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This time is different.
The U.S. Securities and Exchange Commission has set a May 2024 deadline for the switch to a T+1 settlement cycle. Today that date appears to be set in stone, but even if it proves to be a little flexible, buy-side firms need to be fully engaged now in the planning process for this historic move.
The transition to T+1 will be unlike previous settlement compressions in that most of the lessons from past conversions will not apply this time around. Since the 1970s, the buy side has kept pace with the gradual shortening of the settlement cycle through a mix of innovation and increased staffing.
The move to T+1 will differ in two important ways:
With those two facts in mind, buy-side firms should already be well into the planning phase. They should be working to assess the implications of T+1 across the trade cycle and to identify the changes they will have to make to technology, operations and control processes, as well as internal behaviors. If successful in this transition, firms are poised to reap significant benefits in the form of capital optimization, increased operational efficiency and reduced counterparty risk. However, the challenges firms will face over the next year will be equally as large. To be prepared, senior management should make T+1 impact assessments and strategic planning a top priority from this point forward.
Meeting the demands of next-day settlement will require a myriad of changes to the systems and procedures used in key areas such as trade matching and allocations, settlements, securities lending and funding. This transformation will be highly complex due to the sheer number of points at which the shortening cycle will impact operations and settlement processes. As a result, planning for this change must take place at an extremely granular level. Some of the critical issues buy side firms will have to plan for are across the areas of trade matching and allocations, settlements, securities lending and funding.
In every one of these areas, technology is providing new solutions that will help buy-side organizations bridge gaps and make needed adjustments. For this reason, a key part of the T+1 planning process will be finding technology partners with the tools that best fit the organization’s unique needs and work cycles.
The buy side has less than a year to conduct the planning, execution, and testing required for a successful move to T+1. These preparations should start with a complete documentation of each step in the current trade lifecycle. Next, firms should map and overlay T+1 impacts, including knock on impacts beyond the settlement process in areas such as corporate actions. With that roadmap in place, firms should develop an implementation plan and create a testing strategy and business case for the transition.
As they plan their strategies, firms should prioritize the following features and capabilities:
One of the most important and challenging steps in transitioning to a shortened settlement cycle will be establishing processes that keep buy-side firms updated on the real-time status of trades and flag any potential inconsistencies at the earliest possible moment. Next-day settlement will leave little time for the resolution of breaks and fails or to manage risks in the corporate actions process. Currently, asset managers don’t know whether a trade has settled until they are informed by their prime broker or custodian bank. Often, that confirmation doesn’t arrive until T+2. In the meantime, the prime broker or custodian has been instructed to transfer funds to the trade counterparty, starting the clock on interest and fees charged to the asset manager. Failed trades trigger additional charges.
To prepare for T+1, buy-side firms will have to implement digital solutions that provide real-time transparency in the following areas:
Regardless of when the buy-side firm finds out about a potential problem, it will be a major challenge to resolve any issue manually in a T+1 environment. Upgraded settlement systems will have to include automated processes that identify potential problems and automatically initiate a resolution process among all parties to the trade. Those capabilities are already coming onto the market. For example, Broadridge’s NYFIX Matching provides features that automatically generate and send emails to the executing broker with cc’s to the NYFIX Matching’s support desk if the buy-side firm has not received required notifications from the broker within a predefined period of time.
The transition to next-day settlement will represent an important step in the industry’s efforts to achieve 100% straight-through processing (STP). Process automation initiatives required for T+1 will span many of the core operational and settlement functions that make up the trade lifecycle, including operations trade processing, operations settlement processing, corporate actions, fail management, reference data and others.
Some Buy-side firms already have a system in place that can streamline many of these functions. The DTCC’s CTM system can match trades and deliver settlement notifications to custodians and third parties. But routing all trades through CTM is not a viable solution for most firms. Due to high transactional costs, high volume firms route only a relatively small share of flows through CTM. That situation is manageable in the current T+2 environment, where firms have a full 48 hours to process exceptions and resolve problems. Under T+1, firms will officially have until 9pm on the day of trade to fix incorrect matches or disaffirm trades, but the real deadline will be much earlier. Remember, your own operations teams have to go home at some point and so do your brokers. To meet the new deadlines, trades will need to be matched by about 7pm. Broadridge’s NYFIX Matching solution, which is more accessible to many firms, aims to have 90 to 95% of matches consummated by 6pm on trade date and leaves only about 0.25% of trade volume for the following day. That’s the pace buy side firms will have to achieve to function effectively in a T+1 environment.
Every decision made in the transition to T+1 should be made with an eye toward the ultimate move to T+0. Compressing the cycle to next-day settlement will require significant investment of resources and time. Firms will maximize the returns on those investments by using the move to T+1 as an opportunity to set in place a digital, automated and flexible architecture capable of someday serving as the foundation of a T+0 settlement process.
The shift to T+1 will require additional changes beyond the scope of individual firms. To meet the timetable for T+1 and prepare for next-day settlement, the buy side will have to work together with the sell side, industry partners and regulators to address issues including:
Corporate actions: The move to a T+1 settlement cycle will have a significant impact on how corporate actions such as distributions, tender offers, exchange offers and rights subscriptions are handled in the settlement process. Specifically, it will shorten corporate action event dates, which in turn will have an impact on securities pricing in the event of a corporate action that occurs adjacent to a trade. In addition, there is increased risk and impact of managing fails, liabilities and claims in a shortened window. Ultimately, it will probably be up to the Securities and Exchange Commission to adopt reforms that align corporate actions with the new T+1 cycle, and eventually with same-day settlement.
FX markets: Asset managers buying foreign securities need local currencies to settle trades. Accessing the foreign currency in time to meet a T+1 or T+0 settlement cycle will be a challenge if FX markets are operating at a slower pace. Synchronizing the U.S. settlement process and global FX markets will require close collaboration among market participants and potentially regulators.
Securities Lending: The compression of the settlement cycle from T+2 to T+1 will reduce the amount of time that borrowers of securities, and lending agents must meet for recall issuances and processing. Currently, the deadline for recall issuances is 3pm on T+1. As that deadline moves up, lenders will have less time to instruct recalls and borrowers will have less time to return securities for settlement, setting the stage for an increase in fail rates. Regulators will have to set new rules and deadlines that allow the system to function in the shorter cycle, and market participants and technology vendors will have to implement new solutions to streamline the securities lending process.
The move to T+1 is complex and will tax buy-side resources to account for all the idiosyncrasies associated with this change. Next-day settlement will leave no time for manual interventions. Processes will have to be automated across the trade cycle. To achieve this goal, buy side firms will use technology solutions that didn’t exist when the settlement cycle moved from T+3 to T+2.
Given the complexity of the task, buy-side firms should not try to go it alone. Fintech has become one of the most dynamic industries on the planet. Every day, vendors roll out new and innovative solutions, many of which will help buy-side firms address the specific challenges that the T+1 transition poses to their organizations. Individual buy-side firms cannot be expected to have in-house expertise in all the technologies and process automation techniques that will be required for success. Partnering with a knowledgeable technology provider will ensure that the organization is aware of the latest and most effective tools and understands how to implement them seamlessly into their OMS and trade workflow. Just as important, the right external partners can help ensure that the investments the buy side is making to achieve T+1 are laying the groundwork for the next-gen settlement platforms that will eventually support the move the T+0.
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