Earlier this year, The Depository Trust & Clearing Corporation (DTCC) issued a white paper, “Advancing Together: Leading the Industry to Accelerated Settlement,” which underscored the benefits of moving from the current two-day period between trade and settlement, or T+2, to a T+1 settlement cycle, among them greater risk mitigation, reduced operating costs as well as lower margin requirements.
Despite the many advantages, DTCC and collaborating organizations understand that closing the settlement gap leaves some players vulnerable to short-term business impacts. As part of a special US Broker/Dealer Virtual Event sponsored by BNP Paribas in conjunction with DTCC held on April 29, experts considered the potential ramifications on both participants as well as certain products (such as FX and securities lending), including strategies for minimizing service disruptions while preventing new risks from arising throughout the transition.
Accordingly, what should participants expect over the coming months as the industry heads toward T+1? And how are global markets responding to this upgraded settlement model?
“T” talks
According to key speaker John Abel, Executive Director for DTCC, the company began the campaign toward T+1 by engaging with industry leaders to determine if moving directly to same-day, or T+0, settlement was in fact feasible. “Ultimately the decision to go with T+1 reflected the need for many firms to redo entire systems and processes, including building out real-time reconciliation and segregation solutions, in order to facilitate T+0,” said Abel during the conference’s opening session. “And I think the consensus was that T+1 was reasonable enough from both an adoption and ROI standpoint.”
Like the industry’s last settlement iteration—to T+2, beginning in 2017—the current model will focus in particular on areas like corporate actions, stock lending, as well as institutional-trade processing. “There is a lot of activity that needs to take place between the close of trading and beginning of settlement,” said Abel, “therefore, being able to modify systems to facilitate all of the functionality during that fairly compressed time frame will be a significant undertaking.”
For their part, industry associations such as SIFMA and ICI have stated their commitment to ensuring a streamlined period of transition, said Abel. “This includes the creation of steering committees and working groups similar to the T+2 move, and we expect to hear further details around this broader industry discussion going forward.”
In hindsight, I think a better approach would have been to use T+2 as a stepping stone. That is, realizing the benefits, yes, but simultaneously continuing to work towards T+1.
John Abel, Executive Director, DTCC
Four years have passed since T+2, and for many proponents of speedier settlements, the current effort was a bit too long in the making. “In hindsight, I think a better approach would have been to use T+2 as a stepping stone,” said Abel. “That is, realizing the benefits, yes, but simultaneously continuing to work towards T+1. It was an approach that DTCC actively promoted at the time, and since then the various episodes of market turbulence, particularly during March of last year, have helped renew the focus on accelerating settlement.”
Challenges arising from T+1 adoption will vary by company, with determinants including settlement processes currently in use, size of the business as well as type of clientele. The key point for all participants is to stay involved, said Abel. “We want to hear about managers’ specific areas of concern, so we can hopefully work with companies to devise solutions on their behalf. Which is why we’re encouraging everyone in the industry to keep an eye out and be part of the discussion as we move forward.”
Making the move
Leading off the roundtable discussion that followed, Abel and fellow panelists focused on the stateside impact of T+1, as well as ramifications for neighbors Canada and Mexico.
“We have had conversations with Canadian officials, who have been very supportive of T+1,” affirmed Abel. “The idea being that the markets are so intertwined around the settlement cycle that it’s really not an option to be out of sync. And given that Mexico and some other Latin markets went to T+2 concurrent with the US back in 2017, we have reason to believe they would likely follow our lead once more with respect to T+1.”
Still, it is unlikely that all regions can move in lockstep, prompting some concerns around certain global-facing strategies such as depositary receipts (ADRs) and exchange-traded funds (ETFs). Additionally, the FX market remains firmly in T+2 territory, and therefore will have to be rationalized as well.
Despite some differences over what a ‘proper’ settlement cycle should be, there is general consensus that shortening the cycle can help mitigate risk and offer other benefits, noted Gary O´Brien, Head of Broker Segment Strategy, BNP Paribas Securities Services. Nor should settlement discrepancies necessarily be viewed in a negative light, he added.
