Shortening the Settlement Cycle in Equities Trading
Alan Cameron, Head of Financial Intermediaries and Corporates Client Line Advisory, Securities Services, BNP Paribas, and Aman Mehta, APAC Sales Director and APAC Digital Assets Lead, Securities Services, BNP Paribas, discuss compressing the settlement cycle in securities trading with Terry Flanagan, Global Trading’s editor.
Terry Flanagan: Hello and welcome to the GlobalTrading podcast. I’m Terry Flanagan, Editor of GlobalTrading. GlobalTrading is a Markets Media Group publication. Today we’re talking about compressing the settlement cycle in securities trading.
On 15th February, the U.S. Securities and Exchange Commission adopted rule changes to shorten the standard settlement cycle for most broker-dealer transactions in securities from two business days after the trade date, T+2, or, to one business day, T+1. The compliance date is 28 May, 2024.
The SEC’s move is the latest in a long road in accelerating the settlement cycle worldwide. By way of background, in the U.S., settlement moved from T+5 to T+3 in 1993 and then to T+2 in 2017. In the European Union, the settlement cycle has been T+2 since 2014. Most markets in Asia are on T+2, though India recently moved to T+1 and Chinese equity markets are T+1 or even T+0.
Broadly speaking, the aim of accelerating settlement is to reduce the credit, market, and liquidity risks in securities transactions faced by market participants.
Here to make sense of it all, today I’m pleased to be joined by two experts in the space from Securities Services at BNP Paribas.
Aman Mehta is APAC Sales Director and APAC Digital Assets Lead for Securities Services at BNP Paribas. Aman is based in Hong Kong.
And we have Alan Cameron, who is Head of Financial Intermediaries and Corporates Client Line Advisory for Securities Services at BNP Paribas. Alan is based in London.
Why shorten settlement cycles? What’s the real rationale behind this?
Alan Cameron: I would say there are three main reasons for shortening settlement cycles. The first and the most important one is to reduce risk, and here we are talking about pre-settlement risk. Pre-settlement risk is a risk that your counter-party does not deliver on settlement date. Pre-settlement risk increases with the time between trade date and settlement date, so reducing that time simply reduces risk. And if that risk has been margined as with transactions being cleared at CCPs, then reducing the risk reduces the margins, and this all for reduces the capital required. Secondly, I think it’s fair to say that we live in a world where expectations are changing all the time, and people expect things change much more immediately. Nobody wants to wait for anything. So the idea that we should settle days after a trade is made has really become old hat, and it’s not in line with what people are expecting, either in their business or personal financial situations. Finally, there is a need for global standards. As more and more markets move to T+1, the pressure on the remaining markets increases; it’s helpful to everyone if all markets have the same settlement period, especially for international investors.
Why not shorten securities settlement times?
Aman Mehta: I guess the other side of the coin of efficiency is that we have a reduced timeframe to complete more tasks; this includes part of the matching process, and the allocation process. As we start looking into the trading patterns of the world, which is essentially clients are trying to access more markets globally, you then have to take into account more things to do in less time, coupled with different time zones. For example, clients in Asia Pacific are trying to access to the US market. The danger this brings is an increase in operational risk. What we effectively do is we reduce pre-settlement risk, and introduce operational risk. This operational risk can have direct and indirect cost, but also can increase capital, when taking into account things like the Risk Weighted Assets (RWA). The other thing to consider is the situation where not all markets are harmonized in terms of settlement cycles; some are T+1, some are T+2, and some are T+3. For example, if an investor is waiting for cash from one market to pay for securities in another. If they have different settlement cycles, this then creates an overnight funding requirement based on different settlement timings. This of course has to be funded by the investors themselves, or the custodian can come in and provide that type of overnight funding. Lastly, there is a knock-on effect in other areas, such as stock lending and borrowing, where you might have less time for loan recalls based on the settlement cycle.
Settlement cycles across geographic regions
Alan Cameron: From my impression, confidence is quite high in America, that this can all be done. But there is a lot to be done. There are three initial stages that firms have to go through when looking at this. They have to conduct an impact assessment, then build and mobilise a programme with appropriate governance. Thirdly, they have to develop a roadmap and kick-off the project. I think most firms have done the first stage and are moving into the next step. So, they have done the impact assessment, and they are beginning to mobilise their programmes. There is a lot to be happened, so they really have to get on with this. When they are looking at the programmes, I think it is a good opportunity to consider automating anything that is still manual. The other thing I would say is, I would ask all my American colleagues to remember their international offices and international clients in doing all this. Since the impact of reducing the settlement cycle is actually most severe the earlier in the day that you are living, it’s most severe for the Asians, followed by the Europeans, and then the Americans. There is a lot to be done. When all this is happening, the key thing is to reach out to the international clients base and the international offices; they are the areas that are really going to take the heat.
