By Danny Green, Head of International Post-Trade Solutions, Broadridge
T+1 offers a golden opportunity to bolster post-trade processing capabilities to achieve a long-term competitive advantage. Forward-thinking firms can now use T+1 compliance as a driver for real operational efficiency gains. But there remains much to be done.
As we should all be aware, the Securities and Exchange Commission (SEC) has adopted the rule to shorten the settlement cycle to T+1, effective from 28 May 2024 for most US securities transactions that settle through the Depository Trust & Clearing Corporation (DTCC).
Given the interconnectivity of North American markets, this decision is in synch with the Canadian Capital Markets Association (CCMA), which will transition to T+1 a day earlier, on Monday 27 May 2024.
The shift to a T+1 trade settlement cycle represents a critical step for the financial services sector at a time when markets are changing and accelerating at a fast pace.
Shortening the settlement cycle will reduce the depository collateral requirements that put Robinhood and global markets under substantial pressure in the GameStop episode, and will provide significant relief to market participants in periods of heightened volatility. It will also generate other risk reductions, as well as free up capital for high-priority business needs and increase overall operational efficiency.
Other benefits will include lower counterparty risk, increased market efficiency, decreased margin deposits for broker-dealers, and faster access to funds.
I believe it’s crucial we simplify the trade life cycle so we are no longer solving problems 24 hours later. Instead, we should be solving them in the trade support areas on trade date, and reducing the number of failed trades.
T+1 now requires considered engagement across the global industry. As well as the benefits, the compression of the settlement cycle to 24 hours will create significant challenges and potential new costs for individual firms.
The implications from the move will extend far beyond operations and technology, affecting funding practices, revenues, and balance sheets.
Ripples felt across the global landscape
The transition to T+1 has become a global concern. With the US on track for T+1, other markets are feeling increased pressure to follow suit. The UK’s Accelerated Settlement Taskforce, for example, has recommended a two-phased approach1 to shortening the settlement cycle, beginning with operational changes from 2025 and full transition by the end of 2027.
Fund managers have also been urging European regulators to mirror the move to T+1, with the Financial Times reporting many are warning of a “major and serious risk”2 to the continent’s capital markets if regulators don’t copy the US and Canada and cut settlement cycles to one day.
The European Securities and Markets Authority (ESMA) launched a call for evidence last year on whether European Union (EU) markets should also move to T+1. ESMA is now busy assessing the responses, and is set to publish its final report in January 2025.3
Gary Gensler, chair of the SEC, accentuated matters at an event in Brussels earlier this year, saying European regulators and market participants must now consider narrowing the window to finalise deals to a single day. His comments came as Mairead McGuinness, the European Commissioner for Financial Stability, Financial Services and Capital Markets Union said it was a question of “when and how”4 the bloc shifts securities settlements to a single day.
ICI Global’s Michael Pedroni5 is amongst industry voices saying that EU policymakers should commit to move to T+1 settlement and then communicate a clear path to implementation.
The shift to T+1 in Canada and the US will also have a profound impact on investors and their service providers in Asia. Faced with time differences of up to 14 hours, Asian investors will have no choice but to complete all of their processing for North American trades on trade-date – so that all trades are fully funded, matched, and ready to settle before the end of the Asian trading day.
This acceleration of processing will have a significant impact across the entire front-, middle- and back-office operations in Asia, and therefore demands significant preparation and change. However, 6 as well as affecting all geographical markets, the move to T+1 touches on all market participants.
Sell-side firms now need to understand the behavioural, structural, operational, and technological change costs associated with executing a T+1 strategy. In a T+1 setting, the previous strategy of simply adding more resources to perform manual functions will become problematic. Firms will not have the time needed to execute essential functions manually, and will become far more reliant on technology to meet deadlines and demands.
And if they have not done so already, buy-side firms must quickly complete a detailed impact assessment on the implications of T+1 across the trade cycle and identify the changes they need to make to their technology, operations, and control processes to future-proof their business. With the go-live date approaching fast, brokers and buy-side organisations are hurrying to complete a daunting schedule of planning, testing, and implementation.
Ultimately, there is no universal playbook on how to assemble new processes and technologies into an infrastructure, and a governance structure, for next-day settlement.
Every firm must chart its own unique course, identifying the necessary changes for current procedures and finding effective solutions.
