global Head of Capital Markets Client Solutions,
In recent years, many markets around the world have contemplated shortening the settlement cycle on traded securities. Notably, India moved to T+1 for about 80% of the instruments traded there earlier this year.
The rationale for doing so is sensibly investor-centric. The theory goes that a shorter settlement cycle will improve efficiencies and reduce risks for both investors and market participants. Shortening the settlement cycle should reduce the overall risk exposure to unsettled trades and reduce the potential for price movements in the underlying securities during settlement.
The next countries to implement T+1 will be the US and Canada. In February 2023, the US Securities and Exchange Commission (SEC) adopted an amendment which brings T+1 into the US market by May 28, 20241 (after the Memorial Day long-weekend) with the Canadian Capital Markets Association announcing Canada will transition a day earlier on May 27.2 The US represents the largest, most liquid market in the world where notably the percentage of foreign owned US equities has risen by 50% over the past 12 years to exceed USD 12 trillion. There are numerous impacts of this change and each of them bears thinking about.3
Firstly, there is an obvious direct consequence. Moving to T+1 will require trade-related operations support teams and technology platforms to be more highly effective, co-ordinated and efficient. There will be much less time to repair trade breaks and exceptions to ensure that trades are going to be settled. It seems inevitable that there may be an initial period where US trades may see higher rates of failure than is the case now.
Secondly, operational excellence will be very important. Firms all over the world will need to assess how best to deliver that. In many cases, working with partners that are close to respective markets and offer scalable solutions will be a critical route forward to safeguard the operational infrastructure.
Moreover, there is another important consequence that’s not immediately obvious but should be borne in mind. The shortened settlement cycle will also impact the related FX lifecycle required to fund the settlement of these trades, or repatriate proceeds. Managers will need to carefully consider the shortened operating window between trade and settlement. This is particularly relevant for managers where the operating or base currency of the fund / investor is not USD, and even more so for those major Asian or Pacific (APAC) currencies where cut-offs will become an increasingly important factor. It should also be noted that 26% of all US foreign owned equities are held by APAC investors.3
FX will be an important component for investors to consider and manage in the move to US (and Canadian) T+1. While T+1 and same day settlement in FX is not new, the FX settlement process will need to be recalibrated to create a greater STP (Straight Through Processing) environment that not only follows the sun operationally, but also optimises liquidity and execution. The challenge global equity managers will likely face is same day FX funding where trades aren’t matched on trade date. This is especially true for Asia Pacific managers who are not in a conducive time zone to manage North America T+1 in their standard working day. Nobody wants to insist their operations staff become creatures of the night so functions and activities delivered by highly capable solutions providers with a global footprint will undoubtedly factor into the new T+1 environment.
One obvious way to achieve this and mitigate settlement risk will be to link securities trading and the associated trade-related FX as close in time as possible. Managers, especially those domiciled outside of the US and Canada time zone, should consider executing the FX trade in a comprehensive trade lifecycle, as close as possible to the time the underlying assets are traded.
This can be achieved through implementing an automated, tailored and programmatic FX funding mechanism that is linked as close to the underlying transaction as possible and is able to offer flexibility in execution timing together with access to global liquidity. In order to address this, managers may look for comprehensive solutions of the type offered by outsourced providers. Solutions with comprehensive trade-to-FX lifecycles are available, supporting managers with streamlined operational processes with customised execution time-frames and global trading desks.
The upcoming compression of the settlement cycle to T+1 means managers will need to ensure an end-to-end trade lifecycle management framework is in place. Minimising the risk of failed trades will require as much straight-through integration as possible from trade execution to settlement.
1 Source: US Securities and Exchange Commission – Sec Finalizes Rules to Reduce Risks in Clearance and Settlement
2 2. Source: Canadian Capital Markets Association -One-Year Countdown Until T+1 Standard Settlement Cycle Goes Live
3 Source: All data as of June 30, 2022 published by US Treasury in April 2023 from Report on Foreign Holdings on U.S. Securities at end June 2022.
Chief Strategy Officer, Global Foreign Exchange, Northern Trust
Global Head of Capital Markets Client Solutions
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