By Jeff Sardinha, Americas Head of ETF Solutions, State Street
Since the SEC T+1 rule went into effect late last month, U.S. financial markets have officially transitioned from T+2 (two-day) to T+1 (one-day) settlement cycles. Faster settlement cycles have increased market efficiency by freeing up capital for more dynamic trading and investment strategies. They have also reduced counterparty risk by minimizing the risk of one party defaulting.
While this story is well-established at this point, what is less known is that the ETF industry, facilitated by fund administrators and Authorized Participants , has long shown leadership on the shift to faster settlement cycles. It led the way to T+1 settlement before it became official policy, and it’s now charting the course to the next milestone, T+0.
The ETF industry was one of the early industry adopters of the T+1 settlement cycle, recognizing the benefits of reducing the settlement period to enhance trading and liquidity prior to the SEC imposing an official deadline. During the early adoption period of T+1 settlement, primary market ETF settlement saw both T+1 and T+2 cycles; ETF shares would settle on T+1 while the underlying securities in the order would settle on T+2. Now, both primary and secondary market activities are on a T+1 cycle, with primary markets also offering T+0 settlements. This evolution in ETF servicing is paving the way for a future where T+0 becomes the standard. This significantly benefited ETF trading, providing increased liquidity and ensuring smoother market operations.
The transition from T+2 to T+1 settlement cycles for ETFs introduces misalignments between the primary and secondary markets, causing delays and negatively impacting client experiences due to the differing settlement timelines. This shift necessitates significant operational adjustments, as Market Makers and Authorized Participants must expedite processes and potentially increase costs to ensure timely delivery of ETF shares. To mitigate these challenges, the ETF industry, including firms like State Street, has been developing “just-in-time” operating models and technology to align the primary and secondary markets more closely with the T+1 settlement cycle.
To address this, the ETF industry introduced an innovative solution: T+0 settlement for ETF shares. For this to work, T+0 orders have to be placed before the market opens, typically by 9:30 a.m. Custodians, such as State Street, then create and deliver new ETF shares to authorized participants (APs) intraday, based on a value placeholder. The final net asset value (NAV) is calculated at the end of the day, with cash differentials adjusted accordingly.
This approach not only streamlines operations but also ensures that ETF shares are minted and settled within the same trading day. T+0 settlements provide a robust mechanism for handling ETF transactions in a rapidly changing market environment.
The development and implementation of T+0 settlements has and will continue to require significant collaboration across the industry. Custodians, APs, issuers, and industry groups have worked together to design and implement these initial changes. Additionally, regulatory bodies such as the SEC played a crucial role in approving enhancements, including changes to the continuous net settlement (CNS) process by the National Securities Clearing Corporation (NSCC).
Operational adjustments were also necessary to ensure a smooth transition to T+0. Custodians adjusted staff schedules to accommodate the new settlement cycle without needing additional personnel. Early adoption of T+0 has been gradual but consistent, indicating its utility in certain trading scenarios. Support and guidance from the industry have been instrumental in facilitating this transition.
So far, case studies and examples of early usage will reveal the benefits of T+0 in enhancing market efficiency and reducing risk. Market participants have provided positive feedback on the utility and effectiveness of T+0 settlements, underscoring their value as gradual adoption becomes more consistent.
ETFs have always been at the cutting edge of the financial services industry. As ETF adoption becomes more widespread among investors, the shift to T+0 will gain even more significance, solidifying ETFs as a leading force in market innovation.
Looking ahead, there is potential for even shorter settlement cycles, potentially aiming for real-time (atomic) settlement. Such advancements would further enhance market operations, though significant technological and regulatory advancements are required.
ETF servicing firms like State Street have long played a pivotal role in facilitating settlements. The importance of continued innovation in settlement processes cannot be overstated. As we look to the future, the broader financial industry must embrace and support advancements that enhance efficiency and reduce risk. The ETF industry’s journey from T+1 to T+0 settlements exemplifies the progress that can be achieved through collaboration and innovation.