Here are some suggestions that they may find useful as they look to tackle this challenging task.
Sharpening up the sell-side
Brokers rely on their clients for critical data throughout the trade processing and settlement cycle.
Under the new T+1 rules, brokers will need this data much earlier. The sell-side will be required to complete the affirmations, confirmations, and allocations process on the day of trade. In addition to ambitious upgrades of key internal functions, hitting those deadlines will require timely inputs from clients. As a result, a core part of preparing sell-side firms for the switch to T+1 will be ensuring that buy-side partners are equipped to keep pace with the new, accelerated demands.
Planning should have started long ago with a comprehensive mapping of their trade cycle, and a detailed assessment of how – and where – the move to T+1 will impact trade processing and settlement at each point in the cycle.
Effectively analysing those findings will then allow firms to flag adjustments they will have to make to technology, operations and control processes, and internal behaviours. These will not be short lists.
The shift to T+1 therefore requires significant investments of both time and resources. To lay the foundations for a successful outcome and maximise the returns on those investments, I would recommend that sell-side firms follow these five guiding principles when developing their T+1 transition plans.
- Use T+1 as a catalyst for strategic automation projects
If there was ever a catalyst for automation, T+1 is it.
Manual interventions that seem innocuous now will emerge as significant obstacles in a T+1 environment, causing compounding disruptions and delays. Some manual functions catalogued in the planning phase for T+1 transition will be relatively quick and easy to address—with the right solutions.
Third-party vendors can now provide robotic process automation (RPA) applications and other tools that can be used to automate routine tasks relatively quickly, inexpensively, and without interfering in other processes and functions.
T+1 should really provide the motivation needed to get these “low-hanging” automation projects completed now.
Sell-side operations and technology teams should use the looming deadlines for T+1 transition to unlock funding for these valuable projects. Think about it like basic maintenance for your car. A full tune-up can seem costly up front but remediating minor issues now will avoid potentially more difficult issues later on.
- Set your sights on Straight-Through Processing (STP)
T+1 remediation efforts should never be viewed simply as one-off projects.
Rather, all alterations required for T+1 should serve as steps in the firm’s broader and more strategic journey to STP.
SEC Chairman Gary Gensler likened the transition to T+1 to upgrading the market’s plumbing from bronze to copper pipes.7 In the midst of this industry-wide renovation, focusing entirely on individual fixes for T+1 is like patching up leaks with duct tape.
It’s much smarter, and more cost effective, to direct money and time to bigger capital improvements that will enhance the organisation’s overall efficiency.
Many banks and brokers still run on legacy systems that have been pieced together through multiple mergers and business expansions over the course of years – or even decades. Most firms are in the midst of digital transformation initiatives designed to break down siloed systems and eliminate fragmentation. One of the primary goals of these projects is to facilitate the free flow of timely and reliable data across organisations.
Over the long term, sound data management and governance capabilities will serve as the foundation of automated STP platforms that eliminate, or at least dramatically reduce, the need for human intervention.
More immediately, consistent, reliable, and timely data are basic requirements for the RPA tools, AI applications, and other tools that firms will need to meet T+1 deadlines. For that reason, firms that plan well should be able to use T+1 preparedness as a springboard toward more automated trade and settlement processes and, ultimately, to STP.
- Build incrementally with a modular architecture
Digital transformation strategies can often span up to five years. With T+1 imminent, brokers will have to prioritise very carefully.
As they do so, they should take advantage of important technological innovations such as cloud computing, APIs, and software-as-a-service (SaaS). Together, these tools make it easier for firms to build next-generation technology platforms incrementally.
Today’s organisations can construct their technology infrastructure using a “modular” design. Using this approach, firms can select the right components for each function and integrate them into their broader architecture without necessarily interrupting or revamping adjacent functions. With this considered strategy, firms can gradually assemble individual solutions into a comprehensive, automated platform, provided they start with the right plans and the right technology partners.
- Get a real-time view of inventories
The move to T+1 represents a real paradigm shift for the sell-side.
From this point on, firms will have little to no time for manual reconciliations of internal positions. In a T+1 environment, firms will require something close to a real-time view of cashflows and inventories across the entire organisation.