In Asia, we are proud, because we have T+1 and T+0 markets. The last market that moved to T+1 was indeed India, who completed the transaction in January this year. It has been judged as a success both in terms of the actual implementation, as well as the consequences and efficiencies created. They had a relatively short time to move; it was announced by the Securities and Exchange Board of India (SEBI) in September 2021. They did really well on working very closely with the Stock Exchanges, Clearing Corporations, Depositories and custodians. They agreed on adopting the risk-based implementation approach, where they implemented 11 different phases starting with the least risky phases and finishing in January 2023 with the most risky and most liquid securities. The overall feedback was that the implementation went well without any significant issues. Collectively across the Capital market associations, market participants, custodians, and the FPIs community, the response was that moving to T+1 allows for a faster flow of capital and lesser exposure for FPIs. What we have learned this is that strong market advocacy is the key, there are merits of having a phased approach and the benefits of moving to shortened settlement cycles can be achieved and materialised.
Now, let’s move on to Stock Connect. Stock Connect has gone one step further; we have the ability to has partially settled on T+0 markets. This settlement cycle is in line with the onshore cycle of China, where they also have T+0, but the mechanism is a little bit different. In China, it is essentially a pre-funded market where there is zero tolerance of fails. So, once an instruction for settlement is in place, it settles. On the other hand, Stock Connect has separated cash and securities legs, with securities settling on T+0 and cash settling on T+1. On top of that, you also have the pre-execution check. The result is an intrinsic overnight funding requirement, and the need for a seamless operating model especially if you are a broker trying to link between clients who are expecting cash the moment they deliver their securities, who they need to have access to that funding. We have many clients on our platform via Third Party Clearing, where we help them with both the funding and the STP operating model. For Investors, they need an STP operating model with minimal touch points given the reduced timeframe for settlement. This is where we help with the Multi Approved Partner Broker model, which is essentially a multi-broker Execution-to-Custody model for Stock Connect.
Lastly, I want to talk about clients in Asia Pacific, who access markets globally. We really need to think about the reduced latency and increased operational need for this type of clients, as they often sit in time zones that are completely different to the market in which they are booking activity. This is where the key that they have someone they can rely on as their partners. This is where we come in. We do the heavy lifting on their behalf and help bring them with solutions such as the full Execution-to-Custody model, so that they can access markets globally with minimal operational intervention.
Alan Cameron: In Europe, it is more a question of “how” and “when” rather than “if”. There is a broad acceptance, so this is something that will give them enthusiasm even if somewhat is muted. It really splits into the UK and the European Union. In the European Union, there has been some individual markets soundings, but there is nothing really substantial yet. The Association Of Financial Markets in Europe, which is our industry body, has reached out to other industry bodies to start planning and all the work that has to be done. They have written a very good paper on this that I would recommend. But it’s not that far advanced for the European Union yet. The UK is a little bit different; there is a political angle to this. Shortening settlement cycle is actually mentioned in the government’s Edinburgh Reforms package, and the treasury has put together a task force to look into how this can be achieved. The political angle is that the government is keen to show that since Brexit, the UK can move faster than European Union. So, I think that this is all going to be happened first in the UK, and then in the rest of Europe.
Role of the asset servicing specialist firm in helping market participants navigate accelerated settlement cycles
Aman Mehta: Our job is to service the clients globally. This means we give clients access to markets globally, across the buy-side and sell-side. We help to build solutions on top of the market infrastructure and settlement time frame to bring ease of settlement and access. Take for example the Executionto-Custody model; client can execute in markets globally and then receive the settled position directly into their custody account. This can be extended further to outsource dealing types of models fully, and can also apply to Stock Connect via the multi approved partner broker model as mentioned earlier. Clients can go one step further and outsource a part of their operations via Third Party Clearing or full back-office outsourcing. We put in place people, technology, and banking services to completely run the back office operations of our clients. What this essentially means is that the problem is now transferred to us to clear and settle their trade, especially navigating the shortened settlement time frames. Lastly, our own operating model consists of follow the sun operational dual centre, allowing us to service different markets across multiple time zones. For example, we have a full operational team based in Lisbon that helps to service the US market and clients. In situations where we have to provide clients based in Europe access during non-US hours, we can help do so through our team based in Lisbon. Through the combination of strong solutions and operations, we take on the responsibilities to navigate the settlement cycles to help our clients.
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