T+1 settlement reaches America
28 April 2022
The US has announced a reduction of the securities settlement cycle from T+2 to T+1, following a relatively trouble-free transition from T+3 to T+2 five years ago. flow reports on the risks and benefits of this next step, market responses and what it could mean for atomic (immediate) settlement
Most securities transactions currently settle within a couple of days of the actual trade date (T+2). So, for stock bought on a Wednesday, the buyer would have paid for the shares and the seller would have delivered them by the Friday with the buyer becoming the holder of record of that security (T+2).
A combination of better technology, the sheer volume of securities trading and regulatory momentum is making this window smaller. The flow article, ‘Accelerated settlement – the move towards T+0’, (24 September 2021) examined the trend of market volatility driving compression of the securities settlement cycle and outlined the benefits (and risks) of shorter settlement duration.
In September 2017, the US Securities and Exchange Commission (SEC), together with Canada, Mexico, Peru and Argentina, reduced the securities settlement cycle – then T+3 – to T+2. Leading APAC markets – including Australia, India, Indonesia, Japan, Hong Kong, Korea, New Zealand, Singapore and Taiwan – had already migrated to T+2. In February this year, India began the next stage, from T+2 to T+1, adopting a phased approach to transition, which was summarised in the flow article, ‘India trumpets T+1 settlement’ (23 March 2022).
Having made the transition from a T+3 settlement model to T+2,1 the US is also now seeking to further expedite its securities settlement time-cycle to T+1, scheduling the changes to be rolled out in the first half of 2024. Ahead of this deadline, some industry experts are bullishly predicting that if T+1 is successful in the US, then adoption of T+0 – dubbed “atomic settlement” – will swiftly follow.
This article takes a closer look at the US settlement compression landscape, drawing on insights from Kamalita Abdool, Head of Securities Services, Americas, Deutsche Bank.
Settlement compression – sweeping away T+2
Following the equity market volatility triggered by Covid-19 and the meme stock trading turmoil, leading market makers recommended to the SEC that the current two-day trade settlement window should be condensed to one single day (T+1). Proponents included Citadel Securities and Virtu Financial, joined by financial market infrastructures (FMIs) such as the Depository Trust & Clearing Corporation (DTCC) alongside industry bodies comprising the Securities Industry and Financial Markets Association (SIFMA) and the Investment Company Institute (ICI).
“Shortening the settlement cycle should reduce the amount of margin that counterparties would need to post with clearing houses”
In February 2022, the SEC formally onboarded the recommendations by announcing proposals to shorten the settlement cycle from T+2 to T+1.2 “These proposed amendments to the securities clearing and settling process, if adopted, could lower risk to the financial system and drive greater efficiencies in the markets,” said SEC Chair Gary Gensler in the 9 February announcement.
He continued, “As the old saying goes, time is money. Shortening the settlement cycle should reduce the amount of margin that counterparties would need to post with clearing houses. Second, these changes would require affirmations, confirmations, and allocations to take place as soon as technologically practicable on trade date (T+0). Finally, the release would require clearing agencies that provide central matching services to have policies and procedures to facilitate straight-through processing — i.e., fully automated transactions processing.”
What is prompting the industry to lobby so forcefully for T+1? Supporters say a compressed settlement cycle will help negate settlement, counterparty and operational risk – a strong selling point especially when markets are behaving so erratically.3
“By removing a day from the settlement process, the industry will benefit from reduced risk,” comments Deutsche Bank’s Abdool. She concurs with the DTCC’s view that shorter rolling settlement cycles could help unlock vast sums of untapped liquidity once market participants no longer need to post as much margin on trades to cover counterparty exposure.4
While the DTCC concedes there might be some implementation costs to adopting T+1, it expects financial institutions to ultimately achieve net savings and benefit from infrastructure modernisation and the standardisation of industry processes.5 Abdool agrees. “The long-term strategic advantages of T+1 are compelling,” she says. “I believe it will encourage the industry to invest more into technology and in achieving better straight-through-processing (STP). Not only will this help the industry shift away from manual processing, but it will also boost resiliency and accuracy as well, adds Abdool.
