The US T+1 Trade Settlement Cycle, Part 2
Impact of US T+1 Trade Settlement on European and APAC Markets
The impact of the new T+1 security trade settlement cycle in the US is set to be strongly felt by capital markets across the globe. While the decision to switch to T+1 trade settlement has been made with the best intentions, such as reducing market and counterparty risk, implementation poses significant short term financial and structural challenges. In adjusting to the new US trade settlement cycle, different jurisdictions will face their own unique hurdles, which GreySpark identifies below.
European Impact
Intuitively, one might think that moving from T+2 to T+1 settlement would halve the post-trade settlement time, but this is not necessarily the case.
Because of time differences, European firms trading through US markets will not face a 24-hour settlement timeline, but will instead have a seven-to-eight hour period to process their US securities trades.
To make matters worse, if you include the entire trading day, European firms will only be left with a two hour settlement window at market close, inevitably heaping pressure on post-trade divisions, and in particular, leaving less time to source and execute foreign exchange (FX) transactions. Essentially, the window after market-close on trade date will take on greater importance. Cash management processes will also have to be compressed into a shorter period to ensure that correct funding is in place for settlement. Collectively, these issues could lead to more processing errors and a more frenetic, unsettled workflow, especially if legacy systems are in use.
The shift to T+1 in the US may lead to an indeterminate period of heightened settlement failures, accompanied by increased costs associated with Central Securities Depositories Regulation (CSDR) penalties and operational expenses such as overnight funding. CSDR is an EU regulation that aims to enhance the consistency, safety and efficiency of security settlements. Consequently, this could result in greater financial burdens for the European investment community, as brokers and custodians may need to pass on a portion of these costs to clients. These failures may be especially acute and complex for pooled investments. For example, an overseas-listed fund that settles in T+2 that includes US share or bond holdings that will settle in T+1 will create a less smooth settlement process.
Additionally, the European capital market landscape is one of the most fragmented in the world, with roughly 20 exchanges and multiple clearing houses residing here. As such, the adjustment to T+1 trade settlement will require huge coordination, and as structural overhaul process that may be more clunky and nuanced than most.
However, one of the advantages Europe (including the UK) faces is that at the end of the US day, it enters into a new day. For example, at 7pm New York time, European time is 12am the next day. This gives European firms extra time to fix problems and match trades, which even domestic firms in the US don’t necessarily get.
APAC Impact
Market participants in APAC will likely fare worse due to even larger time zone constraints. The difference in time zones means that operations teams there only have a one or two hour window to process trades, which will likely have to take place during market hours and not after close of business. In effect, areas such as Australia and New Zealand are looking at T+0 trade settlement. Trades on a Friday will pose a particular challenge to APAC investors because they would have to complete the post-trade processing on a Saturday (Friday evening EST) unless they can pass the work to colleagues in US time zones. This may not be possible for smaller firms on tighter budgets. Again, this leaves investors facing the possibility of settlement failures and huge backlogs of trade settlements that may disrupt operations.
One option to counteract this may be relocating staff. This is something that is already happening in Europe. A report by the Financial Times found that several European asset managers are currently in the process of moving staff to the US, and weighing up changes to working hours for specific roles. However, given language barriers and increased costs, this may not be as feasible for some APAC-based firms.
FX is also a significant issue for APAC investment firms. Many firms are concerned about receiving unfavourable FX rates from their agent banks, especially when the base currency is weaker than the dollar. Time constraints could mean there is not enough time to shop around for the next best deal or interact with US-based counterparties. Following the US T+1 transition, APAC firms will effectively be facing immediate settlement failure if an FX mistake is made. This could leave APAC firms with little option but to outsource their FX to a custodian bank, or prefunding FX transactions.
More to follow.