However, initiatives are now underway to shorten the settlement cycle even further. This is a development - which market infrastructures and banks need to think about and urgently prepare for.

Led by industry participants in the US, there have been growing calls for equity trades to settle on T+1. According to the US Securities and Exchange Commission (SEC) , the volatility caused by COVID-19 and the meme stock trading “highlighted the significance of the settlement cycle to the calculation of financial exposures and exposed potential risks to the stability of the US securities market.” 1

For example, the Depository Trust & Clearing Corporation (DTCC) processed a record 363 million equity transactions on March 12, 2020, which is roughly 15% higher than the 315 million trades processed during the last peak amid the financial crisis in October 2008.2

Since then, a chorus of high-profile US market leaders have recommended to the SEC that T+1 be adopted, something which the regulator has now acquiesced to. Accordingly, T+1 is poised to become reality in the US from March 2024. But what does this mean?

There are a number of pros to shortening the trade settlement cycle by one day, many of which have been articulated in “Accelerating the US Securities Settlement Cycle to T+1”, a thought leadership paper published jointly by DTCC, Deloitte, the Investment Company Institute (ICI) and the Securities Industry and Financial Markets Association (SIFMA).

“As the volume of unsettled trades over a single trading day and the time between trade and settlement is reduced, there will be a reduction in systemic, counterparty, and operational risk across the settlement ecosystem, particularly in periods of market volatility. Furthermore, T+1 settlement preserves the benefits of settlement netting at National Securities Clearing Corporation (NSCC) and, thereby, significantly reduces the volume of securities and currency required to be moved across markets on any given trading day,” highlights the white paper.3

The paper continues that a shorter settlement cycle would mean that trading firms have less market and counterparty risk during the settlement process. Consequentially, there will be a substantial reduction in margin that needs to be posted to NSCC. According to the DTCC, a move to T+1 could correspond to a 41% reduction in the volatility component of NSCC’s margin.4

This would allow “broker-dealers to better manage their capital and liquidity risks and better utilise their available capital. For investment funds, T+1 will align the settlement cycle of US mutual fund shares with the portfolio securities settlement cycle, thus improving cash and liquidity management,” adds the paper.5 T+1 could unlock other advantages, including further standardisation of capital markets and infrastructure modernisation, both of which will help generate efficiencies and deliver cost synergies.

Proposed industry migration timeline3

T+1 – Overcoming Some Implementation Obstacles

T+1 might be able to facilitate capital optimisation for market participants and prompt intermediaries to automate their legacy infrastructure, but its introduction is laden with all sorts of challenges, some of which have been acknowledged by the initiative’s chief architects.

While T+1 has the potential to shave off a lot of the intermediary costs rife in post-trade processing, its initial implementation will not be cheap. In fact, the one-time investment required to make sure that organisations’ operations and technology systems can handle T+1 is likely to be very significant. This comes at a time when the industry’s outgoings are ramping up as a result of regulation and new, post-COVID-19 operational requirements.

However, cost challenges are likely to persist over the longer-term with the roll out of T+1. Firstly, market participants could face heightened time-pressures when conducting reconciliations, exceptions processing and FX transactions. In the case of the latter, trading firms in different time-zones to the US will need to build systems to ensure they can meet their FX management requirements in time for T+1 settlement. As such, resources will need to be thrown at internal operations so that organisations can meet their t+1 obligations.

Trade fails risk becoming increasingly ubiquitous too, which will also have cost implications, not least because they can incur penalties under the  CSDR. The white paper continues that T+1 “could lead to a reduced percentage of trades that will timely settle through NSCC’s CNS system, which could, along,  with the abbreviated timeframe for borrowers to source securities to return to securities lenders, lead to an increase in fails to deliver.’’6

Preparation and Testing Is Everything

Just as market participants have navigated previous changes to settlement cycles, the switchover to T+1 ought to be equally manageable. Nonetheless, firms do need to make some considerations ahead of the transition.

Firstly, firms will need to make sure that they have the systems in place to support trade confirmations, allocations and affirmations – together with FX – in a T+1 environment, something which will require investment into their operations and technology.

Similarly, implementation of T+1 will usher in changes in terms of how corporate actions are processed, a point made in the paper. “Typically, the ex-date will occur prior to the record date of the event, and in a T+2 settlement cycle, the ex-date falls on the trading day before record date. Regular way ex-date occurs when the ex-date is established prior to the event’s record date. A move to T+1 settlement will subsequently move the ex- date to the day of the record date of the event,” according to the paper.7

The shorter settlement cycle will also force financial firms to revisit the way  in which they manage trade fails. While trade settlement fails do happen under a T+2 model, they are fairly infrequent, but T+1 could be a shock to the system for some.

“In the current T+2 settlement cycle industry participants have 48 hours to remediate trade errors to prevent trades from failing. In transitioning to T+1, there will need to be a heightened focus on both the prevention and remediation processes for errors, as participants will have less than 24 hours to remediate trades,” says the paper.8 Firms should be thinking about putting in place mechanisms to ensure that trade errors are corrected in good time once T+1 takes effect.

Thinking about the Next Steps

If organisations are to be fully prepared for T+1, they need to ensure their systems are well-tested ahead of the implementation date, which is now less than two years away. In addition to thorough testing, firms need to ask themselves tough questions about their ability to meet T+1’s obligations. These might include whether or not T+1 will affect their clearing fund deposits, or if they have the wherewithal to cover unexpected settlement obligations.

Other considerations for companies might include finding ways by which to estimate funding and financing  requirements throughout the day, and determining if they have the right tools to perform forecasts in real-time. If firms are to effectively navigate the T+1 transition, they need to be actively planning and testing their systems to ensure they can cope with the newfound changes.

1 SEC
2 DTCC – February 2021 – Advancing together – Leading the industry towards accelerated Settlement
3 DTCC, SIFMA, Deloitte, ICI – December 1, 2021 - Accelerating the US Securities Settlement Cycle to T+1
4 DTCC – February 2021 – Advancing together – Leading the industry towards accelerated Settlement
5 DTCC, SIFMA, Deloitte, ICI – December 1, 2021 - Accelerating the US Securities Settlement Cycle to T+1
6 DTCC, SIFMA, Deloitte, ICI – December 1, 2021 - Accelerating the US Securities Settlement Cycle to T+1
7 DTCC, SIFMA, Deloitte, ICI – December 1, 2021 - Accelerating the US Securities Settlement Cycle to T+1
8 DTCC, SIFMA, Deloitte, ICI – December 1, 2021 - Accelerating the US Securities Settlement Cycle to T+1