Winners and Losers from the US Move to T+1 Settlement

The US move to a T+1 settlement cycle significantly changes the securities trading landscape. This transition will decrease the settlement period from two business days (T+2) to just one business day after the trade date, substantially impacting market participants' operations and processes. While this shift offers numerous benefits, including reduced settlement risk and enhanced investor protection, it presents challenges and potential drawbacks for certain market participants.

A crucial part of understanding the winners and losers in this scenario involves examining the technical aspects of T+1 settlement, global adoption trends, and the role of technology in facilitating this change. Additionally, it is crucial to consider the regulatory role in implementing T+1 settlement, particularly with the Securities and Exchange Commission (SEC) adopting a final rule that shortens the settlement cycle.

Key Takeaways

• T+1 settlement reduces settlement risk and enhances investor protection while posing challenges for some market participants
• Regulatory authorities and technology advancements play significant roles in successfully implementing the T+1 settlement cycle.
• Global adoption trends and market participants' adaptation will determine the ultimate winners and losers from the US move to T+1 settlement.

Understanding T+1 Settlement

The T+1 settlement refers to a process for settling securities transactions within one business day after the trade date. This represents a significant shift from the current T+2 settlement cycle, wherein transactions are paid within two business days after the trade date. The T+1 settlement cycle aims to reduce counterparty risk, enhance market liquidity, and improve operational efficiency.

The Securities and Exchange Commission (SEC) has adopted the T+1 settlement cycle for most broker-dealer transactions in the US and Canadian markets. This impacts trading across various products, including equities, mutual funds, REITs, corporate bonds, municipal bonds, and equity derivatives. Market participants, such as broker-dealers, institutional investors, and custodians, must adapt to this accelerated timeline to ensure compliance with the new regulations.

Moving to a T+1 settlement cycle will require enhancements in technology and operational processes. Real-time data sharing and application programming interfaces (APIs) will become crucial for seamless data coordination among the parties involved. Additionally, custodians will need to affirm trades within a shorter timeframe, as businesses must be verified by 9 p.m. on the trade date, according to Depository Trust and Clearing Corporation (DTCC) data.

While the T+1 settlement cycle presents challenges related to technological advancements and operational adjustments, it also brings potential benefits to the capital markets. Shortening the settlement timeframe reduces the overall counterparty risk, thereby increasing market stability and investor confidence. Furthermore, shorter settlement periods may result in improved capital allocation and enhanced market liquidity, enabling more efficient use of resources by market participants.

In conclusion, the transition to the T+1 settlement cycle is an essential development in the securities market. Market participants must be prepared and make the necessary adjustments to thrive in this new environment.

History and Transition From T+3 to T+2 and T+1

T+3 Era

In the T+3 era, securities settlement in the US occurred three business days after the trade date. T+3 settlement was the industry standard for many years, providing market participants adequate time to complete the necessary processes and manage risks associated with settling trades.

T+2 Settlement

In September 2017, US settlements transitioned from the T+3 system to T+2, shortening the settlement cycle by one business day. The shift aimed to reduce counterparty risk, increase efficiency, and align the US market with international standards. The transition to T+2 made some adjustments for market participants but was generally deemed successful.

Shift to T+1

In February 2022, the US Securities and Exchange Commission (SEC) proposed rule changes to further shorten settlement cycles to T+1, with industry testing scheduled to begin in Q3 of 2023. By reducing the time between the trade date and settlement, T+1 aims to improve efficiency and address the potential for liquidity constraints. Participants preparing for the T+1 transition face more significant challenges as they have limited opportunities to make changes and resolve any exceptions during the settlement cycle.

The move from T+2 to T+1 involves a more profound need to ensure accurate instruction and seamless processes. The transition requires market participants to make a plan, automate trade date activities, assess capital and liquidity impact, engage proactively with clients, and consider long-sighted technology updates to prepare for the shortened settlement timeframe. With the SEC planning on making the necessary regulatory changes, T+1 is not a question of if but when, making it essential for market participants to adapt accordingly.

