Investors are scrambling to overhaul trading operations before new rules kick in later this month that will halve the deadline for settling US stocks and bonds trades, in what amounts to the biggest shakeup of the US$100trn-plus US securities market in seven years.
The settlement timeframe for US securities transactions from May 28 will be cut to one business day from two after a trade takes place in a move that the Securities and Exchange Commission says will reduce risks in these markets.
A quarter of US securities trades in March failed to meet the “T+1” deadline, according to analysis from clearing and settlement specialist Depository Trust and Clearing Corp, fuelling concerns that many companies will face costly – and potentially risky – settlement failures when the new regime begins.
"Clients with legacy systems will struggle," said Sabine Farhat, head of securities financing, lending and repo product management at fintech company Murex. "We may see a lot of settlement failures ... Some clients are well prepared for the potential impact of failures, while others are doing the most basic technological updates."
The shift to T+1 by US regulators comes after adopting T+2 as the market standard in 2017. Although seemingly a mundane update to financial market plumbing, the adoption of T+1 has serious consequences for investors buying and selling US stocks, bonds and some types of derivatives.
Most trades will need to be submitted to DTCC by 9pm on the day of the trade to comply with T+1 – five hours after the US stock market closes. There will be no regulatory penalties for failing to meet the deadline or for failed trades but investors will face much higher costs. DTCC said investors delivering securities shortly after the 9pm cutoff would see costs triple, while costs for the counterparty would double.
Investors falling foul of the new regime could also face greater risks. Funds using US securities for hedging, for instance, could be exposed to moves in financial markets because of their unhedged position if settlement fails.
Manual no more
For many, particularly smaller asset managers, the shorter timeframe poses a serious problem because it gives them little leeway to address any settlement issues that arise, such as from creaking technology.
“As a whole, the market has relied on lots of manual workarounds for many issues for far too long,” said Alex Knight, head of EMEA at post-trade firm Baton Systems.
“That works when you have extended periods for remediation... but as we enter a world where the timelines available to successfully complete your processes are becoming increasingly compressed... now everything is under enormous pressure.”
Nearly 90% of the 325 companies surveyed recently by research and data company ValueExchange said they were revising their operating procedures ahead of T+1. The SEC has estimated that institutional investors would have to spend US$4.3m to upgrade operating systems to meet the requirements, although costs vary depending on how much they had automated already.
“If institutions have to do this manually then meeting the T+1 settlement deadline will be much harder,” said Michelangelo de Marzio, director of market structure and technology at the International Swaps and Derivatives Association. “Automating that process as much as possible is key.”
Val Wotton, general manager of DTCC's institutional trade processing service, suggested manual workarounds had no place in this new world. “Automating the trade allocation and affirmation process is crucial in achieving timely settlement,” he said.
Foreign problems
T+1 is particularly troublesome for foreign investors, which held about US$27trn in US securities as of mid-2023. That is because timezone differences materially reduce the window investors have to complete currency trades used to purchase US stocks and bonds.
It also means they may struggle to funnel their FX trades through CLS, which settles more than US$6.5trn in daily FX volume and helps reduce settlement risk in these markets. T+1 could affect between 0.4% and 0.5% of CLS’s average daily settlement volumes – or as much as US$32.5bn of FX trades – the post-trade group estimates. Those transactions may have to settle outside CLS, which could increase risks and costs for the firms involved.
“We’re expecting a minimal impact based on our current flows,” said Lisa Danino-Lewis, CLS’s chief growth officer. “But if you're an asset manager with a lot of US securities business then the impact of these changes to T+1 settlement is obviously going to be magnified and feel much more significant to you.”
ValueExchange said half the foreign investors it surveyed are updating their FX operations to execute currency trades at the same time as US securities transactions. Around a quarter of these foreign investors, meanwhile, are planning to rely on their custodian banks to take care of the currency leg.
“It’s the smallest asset managers that are going to be impacted hardest by T+1 as they don’t necessarily have the resources and funding that’s needed to put technological solutions in place, which is why many will end up relying on their custodians,” Danino-Lewis said.
