The dawn of T+1: how to prepare for a shorter settlement cycle

As firms prepare for the T+1 transition, migration plans should consider the potential challenges. They should also provide enough time for market participants—including brokers, investors, and custodial banks—to upgrade their systems and operational processes to minimise trade failures or other related disruptions due to the new compressed timeline.

Firms facing funding challenges will benefit from a shortened settlement window via improved cash flows, leading to increased liquidity in the market and ultimately giving investors quicker access to funds. The market will inevitably see a reduction in counterparty risk, and market participants will see a reduction in the amount of collateral required to cover their potential exposure to market and counterparty risk during the settlement period.

The transition to T+1 will strike a balance by reducing the potential for procyclical behaviour in the market while maintaining appropriate levels of risk-based margin. Depository Trust & Clearing Corporation (DTCC) risk model simulations estimate a 41% reduction in the volatility component of the National Securities Clearing Corporation (NSCC) margin requirement. This could result in billions of dollars of savings for member firms, according to a DTCC white paper.

The transition is also an opportunity to modernise post-trade processing systems through technology adoption and the automation of manual processes. This could significantly reduce operational risk, increase productivity and reduce friction for market participants.

While an increase in initial buy-ins, earlier up-front close-outs and up-front implementation costs are possible in the transition to T+1, the industry expects a long-term cost reduction for market participants and, ultimately, the costs borne by end investors.

By adopting these recommended practices and implementing behavioural changes across the industry, all market participants have an opportunity to standardise and synchronise processes to facilitate greater transparency and attain real-time access to critical data across the financial ecosystem.

The Securities Industry and Financial Markets Association (SIFMA) has outlined its key considerations on T+1 settlement for businesses:

Business model

Firms should assess the impact of the T+1 settlement cycle on their business model. While business models are unlikely to be significantly affected by changes in the trade processing lifecycle there may be staffing and workload considerations to take into account. Teams may need to acquire different skill sets to effectively utilise automation tools for these processes.

Product type

Firms must consider the various implications for specific product types impacted by industry-level requirements or sub-requirements. For example, there will be better alignment of portfolio shares with mutual funds that currently settle T+1, which can help firms from a cash management perspective. On the flip side, exchange-traded funds (ETFs) often contain underlying securities from different jurisdictions, which can lead to settlement delays in the T+2 cycle. The move to T+1 will make these challenges even harder to overcome.

Vendor and third-party service support

Firms should ensure that any vendor or dependent service bureau has the support needed to implement end-to-end T+1 trade flows and processes and complement asset service providers in providing up-to-date record-keeping functionalities concerning corporate actions and distributions.

Trading venue

Market participants should review trading venue-specific requirements to changes in the settlement cycle and the impact on ex-date. Also, foreign investors may be deterred from trading in U.S. financial markets if they are unable to pre-fund their trades.

Risk and compliance

Firms should assess the operational process, procedure and policy changes impacted by the T+1 implementation. Risk management and regulatory compliance must be maintained. Failure to appropriately transform trade processes and relevant systems for the new settlement cycle may compromise their ability to execute and settle trades in accordance with regulatory guidance.

Client experience

All market participants should evaluate the shortened settlement cycle’s impact on internal and external stakeholders. For example, clients and investors in Europe and Asia may be required to pre-fund cash positions and deposit securities before trading. They will also be impacted by foreign exchange and time zone differences, which will complicate US and Canadian post-trade processing. All of which points to the benefit of Europe and other jurisdictions following a similar transition timeline.

Technology enablers

Market participants will want to assess existing technology and schedule updates and testing to support T+1 implementation, given the inevitable move to real-time settlement. Firms should evaluate and enhance technology platforms supporting corporate action announcements, pricing, stock records, securities lending, liquidity management, global markets, options settlement, and primary offerings to avoid operational and data-related issues.