Technical Aspects Involved in T+1 Settlement

Affirmation and Confirmation Process

In the transition to T+1 settlement, the affirmation and confirmation process becomes critical. Firms need to prioritize same-day allocation of transactions, ensuring that both parties involved in trades can confirm the details swiftly. This reduces the need for manual processes and increases the likelihood of straight-through processing, a necessary element for this accelerated settlement cycle. Automation is vital to handle the increased volume of trades under T+1, streamlining the back-office operations and improving data accuracy throughout the reconciliation process.

Clearing and Settling of Transactions

Clearing agencies like DTCC and DTC have become increasingly essential in T+1 settlement. These agencies facilitate settling transactions and need to adapt their operations to accommodate the shortened settlement period. With T+1, there's a significant reduction in counterparty risk and a consequential decrease in margin requirements thanks to the faster settlement process. It's vital that clearing and settling entities maintain efficient operations to ensure seamless transitions and minimize disruptions in the market.

Operational Adjustments Needed for T+1

To adopt the T+1 settlement cycle, firms must make various operational adjustments. Some of these changes include:

• Streamlining post-trade processing to manage the accelerated timeline.
• Reducing reliance on manual processes by implementing robust automation systems.
• Enhancing reconciliation procedures to maintain accuracy amidst higher transaction volumes.
• Investing in technology infrastructure upgrades to support the increased demands of the shortened settlement cycle.

In conclusion, the T+1 settlement presents challenges and opportunities for market participants. By better understanding the technical aspects involved, firms can adapt to this new environment and work collaboratively with clearing agencies, regulators, and market partners to ensure a smooth transition to the T+1 settlement cycle.

Regulatory Impact and Role in Implementing T+1 Settlement

The move to the T+1 settlement in the US has several regulatory impacts, primarily involving the Securities and Exchange Commission (SEC), which plays a crucial role in the transition. The SEC has adopted a final rule to shorten the standard settlement cycle for most broker-dealer transactions from two business days (T+2) to one (T+1) after the trade date. This change aims to reduce risks in clearance and settlement and improve overall efficiency in the financial markets.

The SEC's adoption of the T+1 settlement cycle impacts several entities under its jurisdiction, including broker-dealers, clearing agencies, and institutional investors. To implement the T+1 settlement, the SEC has amended specific rules and recordkeeping requirements for registered entities. One such amendment is the revision of the Exchange Act Rule 15c6-1, which mandates the new settlement cycle.

In preparation for the T+1 settlement transition, regulators like the SEC have been working closely with impacted firms and providing guidance. These affected entities are encouraged to develop policies and procedures addressing the shorter settlement cycle and review their technology infrastructure. They are advised to engage with clients proactively, assess potential capital and liquidity impacts, and automate trade date activities. This collaborative approach between the SEC and market participants ensures a smooth transition to the T+1 settlement framework.

Overall, the regulatory impacts of the T+1 settlement transition reflect the SEC's commitment to modernizing the financial markets and reducing systemic risk. Efforts from various entities, including regulators, broker-dealers, and clearing agencies, facilitate the adoption of this new settlement cycle while maintaining the efficiency and stability of the securities market.

Global Adoption of T+1 Settlement

Adoption in Canada and Hong Kong

Canada is among the first nations to join the US in moving towards a T+1 settlement cycle to reduce risk and strengthen and modernize securities settlement in the financial markets. This change will impact Canadian securities markets and anyone operating in these markets, regardless of their geographical location Worldwide.

Hong Kong, on the other hand, has not yet announced any plans for T+1 settlement adoption. However, there may be potential opportunities for Hong Kong to consider this move, considering the benefits of reduced settlement risk and enhanced efficiencies in trading. The time zone differences between North America and Asia may pose some challenges, but they can be addressed through collaboration and coordination of market practices across the regions.

Adoption in India and Singapore

As for India and Singapore, although no official statements have been made regarding their intent to adopt the T+1 settlement cycle, it is expected that the move by the US and Canada could potentially influence their decision shortly. Their financial markets are closely connected with global markets, and a shift to expedited settlement could offer advantages in risk management and smoother trade processes.

However, time zones continue to be an area of concern, as the operational timings in these countries significantly differ from those in the US and Canada. Overcoming these challenges may require a concerted effort by financial institutions, regulators, and market participants to adapt to the changing global landscape in securities settlement.

