By Doug Gifford, Senior Director, Regulatory at Broadridge Financial Solutions
The financial services industry is now well underway with testing in advance of the May 2024 shift to T+1. With more than a quarter of the testing period now in the books, the good news is that testing to this point has not uncovered any systemic breakdowns. That said, the tests have revealed a number of challenges that individual firms and the industry will have to address to ensure the migration to next-day trade settlement in North America in May 2024 goes off without any major hitches.
One challenge is a number of buy-side firms have yet to focus on the T+1 migration. Many buy-side firms, especially smaller ones, are working under budget constraints. They have less access to technology solutions and are moving more slowly than the rest of the industry to prepare. That could create troublesome gaps as the industry moves to next-day settlement.
In order for trades to be settled on the day after the trade date, the allocation, confirmation, and affirmation process must be completed on the day of trade. The DTCC has set 9:00 PM on trade date as the cutoff for affirmation. To hit that deadline, buy-side firms will have to be prompt in sending allocations to sell-side counterparties and responding to confirmation with their affirmations.
Recent statistics show that overall buy-side engagement with T+1 migration has improved. DTCC has reported the same-day affirmation rates in the United States have risen 5% in the past four months, but some individual firms are struggling to hit that mark. DTCC reports the 9:00 PM affirmation rate for bilateral trades, (excluding Prime Broker trades) was 53% in September, and in Canada, The CDS reports the same-day match rate currently sits at 46%, measured at the 3:59am T+1 cutoff that will be recommended by the CSA in amendments to NI 21-104.
Sell-side firms need to take the initiative by identifying buy-side counterparties that are lagging behind and proactively reaching out with advice and assistance. Under Rule 15c6-2 the SEC has placed the onus on sell-side firms to document that they have rigorous processes in place to complete the allocation, confirmation, and affirmation process on trade date. Firms should be leveraging their allocation confirmation and allocation data to analyze their current performance, both on an overall basis and by counterparty. Particular attention needs to be given to non-North American counterparties.
Regulators will be assessing sell-side firms on the robustness of their overall process so it is in the best interests of every sell-side firm to help ensure counterparties are prepared in order to avoid problems and delays in May. Further, The SEC has announced in their 2024 Exam Priorities they will assess firms preparations for the shortened settlement cycle.
Match to Instruct
One way sell-side firms can help counterparties quickly upgrade unstructured manual processes is to direct them to the DTCC’s Match to Instruct process, which the DTCC describes as a solution designed to facilitate T+1 settlement by automatically triggering trade affirmation and delivery of DTCC-eligible securities directly to DTCC for settlement when a trade match between an investment manager and executing broker is achieved. Interest in Match to Instruct has been growing. Although usage remains relatively low in absolute terms, the DTCC recently reported a 91% increase in the number of buy-side firms utilizing the solution in 2023. DTC reports that the 9PM affirmation rate for Match to Instruct transactions is 99%.
End-to-End Testing
As the testing moves forward, both sell-side and buy-side firms should be taking steps to ensure they get the most out of the process. That means extending internal testing to the entire trade ecosystem. Firms that limit testing to specific back-office functions risk missing issues that can potentially delay the settlement process. The only way to ensure firms uncover any and all potential chokepoints is to conduct testing across the entire trade lifecycle, including all upstream and downstream processes, from execution to settlement, asset servicing, and downstream processing. Testing should include counterparties and all relevant vendors.
Beyond T+1
SEC Chairman Gary Gensler has been clear that he views T+1 as a stepping stone to T+0. Both buy-side and sell-side firms should be using the current T+1 planning and testing phase as an opportunity to identify and document the many process and technology upgrades that will be needed for a move to same-day settlement. Where possible, solutions implemented for T+1 should be designed with T+0 requirements in mind. The industry as a whole should adopt the same mindset. Making the jump to T+0 will require structural changes to address issues of liquidity, reduced netting benefits, increased costs of funding and a host of other concerns.
The more immediate change to T+1 will require coordination among market participants for things like ensuring settlement rates and liquidity in securities lending markets and addressing collateralization and stock lending issues inherent in the ETF create and redeem process. That cooperation will set an invaluable precedent for the coming move to same-day settlement, which will require market structure change on an entirely different scale.
The industry and regulators should take comfort that T+1 testing has not uncovered any major fault lines. But as the rest of the testing process unfolds, all market participants should bear in mind that the May transition to next-day settlement is not the end goal, but merely the next big step in the direction of T+0.
