The T+1 Trade Settlement Conundrum
Why Thursday's global market liquidity is running dry
Capital markets underwent a seismic transition earlier this year with the introduction of a ‘T+1’ trade settlement period in the US from 28 May, 2024, in a bid to reduce market and liquidity risks.
The condensed settlement cycle has brought the expectation of a short-term increase in settlement failures as capital market participants adjust technical infrastructure and operational processes to meet the new requirements. However, it seems that the transition to the new settlement period has been more successful than industry players may have originally expected.
For example, The Depository Trust and Clearing Corporation (DTCC) noted that 94.55 per cent of transactions were affirmed by the DTCC’s cut-off time. This marked an increase in the affirmation rate from 73 per cent in January 2024. Prime broker affirmation rates also stood at 98.6 per cent.
In addition, the DTCC highlighted a decrease in trade failure rates. On the first day of trading on T+1, the CNS trade fail rate stood at 1.9 per cent - down from May 2024’s average of 2.01 per cent. What’s more, geographic and time zone disparities between exchange-traded fund constituents and foreign exchange transactions have seemingly been navigated with minimal problems so far.
However, while the transition to the new settlement period can so far be seen as a success, some unexpected trading patterns have been emerging that could, going forward, impact the level of market efficiency that T+1 settlement aims to achieve.
In particular, it is now becoming more expensive to trade on Thursdays due to misalignment with other regions that have not shortened their settlement cycles, leading to a lack of liquidity. Given that the settlement cycle in the US is now shorter than other major economies, trading volumes on Thursdays have dropped significantly thanks to funding requirements that require brokers to fund a position for an additional three days on Friday, Saturday and Sunday given the slightly longer settlement cycle in Europe, the UK, and most of Asia Pacific (APAC). The problem is the most pronounced in the APAC region.
For example, a broker in Tokyo making a transaction on a Thursday at 4pm eastern time (roughly 5am Tokyo time on a Friday) will have roughly nineteen hours to allocate the trade, meaning it would otherwise have to settle the trade during its night time hours on the Friday. With this being unfeasible, the broker must ensure it has the correct pre-funding in place to meet the T+1 requirements on the Thursday, ahead of Friday and the weekend.
Essentially, trading on Thursdays requires the broker to put up additional funding for the weekend, reducing liquidity and leading to higher spreads. In fact, some market participants have experienced up to five extra basis point charges for some trade orders on Thursdays. As a result, lower liquidity and trade volumes have impacted best execution and increasing volatility on other days of the week as market participants seek to capitalise on the reduced spreads (relative to Thursday).
In addition, industry players have also pointed out that the US is yet to go through a public holiday falling on a Monday, which will likely exacerbate many of the trading patterns that we are now seeing emerge. The next three-day public weekend in the US is in September 2024.
The DTCC is currently exploring ways in which the Thursday trading burden can be alleviated.
Either way, this conundrum emphasises the need for other major global jurisdictions to become aligned with the US trade cycle as soon as possible in order to maintain formality. As a reminder, the UK is seeking to move to T+1 trade settlement by 2027, with the prospect of adoption from the EU alongside.
We look forward to bringing you further updates on these developments in due course.