The greatest challenge from shortening the settlement cycle is time, according to Robert Cavallo, Director, Clearance and Settlement Product Management, DTCC.
Speaking at the latest STA Open Call, he said that when the industry went from T+3 to T+2 in 2017, there was still one day left to do certain activities related to trading prior to getting a settlement.
Moving to a T+1 cycle will require more activity on trading.
Cavallo acknowledged the transition would be difficult. By moving to T+1, 24 hours was effectively being shaved off the existing settlement cycle.
On February 9, 2022, the SEC proposed to adopt rules and rule amendments to shorten the standard settlement cycle for most broker-dealer transactions from two business days after the trade date (T+2) to one business day after trade date (T+1).
The Commission also requested comments on a number of aspects of its proposed rules and rule amendments, as well as on considerations relating to shortening the standard settlement cycle to the trade date (T+0).
According to STA, there is a high likelihood that these amendments will pass. “This will require a change of behavior by all parties involved in the execution and allocation of trades.”
STA recommends that traders, sales traders and middle-office personnel gain a working knowledge and appreciation of the SEC’s proposal.
Cavallo said that DTCC and the Industry Working Group (IWG) including SIFMA, The ICI and Deloitte were able to identify critical trade processing and settlement activity and deadlines.
The allocation of institutional trades is one of the key post-trade processing steps, according to Cavallo.
“Once trades are allocated in the account level, the affirmation and confirmation process begins,” he said.
Current processing shows that approximately 20% of allocations occur throughout the trading day with the remaining 80% of allocations occurring after market close on trade date.
He noted that the confirmation and affirmation process can only occur once allocations have been completed.
Given that most allocations occur post-market close, the current affirmation timeline is set at 11:30 AM ET on T+1. This will need to change in order to meet a T+1 settlement cycle.
In a T+1 settlement cycle, the group agreed that a new affirmation cut off should be 9:00 PM ET on trade date. Both U.S. and non-U.S. institutional investors will need to adopt process and behavioral changes to meet this new cut-off time.
In December, DTCC and the IWG published a paper: “Accelerating the U.S. Securities Settlement Cycle to T+1.”
To meet a new affirmation cut-off time of 9:00PM ET on trade date, the IWG recommends that allocations are made as soon as practicable after an order is executed to ensure members have sufficient time for affirmation processing.
Market participants located outside of the U.S. may need to consider pre-allocating trades prior to the close of their business day or the complete execution being filled to ensure the allocation process is completed, according to the paper.
Encouraging trades to be affirmed throughout the trading day increases the time firms have to process allocations and increases the likelihood of timely affirmation.
Moving to a T+1 settlement cycle, which involves compressing the allocation timeframe, could lead to an increase in trade breaks if the allocations are not completed in a timely manner.
DTCC and the IWG recommends updating legacy technology systems and processes to increase allocations and affirmations by deadlines.
“Firms should update the legacy technology systems and processes to increase allocations and affirmations,” said Cavallo.
The firms should also look into adopting technology as well as updating any messaging protocols flow to achieve a more timely estimation process, he said.
“I think, there’s a lot to do, but it’s achievable. It just requires a combination of looking at your system,” stressed Cavallo.
