By Scott Gold, Head of Sales, Americas at SGX FX
With less than ten days to go until the shortening of the settlement cycle for U.S equities and bonds (T+1), there is an undeniable urgency to dot the I’s and cross the T’s on final preparations. Asset managers outside the U.S find themselves at the forefront of significant upheaval, grappling with a myriad of time zone driven challenges. What’s particularly interesting is that the mood of market participants across continents reveals a common thread of apprehension, underscored by the absence of a perfect solution. However, amid the frantic final days, an opportunity for nuanced, as opposed to wholesale change, could not only increase efficiency across the cash equity and bond desks, but FX as well.
How FX trades are conducted to source the required currency when purchasing, for example, S&P 500 or Nasdaq stocks is a key consideration. Asset managers, particularly those based in either APAC or Europe, will be up against it to match their equity trades and execute the FX trade required to source dollars to settle the U.S stocks. A lot of non-U.S. based asset managers, particularly those with smaller assets under management (AUM) and limited resources, are considering a sticking plaster short term fix of either opening a US based office or having their FX traders work US hours. This is due to the small window, from 4-6pm NY, to get FX trades finalised and completed. This is certainly an option, but it is not exactly ideal.
A more common approach, which is prevalent among Asian based funds, is pre-funding. Pre-funding trades in FX means having enough money in the account to ensure the necessary funds are available to execute equity and bond trades without delay or risk of being unable to fulfil them. On the surface, this seems like the most logical option, but pre-funding comes with its own costs. Investment managers who pre-fund will only be able to account for around 75-80% of the FX they’ll need. The remaining 20-25%, known as the ‘true-up’ will need to be done between the all-important 4pm (EST) equity market close, and the Continuous Linked Settlement (CLS) 6pm (EST) window. As there are no global markets open during this time, roughly, less than 1% of trades in the $7 trillion OTC FX market are carried out in this window which makes execution quite costly. This cost is exacerbated at 5pm (EST), when most of the large investment banks shutdown their market making pricing engines for anywhere up to 30 minutes.
All this means that between 5pm and 5:30pm, there is even less liquidity because banks are sifting through their trading system restarts. As a consequence, bid/ask spreads widen and liquidity shrinks – leaving traders worried about their performance being reviewed during a small window where it is neigh on impossible to deliver strong returns. Then there is the third alternative option to pre-funding – which involves an asset manager outsourcing all their FX trading to a custodian bank. But much like going down the 100% pre-funding route, or flying out an FX trader to the U.S., giving everything over to the custodian approach is not ideal because fund managers could end up getting filled at much worse prices.
This begs the question – what is the ideal approach? So much of what constitutes a successful migration to T+1 will be down to technology. While a complete tech stack overhaul may not be possible, there is a real opportunity for asset managers to make incremental changes to their FX workflows in order to reduce their operational risk and limit additional FX related costs that T+1 will bring.
For instance, one specific area that could make a noticeable difference from day one is around rules-based execution. An investment manager that is pre-funding, should know time horizons by the currency pairs that are most liquid and when spreads are tightest, specific to their own bespoke liquidity. Then, they can create automation around executing their FX during peak windows of time which would reduce the overnight wake up calls traders may have otherwise. Further, this would reduce the time it would take for a trader to seek out the best execution method. Detailed insights such as what times of day an asset manager should be trading a particular currency pair, and where the liquidity provider is pricing an asset manager throughout the trading day, are also important and would reduce execution costs. Another piece of technology that has not been adopted by the real money community is the mobile app. For traders working odd hours or forced to login in the middle of their night, being able to have a view only look at the orders on your mobile device, to have piece of mind your automation is working as expected, will be a big value add.
While the move to T+1 settlement undoubtedly presents a complex web of challenges for asset managers, particularly those operating outside the U.S., it also heralds an era of potential technological refinement rather than wholesale transformation. As these managers navigate time zone constraints and liquidity bottlenecks, the adoption of incremental, tech-driven solutions— such as rules-based execution and pre-funding — can mitigate the risks and costs associated with the new settlement cycle. The final few days in the lead up to T+1 may not be seamless, but it offers a pivotal moment for asset managers to enhance efficiency in FX trading. Ultimately, those who focus on nuanced advancements will be better positioned to thrive in a post T+1 world.