“For example, during Australia’s ongoing infrastructure-replacement project there had been discussion around putting in place a set of market-driven, optional settlement cycles, ranging from T+3 to same-day, by integrating financing, securities lending and borrowing solutions directly into the market infrastructure. So while there may be some impact from various parties moving at different times, if done properly there could be opportunities for participants that may not have been previously available.”
With so much of the transactional world operating on a real-time basis, not surprisingly there are those who clamor for more widespread same-day settlement capability. Though currently supported through DTCC’s equities clearing and settlement subsidiaries, National Securities Clearing Corporation (NSCC) and The Depository Trust Corporation (DTC), there remain significant barriers to T+0, such as the inability to post margin for stock purchases in certain markets.
“Based on that scenario, you would have trillions of dollars crossing each day, which would put a significant liquidity strain on the system,” remarked Grace Tarelho, Director, US Local Custody, BNP Paribas Securities Services. As Tarelho pointed out, by contrast net-settling trades—that is, imposing an automatic offset to a firm’s account when a buy order is issued—eliminates the need to post cash or securities, thereby reducing the operational risk element.”
While presenting some technology issues, on balance the system of netting—which has long been on offer through NSCC—could work, particularly for settling U.S. equities, said Tarelho. Nevertheless, getting to T+0 will require a significant redesign of existing processes, she said, “in order to ensure that operational flows will function properly, given the exceedingly short time frame.”
Getting ready
How will the industry fare during this period of transition? According to Paul Karrlsson-Willis, Managing Director, Head of Global Trading Network, Stone X, “If you’re a larger firm, chances are these changes will not be that impactful, since the technology is already available, as are other necessary resources.” For some mid-size and smaller broker-dealers, however, prepping for T+2 is likely to be a bit more challenging. “It’s similar to the implementation of MiFID initially, and more recently as the EU implements its CSDR program for regulating settlement around central security depositories,” said Karrlsson-Willis. “When you start looking at rolling out T+1 on a global basis, you run into countries like Turkey, that require investors to put money up front, otherwise they cannot settle. For smaller institutions, this need to pre-fund is often more difficult, as you have to rely on a clearing agent to help support that activity.” In some instances, such barriers could possibly deter, rather than accelerate, settlements. “So while this may be the right direction for the industry as a whole, there is still ample work to be done, because there really isn’t a one-size-fits-all for T+1,” said Karrlsson-Willis.
BNP Paribas’ O’Brien pointed to the London-Shanghai Stock Connect depositary receipt model as an example of the effort required to maintain disparate settlement cycles. “You’ve got DRs being issued from the UK at T+2, and received under Shanghai’s model at T+0,” said O’Brien, “and as a result the agent has to purchase or sell the underlying position in China in order to compensate. Which is why changing settlement cycles is not something that just happens overnight—it requires serious industry engagement and consideration among participants, including whether all parties will continue to be connected to the market as settlement cycles shorten, or will they instead consider introductory or agent models as alternatives.”
[…] there is a general consensus that applying a further shortened settlement cycle (to T+1 and perhaps even T+0 eventually) can bring benefits to the market as whole.
Gary O´Brien, Head of Broker Segment Strategy, BNP Paribas Securities Services
Tarelho emphasized the importance of industry working groups like SIFMA fielding questions and concerns within the greater financial community. “That way we can determine which solutions to prioritize, and also establish a feasible transition plan for firms to adopt T+1,” said Tarelho. At BNP Paribas, for instance, internal planning includes ongoing discussions with IT, risk and legal compliance in order to understand how T+1 will affect current requirements, and then prepare accordingly. “I think we learned a lot during the migration from T+3 to T+2, which for us was seamless, as we are fortunate to have a state-of-the-art custody platform that serves both local and global clients, and therefore is already capable of rationalizing the different settlement cycles.” Tarelho also agrees that offering clear and consistent client communications throughout the transition process will be key to reducing T+1 pain points.
“As we can see, there is a general consensus that applying a further shortened settlement cycle (to T+1 and perhaps even T+0 eventually) can bring benefits to the market as whole, concluded O’Brien. “That being said, there will be a need for significant engagement with different impacted parties and review of the detailed market operating model to ensure a seamless transition.”
