The global impact of T+1
11 May 2022
As more markets — namely the US, Canada and India — look to shorten their trade settlement cycles from a T+2 model to T+1, Aneet Shah, managing director and head of custody product and network management at RBC Investor & Treasury Services, shares his insights on how market participants can manage the transition
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The US and Canada bide their time on T+1 implementation, while India pushes ahead
India recently began phasing in a rolling T+1 settlement cycle, starting with the bottom 100 stocks by market.
This change suggests that all publicly-traded securities in India will be traded on a T+1 basis within the next 18 months to two years.
In contrast, the US and Canada — both of which have announced that they will transition to T+1 — are not planning to change their settlement cycles until 2024.
T+1 will spur risk reduction, enhanced liquidity and greater innovation
Risk reduction — especially given the volatility sweeping through securities markets today — is one of the primary benefits of moving to a T+1 model. Optimisation of the settlement cycle will help market participants reduce their risk exposures, prior to the exchange of cash and securities between trading counterparties.
Faster settlements will allow cash to be released quicker into the financial system, thereby driving up liquidity. A faster settlement cycle could additionally help strengthen market infrastructures as it will encourage participants to modernise their systems and processes by embracing innovative technologies.
The pivot to T+1 will create challenges for market participants
Shorter settlement cycles create operational complexities for trading counterparties.
A shorter settlement cycle will result in higher trade settlement fail rates in the short- to medium-term, although this should improve over time. With penalties being imposed for trade fails under the EU’s Central Securities Depositories Regulation, this is something firms need to be aware of.
The transition to T+1 may be disruptive for allocations and affirmations, securities lending and corporate actions.
For example, a T+1 settlement cycle could put pressure on the securities lending business to ensure timely recall of securities on loan or buy to cover. It may also have an impact on income distributions. The ex-dividend date will now take place on the record date of the event, as opposed to just before the record date.
Market fragmentation is not a problem
Market fragmentation is not a problem, but financial institutions need to think about how they manage their foreign exchange (FX).
Financial institutions have a long track record of operating in an environment where settlement cycles in different countries are not synchronised. Accordingly, the risks of some markets shifting to T+1 while others retain T+2 or T+3 should not be met with alarm.
Custodians have the ability to support clients trading in multiple markets and running on different settlement cycles. However, the divergent time zones might create complications in FX management as this could force firms in different markets to pre-fund their trades in T+1 countries, unless they are long currencies in those particular jurisdictions.
Firms must optimise their FX management processes. This can be done either through engaging with an FX settlement support provider or by tightening up FX booking instructions to avoid the need to pre-fund transactions. Such actions will be vital, as pre-funding can mean that financial institutions’ cash is tied up in the trade settlement process, instead of being properly invested and producing returns.
Further compression of the settlement cycle is likely
A move to “T” is not out of the question as several markets already adopt this cycle — most notably the northbound leg of Hong Kong’s China Stock Connect.
Atomic settlement is possible through the deployment of new technologies such as application programming interfaces, blockchain, central bank digital currencies (CBDCs) and stablecoins, in addition to working towards a single source of truth or ‘golden source data’ that can be shared securely across the value chain.
Blockchain allows for the real-time transmission of data while CBDCs would ease some of the FX challenges faced in today’s cross-border settlement processes.
India recently began phasing in a rolling T+1 settlement cycle, starting with the bottom 100 stocks by market.
This change suggests that all publicly-traded securities in India will be traded on a T+1 basis within the next 18 months to two years.
In contrast, the US and Canada — both of which have announced that they will transition to T+1 — are not planning to change their settlement cycles until 2024.
T+1 will spur risk reduction, enhanced liquidity and greater innovation
Risk reduction — especially given the volatility sweeping through securities markets today — is one of the primary benefits of moving to a T+1 model. Optimisation of the settlement cycle will help market participants reduce their risk exposures, prior to the exchange of cash and securities between trading counterparties.
Faster settlements will allow cash to be released quicker into the financial system, thereby driving up liquidity. A faster settlement cycle could additionally help strengthen market infrastructures as it will encourage participants to modernise their systems and processes by embracing innovative technologies.
The pivot to T+1 will create challenges for market participants
Shorter settlement cycles create operational complexities for trading counterparties.
A shorter settlement cycle will result in higher trade settlement fail rates in the short- to medium-term, although this should improve over time. With penalties being imposed for trade fails under the EU’s Central Securities Depositories Regulation, this is something firms need to be aware of.
The transition to T+1 may be disruptive for allocations and affirmations, securities lending and corporate actions.
For example, a T+1 settlement cycle could put pressure on the securities lending business to ensure timely recall of securities on loan or buy to cover. It may also have an impact on income distributions. The ex-dividend date will now take place on the record date of the event, as opposed to just before the record date.
Market fragmentation is not a problem
Market fragmentation is not a problem, but financial institutions need to think about how they manage their foreign exchange (FX).
Financial institutions have a long track record of operating in an environment where settlement cycles in different countries are not synchronised. Accordingly, the risks of some markets shifting to T+1 while others retain T+2 or T+3 should not be met with alarm.
Custodians have the ability to support clients trading in multiple markets and running on different settlement cycles. However, the divergent time zones might create complications in FX management as this could force firms in different markets to pre-fund their trades in T+1 countries, unless they are long currencies in those particular jurisdictions.
Firms must optimise their FX management processes. This can be done either through engaging with an FX settlement support provider or by tightening up FX booking instructions to avoid the need to pre-fund transactions. Such actions will be vital, as pre-funding can mean that financial institutions’ cash is tied up in the trade settlement process, instead of being properly invested and producing returns.
Further compression of the settlement cycle is likely
A move to “T” is not out of the question as several markets already adopt this cycle — most notably the northbound leg of Hong Kong’s China Stock Connect.
Atomic settlement is possible through the deployment of new technologies such as application programming interfaces, blockchain, central bank digital currencies (CBDCs) and stablecoins, in addition to working towards a single source of truth or ‘golden source data’ that can be shared securely across the value chain.
Blockchain allows for the real-time transmission of data while CBDCs would ease some of the FX challenges faced in today’s cross-border settlement processes.
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