T+1 – No change without risk
For all the anticipated benefits, there is a tacit acknowledgement that T+1 could also pose logistical challenges. For financial institutions operating in different time zones, settlement compression can create inefficiencies, especially around trade matching, end of day reconciliations and foreign exchange (FX) management. This is because the traditional two-day settlement window helps global investors manage FX, but a shift to T+1 would force FX to be booked on the same day/T+1 meaning all parties in the settlement chain will need to confirm trades on the trade-date – potentially resulting in issues around pre-funding.6
“As long as the industry continues to implement new technologies to address accelerated settlement then T+1 should be achievable”
Despite the potential pitfalls, many believe the T+1 transition will be relatively smooth. First, the industry has given itself more than two years to prepare and test its operations and technology infrastructure in advance of T+1’s go live date.7 “As long as the industry makes the technology changes which are required in advance of deadlines, then T+1 adoption is achievable,” says Abdool. “Custodian banks, FMIs and non-bank financial institutions are all impacted by these changes and are looking to test their systems accordingly.” Past precedent in the US also suggests that T+1’s adoption will be pain-free. For example, Abdool says industry experts warned that settlement fails would skyrocket ahead of T+2’s adoption in 2017, yet these warnings never materialised.
Betting on T+0
Assuming the migration to T+1 goes to plan, Abdool says the introduction of T+0 or atomic (i.e., immediate) settlement is the next logical step for the industry. However, she adds that digitalisation and the adoption of new technologies will be vital if T+0 is to actually happen. In the case of atomic settlement, proponents say this could be facilitated if disruptive technologies such as blockchain, smart contracts and central bank digital currencies8 (CBDCs) are integrated into post-trade activities. For instance, the use of digital money – i.e., CBDCs – in trade settlement could dramatically speed up the process, paving the way for real-time settlements. However, Abdool notes that collaboration between the industry and regulators is essential if T+0 or atomic settlement is to become the benchmark.
Against this, sceptics counter that some of these technologies are still untested, non-standardised and have yet to demonstrate proper scalability. While T+0 theoretically offers similar risk and efficiency benefits as T+1 (i.e., reduced settlement risk), one Industry Working Group says it is not feasible in the short term. On 1 December 2021, The Securities Industry and Financial Markets Association (SIFMA), the Investment Company Institute (ICI), and The Depository Trust & Clearing Corporation (DTCC) published a report targeting the first half of 2024 to shorten the US securities settlement cycle from trade date plus two days (T+2) to trade date plus one day (T+1).9
In the report, they explain that T+0 would require an overhaul of the existing clearance and settlement infrastructure; changes to business models (e.g. revisions to securities processing functions such as trade processing; ETF processing, margin investing, FX, securities lending, etc.); widespread regulatory reform and the adoption of real-time currency movements.10 Most significantly, T+0 would preclude firms from obtaining netting benefits – forcing them to pre-fund their trades. If T+0 or atomic settlement is to gain any traction, these non-trivial issues will need fixing.
Where do we go from here?
Having introduced T+2 smoothly, the industry is quietly confident that T+1 should prove to be equally frictionless, especially as there is ample time until the actual implementation date. If T+1 provides the risk management benefits claimed by its proponents, then the calls for a further optimisation of the settlement cycle will inevitably grow louder.
1 See https://bit.ly/3Kd8HB7 at sec.gov
2 See https://bit.ly/3kaXVAO at sec.gov
3 See SIFMA, DTCC, ICI, Deloitte– December 2021 - Accelerating the US Securities Settlement Cycle to T+1
4 See SIFMA, DTCC, ICI, Deloitte– December 2021 - Accelerating the US Securities Settlement Cycle to T+1
5 See SIFMA, DTCC, ICI, Deloitte– December 2021 - Accelerating the US Securities Settlement Cycle to T+1
6 See Business Standard (November 6, 2020) T+1 settlement not aligned to global standards, ASIFMA tells SEBI
7 See Pensions & Investments – December 27, 2021 – Push for T+1 settlement cycle gaining momentum
8 See CBDCs: what’s not to love? at flow.db.com
9 See https://bit.ly/3y9WD1p at dtcc.com
10 See https://bit.ly/3y9WD1p at dtcc.com
Head of Securities Services, Americas, Deutsche Bank
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