Unfortunately, most firms do not have a holistic vision of their inventories—at least not in real time. Inventories are typically fragmented by line of business and geographies.
Positions are often held in multiple DTCC accounts. This system is generally sufficient in a T+2 environment, but it will be challenged in T+1. For example, in the securities lending business, brokers currently have until 3pm* on T+1 to recall securities from borrowers. In the faster settlement cycle, that deadline will be advanced to 11:59pm on day of trade, or even earlier.
In many cases, that won’t leave enough time for the broker to receive notice that the original holder of the security is selling, send out a recall to the borrower, and receive and deliver the security. Missing that deadline would most likely result in a failed trade and the introduction of market risk – not to mention the knock-on impact to other parts of the post-trade ecosystem, such as corporate actions processing.
As a result, brokers will have to become much more efficient in netting out positions across their entire inventories and organisations. To do so, they will need a consolidated view of positions across asset classes, geographies, and business lines. It won’t be enough to generate that view at the end of the batch cycle—it will have to be available in real time.
Upgrading to that real-time, consolidated view will create real benefits. New real-time transparency and predictive analytics will allow firms to project availability and demand, and optimise inventories for lending and borrowing. The same capabilities will create similar opportunities to enhance efficiencies in other businesses.
Achieving this goal is much less difficult than it would have been just a few years ago. Today, fintechs are offering comprehensive systems that help even the biggest sell-side firms to monitor and manage inventories in real time.
- Find the weak links in your client lists
As mentioned earlier, sell-side firms will have to rely on their clients to help hit new deadlines imposed by T+1.
In some cases, that shouldn’t be a problem. Some buy-side firms, especially large hedge funds and asset management complexes, match their sell-side counterparts in terms of technology stack and automation. These firms should be well prepared for the switch. However, other buy-side firms are still using many manual processes, with some firms still emailing allocations to their brokers.
As they create the policies, procedures, and working agreements that will govern trade processing and settlement in the new trade cycle, sell-side firms should be carefully reviewing their client lists, assessing the capabilities and preparedness of individual clients, and flagging the firms most likely to cause problems.
Sell-side firms should be reaching out to their slowest and most manual clients to help them head off issues that could disrupt the settlement process in live T+1 trading.
This effort can actually serve multiple purposes. Most importantly, it can help ensure that both sides are prepared for the new deadlines imposed by next-day settlement. However, this outreach can also be positioned as an educational and advisory service to clients, creating new opportunities for positive interactions with the buy-side, and potentially strengthening client relationships.
Bolstering the buy-side
It’s important to be aware that the transition to T+1 will be unlike previous settlement compressions in that most of the lessons from past conversions simply do 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. But the move to T+1 will differ in two important ways.
Firstly, in a T+1 environment, buy-side firms will simply not have the time needed to execute essential functions manually. As they transition to T+1, firms will become far more reliant on technology to meet new deadlines and new demands.
And secondly, innovation has now provided a host of new solutions, including RPA, AI and enhanced data exchange, that can help buy-side firms to better automate processes. Much of this technology did not exist – or was not widely available – during the T+2 transition.
With those two important facts in mind, buy-side firms should be working hard to assess the implications of T+1 across the trade cycle and to identify the necessary adjustments they will have to make. To be properly prepared, senior management should make T+1 impact assessments and strategic planning a top priority.
Meeting the demands of next-day settlement will require countless 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.
The good news is that in every one of these areas, technology is providing new solutions that will help buy-side organisations 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 organisation’s unique needs and work cycles. And as they plan their strategies, I suggest firms prioritise the following features and capabilities.
Real-time transparency
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, of course, trigger additional charges.
To be truly ready for T+1, buy-side firms will have to implement digital solutions that provide real-time transparency in the following areas:
- SSI: A large proportion of trade breaks originate in the default standing settlement instructions (SSI) established by individual market participants for payment and delivery of securities. Identifying inconsistencies in these instructions at the start of the trade process will give buy-side firms the opportunity to resolve problems immediately. That will achieve two important goals.
Firstly, it will eliminate time wasted waiting for custodian banks and brokers to report an issue, potentially saving as many as 24 hours; and secondly, it will dramatically reduce the number of trade breaks that need to be addressed and resolved after the fact.