Overall, the global adoption of T+1 settlement is expected to lead to a more efficient and safer trading environment, albeit with the need for close collaboration among countries, efficient handling of time zone differences, and a gradual reform in market practices.

Impact on Different Market Participants

Impact on Institutional Investors

The move to the T+1 settlement in the US will impact institutional investors, such as investment managers and registered investment advisers. With a shorter settlement cycle, these market participants will experience reduced counterparty and credit risk, as there will be less time for changes in the market to impact unsettled trades. This shortened timeframe will also require them to optimize their trade processing and potentially seek more efficient technology solutions to handle the faster turnaround.

However, the real-time nature of T+1 settlement may also generate additional pressure on liquidity management for institutional investors. They must adapt their strategies to promptly ensure sufficient cash and securities are available for trade settlements.

Impact on Broker-Dealers

Broker-dealers will need to make adjustments in response to the move to T+1 settlement, both in their internal systems and external relationships. For example, they will need to enhance their capabilities in intraday reconciliation, a crucial step in ensuring accurate trade details are shared between market participants in a shorter time frame. Additionally, broker-dealers may see changes in margin requirements, as the shortened settlement cycle will influence their market risk exposure.

There may also be an increased demand for automation and real-time risk management solutions, as maintaining compliance with regulatory requirements in a T+1 environment would become more challenging due to accelerated transaction timelines.

Impact on Custodians

Custodians play a vital role in the trade settlement process, safeguarding their clients' assets, including institutional investors. With the shift to T+1, custodians must upgrade their systems and resources to handle the increased operational efficiency requirements. This may include investing in advanced technology solutions, such as distributed ledger technologies or artificial intelligence, to enhance their ability to process transactions rapidly and securely.

Furthermore, T+1 may lead to an altered client servicing landscape as custodians seek to maintain their competitive edge by offering innovative offerings tailored to client's needs in this new settlement environment. Adopting the T+1 settlement is expected to reshape the industry landscape, with varying effects on market participants.

Risks and Challenges in Implementing T+1 Settlement

The move to T+1 settlement in the US financial system comes with various risks and challenges that need to be addressed by industry participants. One significant concern is the operational risk associated with the accelerated settlement cycle. Firms must adapt to a tighter timeframe, which requires more straight-through processing and less cumbersome or customised processes¹. Moreover, it will increase the pressure to ensure accurate and timely trade execution and settlement.

Another aspect to consider is the potential for increased counterparty and market risks during the transition period. Changing to a shorter settlement cycle might lead to temporary dislocations or imbalances as market participants adjust to the new settlement timeframe. These short-term fluctuations could result in higher market volatility, affecting the value of security-based swaps and other financial instruments.

Furthermore, more minor market participants or those with outdated or inflexible technology systems may face difficulties implementing the necessary operational and business changes to meet the T+1 requirement². Such entities would need to invest significantly in systems upgrades or even new infrastructure, which could pose a financial challenge.

Despite these challenges, transitioning to T+1 is expected to reduce any long-term risks associated with the trading and settlement process³. A shorter settlement period would mitigate counterparty risk by reducing the time market participants are exposed to credit and default risks, ultimately enhancing overall market stability.

However, as the financial system evolves to accommodate the new T+1 settlement cycle, market participants must work together to overcome the operational, technological, and economic obstacles. This collaborative effort will be crucial for smoothly implementing the T+1 settlement, benefiting the industry and financial markets.

Footnotes

1. Time is money: the hidden challenges of T+1 - Funds Europe ↩
2. The move to T+1 in the US - S&P Global ↩
3. The Journey to T+1: An Analysis of Key Impacts Across the Trade Process - State Street ↩

Benefits and Advantages of T+1 Settlement

The move to a T+1 settlement cycle in the US has several benefits and advantages for various market participants. One of the primary gains comes in the form of enhanced liquidity. A shorter settlement period allows participants to access funds and securities more quickly, improving their cash management and capital efficiency. As a result, organizations can better allocate resources and investments to optimize their financial performance.

Another critical advantage of T+1 Settlement is its impact on risk management. A reduced settlement period means the exposure to credit, market, and counterparty risks is also reduced. This can be particularly beneficial in times of market volatility as it minimizes the potential for trade failures and defaults, thereby protecting investors and market participants.

