With the US now set to reduce its trade settlement cycle for equities from T+2 to T+1 beginning in March 2024, asset managers in the UK need to start thinking about how this change could impact their operations.
Why asset managers should take note of the move to T+1
Pushed for initially by SIFMA (Securities Industry and Financial Markets Association), the ICI (Investment Company Institute) and the DTCC (Depository Trust & Clearing Corporation) following the market pandemonium caused by COVID-19 and the meme trading escapade, the SEC (Securities and Exchange Commission) finally gave its backing in February to shortening equity settlement times from T+2 to T+1.
By narrowing the time it takes to settle a trade by a whole day, regulators argue it will help mitigate settlement and counterparty risk during the transactional process, curtailing the need to post as much margin on trades, and ultimately allowing for capital to be freed up, and deployed elsewhere, generating surplus liquidity. The US’s transition to T+1 is something which many financial institutions – including asset managers – largely welcome, at least from a balance sheet perspective
Confronting the challenges of settlement compression
Although T+1 could help generate capital efficiencies, there are some unresolved issues, which need clarifying. Firstly, there are concerns about whether financial institutions based in different time zones to the US will need to pre-fund some of their trades. Under the existing T+2 model, financial institutions have two days after the trade date to settle their FX transactions, but under T+1 organisations would need to book FX trades on either the same day or T+1.
A move to T+1 could also lead to fund managers suffering from an increase in trade fails, resulting in additional costs or even fines. If penalties for settlement fails are to be avoided, it is vital that managers ensure their operational processes and in-house systems can handle T+1.
Another risk which needs avoiding is market fragmentation. Not all markets will move to T+1 simultaneously raising the prospect of having a multiplicity of different trade settlement times in various markets. Not everyone is convinced that fragmentation of this sort will be a problem though. Asset managers, for instance, have a long track record of operating in markets where trade settlement times are not harmonised, so the US’s move to T+1 should not be particularly onerous for them.
Is anyone else following in the US’s footsteps?
The US is not the only market adopting T+1. India is already phasing in T+1, while Canada is poised to introduce T+1 at the same time as the US. A handful of emerging markets (especially those whose equity markets are closely tied to the US) have also indicated they could eventually move to T+1, although it is still early days.
Experts – speaking during an AFME (Association for Financial Markets in Europe) Conference in London, recently said that Brexit could potentially enable the UK to take a lead on embracing T+1, ahead of the EU. Nonetheless, the appetite for T+1 in the EU is fairly limited (although not non-existent), especially following the trading bloc’s laborious implementation of T+2 several years earlier.
With settlement times likely to change across more markets, asset managers should think about how this could affect their core operations.