- Parallel processes: Buy-side firms will have to create new procedures for delivering trade details to prime brokers and coordinating information amongst the asset manager, executing brokers, and prime brokers.
Currently, buy-side firms deliver trade data to executing brokers and prime brokers separately. The trade and allocation details are sent to the prime broker before the trades are matched with the executing broker. This is a timing problem which causes issues on T+1 if there are any trade discrepancies between the asset manager and the executing broker. When the asset manager and executing broker identify and resolve an exception, the prime broker is out of the loop. That disconnect introduces timing and market risk, not to mention a delay that often stretches for a full day. Obviously, that process won’t suffice in a T+1 environment.
Buy-side firms will have to implement solutions that supply prime brokers with trade details in real time as soon as trades are matched between the asset manager and the executing broker, or send the trade details to the prime brokers after the trades are matched.
Automated follow-up
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 amongst all parties involved in the trade.
Those capabilities are already coming onto the market. For example, there are solutions with features that automatically generate and send emails to the executing broker with CCs to the relevant support desk if the buy-side firm has not received required notifications from the broker within a predefined period of time. It’s worth firms taking the time to check out such solutions, and work out which are the best fit.
Process automation
As touched on earlier in the article, the transition to next-day settlement represents an important step in the industry’s ongoing efforts to achieve 100% 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, fails management, reference data, and others.
Some buy-side firms already have a system in place that can streamline many of these functions.
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, it is likely that trades will need to be matched by about 7pm.
Laying a future-proof foundation
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 a significant investment of resources and time.
Firms will maximise the returns on those investments by using the move to T+1 as an opportunity to put in place a digital, automated, and flexible architecture capable of someday serving as the foundation of a T+0 settlement process.
Thinking about the critical next steps
On the subject of T+0, it’s perhaps inevitable that as we approach the switch to T+1 settlement, many in the market are already trying to look further ahead to potential same day settlement, in order to avoid future lengthy implementation delays.
However, many believe it’s currently not a viable reality. Recent research by Coalition Greenwich8, for example, found the feasibility of shortening the cycle even further “would represent a more radical transformation with far-reaching implications and potential unintended consequences” and demands careful consideration before empirical moves can be made.
I believe the industry will need roughly another five years after the start of T+1 to be truly ready for the ultimate move to T+0. In that timeframe, regulators and market participants will have to come together to tackle three key issues:
- A consensus on what T+0 actually means. Should the industry adopt an instantaneous real-time gross trade settlement model, or T+0 end-of-day net settlement?
- Construct a practical framework. The technology infrastructure required to achieve T+0 cannot be so cost prohibitive that smaller market participants can no longer be competitive.
- Create benefits for end investors. T+0 needs to deliver net benefits to the end investor, either through price improvement or liquidity.
Ultimately, when it comes to T+1, and in the future T+0, collaboration is going to be absolutely crucial.
It’s important that firms don’t try to go it alone. Every day, vendors are rolling out new and transformative solutions that can help firms to address the specific challenges that the T+1 transition poses to their organisations, whilst taking advantage of the new benefits it unlocks.
Such solutions are now more widely available from a growing number of fintech providers that can help the industry to address inefficiencies, embedding operational excellence as a core competency.
We have a genuine opportunity to future-proof our industry. Let’s make sure we take it together.
*Editor note: All times referenced in this piece are Eastern, or generally five hours behind London time.
——————————————
1 – “UK Taskforce recommends T+1 settlement by the end of 2027 in two-phase approach”, The Trade, 28 March 2024; 2- “Fund managers urge European regulators to mirror US move to T+1”, Financial Times, 15 Jan 2024; 3- “UK looks to harmonise T+1 move with Europe”, ETF Stream, 2 April 2024; 4 – “SEC’s Gensler calls for shorter settlement times in currency markets”, Financial Times, 25 Jan 2024; 5- “ICI and ICI Global Welcome EU Consideration of T+1 Settlement Cycle,” ICI Global, 15 Dec 2023; 6- “T+1 for Asian Brokers – Risk and Rewards” Broadridge; 7- “Time is Money. Time is Risk” Prepared Remarks before the European Commission, ” Gary Gensler, 25 Jan 2024 as published on the website of the US Securities and Exchange Commission; 8 “Top Market Structure Trends to Watch in 2024”, Coalition Greenwich, 3 January 2024