The accelerated settlement process also leads to improved operational efficiency. By shortening the time between trade execution and settlement, market participants can streamline their operations and reduce the resources needed for trade reconciliation, post-trade processing, and regulatory reporting. This operational enhancement drives cost savings and allows participants to focus more on their core competencies and strategically essential activities.

Finally, T+1 Settlement fosters better alignment with global markets. As the world becomes more interconnected, harmonizing settlement cycles across jurisdictions is essential for maintaining a competitive edge and facilitating seamless cross-border transactions. The transition to T+1 in the US helps synchronize with other global financial centres, promoting increased worldwide cooperation and collaboration in the financial markets.

In summary, the move to T+1 Settlement offers several advantages to market participants, such as enhanced liquidity, better risk management, accelerated settlement, and a more synchronized global marketplace. These benefits have the potential to significantly improve the financial industry's efficiency and fortify its resilience.

Role of Technology in Facilitating T+1 Settlement

The transition to T+1 settlement brings several challenges for market participants, requiring adaptations in trade financing, technology infrastructure, and operational processes ¹. The technology addresses these complexities and facilitates a more efficient settlement cycle.

Artificial intelligence (AI) serves as a critical enabler in this transition. AI can streamline the affirmation and settlement process by automating manual tasks and reducing human intervention. This accelerates trade processing and helps ensure that trades are affirmed by the required 9 p.m. deadline on the trade date. Additionally, AI can aid in detecting potential errors and discrepancies in trade data, reducing the risk of failed trades and associated penalties.

Software solutions tailored explicitly for T+1 settlement enable the required speed and efficiency. Such solutions can manage the trade lifecycle end-to-end, including order routing, trade matching, affirmation, and regulatory reporting. They integrate seamlessly with existing infrastructure to provide a unified view of trade-related information, simplifying operational workflows and fostering better collaboration between trading, operations, and compliance teams.

Communication technology advancements are also pivotal in ensuring that all parties involved in the trade process can smoothly exchange information and coordinate the affirmation process. Reliable, secure, and rapid communication channels are essential for the timely transmission of trade details. Furthermore, standardized messaging formats and protocols, such as FIX and ISO 20022, contribute to a seamless flow of information between trading entities, custodians, and the Depository Trust & Clearing Corporation (DTCC).

Enhanced technology infrastructure is paramount in supporting the increased system demands of a faster settlement cycle. Improvements in computation and data storage capabilities enable financial institutions to manage the larger trade volumes and higher frequency of transactions that T+1 settlement entails. Robust and scalable technology solutions – such as cloud platforms – help market participants securely and efficiently handle the demands of the accelerated settlement cycle.

In summary, technology – AI, software, communication, and improved infrastructure – facilitates the T+1 settlement process. By adopting cutting-edge solutions and making necessary changes to their operational workflows, market participants can successfully navigate the transition to the one-day settlement cycle and benefit from its increased efficiency and risk reduction.

Footnotes

1. T+1: Answers to Pressing Questions About Accelerated Settlement ↩

Conclusion

The US move to a T+1 settlement cycle has both winners and losers. On one hand, market participants will see a significant reduction in counterparty risk and increased liquidity within the markets. Institutional investors and broker-dealers can also expect a more efficient trade clearing process, allowing for easier management and a streamlined workflow¹.

However, this change also challenges market participants, particularly regarding operational workflow and technology. With the shortened settlement cycle, organizations must invest in the necessary infrastructure and systems to accommodate the new requirements². Thus, while the shift appears beneficial overall, the associated costs and efforts to comply might impact more minor market participants who could struggle with the required upgrades.

In conclusion, transitioning to T+1 will likely yield a faster and more efficient settlement process while reducing counterparty and broader market risks³. Nevertheless, the move also entails significant operational shifts, with smaller players in the industry possibly facing more substantial challenges in adapting to the new environment.

Footnotes

1. SEC final rule for T+1 settlement cycle - KPMG ↩
2. The Journey to T+1: An Analysis of Key Impacts Across the Trade Process ↩
3. The move to T+1 in the US - who benefits? ↩