What impact will a shift to T+1 have on liquidity?
This is a truly significant structural change for the markets in North America, but it’s going to have a broad impact across global markets and across the industry. Compression of settlement cycles has become a very important theme for all of us in the financial markets. In terms of improving liquidity, it should be said that this is one of the main drivers for this regulatory change in the sense that if you have a faster settlement cycle, it reduces the bottlenecks in the overall system. It allows assets to move more quickly throughout the whole market and that has a lot of positive implications for cost, credit, liquidity risks and risk management overall. Liquidity brings benefits to everybody – it lowers cost, lowers risk. In particular, with a shorter settlement cycle, the cost of capital reduces for trading – and especially when we’re looking at today’s higher interest-rate environment, which could continue for some time – this matters.
The other area is risk management. A shorter settlement cycle decreases credit risk, decreases liquidity risks, lowers margins, and ultimately improves liquidity. However, the move to T+1 is going to put a lot of stress on existing systems and technology for many market participants and market infrastructure. Any operational issues or settlement delays, specifically any spike in settlement failures that arise when T+1 gets implemented, will definitely impact confidence, risk, and hence liquidity. There will be a lot of focus on liquidity in the period immediately after the transition because any firms that aren’t properly prepared and haven’t executed their system modernisation strategies to enable this, will have issues. There’s a very high risk of a period where we see higher settlement failures and it’ll be interesting to see how long that impacts liquidity. The industry will work through that in time, and while many of these issues may not get solved in the short term right after implementation, ultimately in the medium to long term liquidity benefits will materialise.
How will cross-border ETFs be traded following the implementation of T+1?
ETFs are an increasingly important set of instruments, but with cross-border ETFs we’re adding even greater complexity to an already complex environment with the move to T+1. There’s clearly a potential for greater misalignment between FX and equity settlement cycles.
ETF managers are regularly moving the underlying ETF constituents between different markets and different CSDs to settle these trades. In that, there’s a lot of manual fine tuning done around net asset values (NAVs) – every day they have to be constantly updating NAVs and when we’re looking at different settlement cycles in different zones and then the misaligned FX settlement angle, that’s going to require a lot of automation. Essentially, we’re taking a fairly finely tuned structure around this particular type of instrument, and we’re making it even more complex with more time pressure, and so that particular segment of the market is going to be very much under pressure for more automation and real-time processing.
What sort of complications will arise as a result of T+1 in international markets?
One of the things that international markets have been waking up to over the past year is that this is very much a regulatory change with global impact. Almost everybody in Europe and Asia has North American exposure and flow, with 40% of the US market coming from foreign investment. The challenges for the domestic players – in the US and Canada – are exacerbated for firms working outside the region because of the obvious time zone issues. So, it’s a big issue for Europe, and an even more significant issue for Asia.
T+1 is going to require the entire industry to be looking at their global operating model and whether or not they are able to have a follow-the-sun model within their own operations, or whether they need to work with a third-party provider who can support that. The last thing you want to do if you’re in Europe, or especially Asia, is to walk into the office the next day on T+1 with unallocated trades and you’re having to scramble around to deal with issues. And we’re not just talking about pure equity settlement, it includes corporate actions, securities lending, and how you’re managing your cash and your collateral.
The other interesting angle to this is how other countries outside of North America are looking to be competitive with their own settlement cycles, for example with the UK starting to review its own move. We’re not talking about everyone being on a T+1 cycle anytime soon, we’ll have different settlement regimes in different markets and anybody who’s active globally is just going to have to have the operational flexibility to deal with that.
How can automation help aid with the move to T+1?
Automation on top of real-time straight-through processing is going to be enormously helpful with the move to T+1. If you’re on a real-time post-trade system, you’re going to be managing your flow through the day as you interact with your counterparties. The ability to manage exceptions pretty much as they happen and not wait until the end of day or the morning after is critical to lower the risk of settlement failures. While the T+1 change is focused on the securities markets, it’s important to look at the rapid developments with digital assets and tokenisation – which all have a different market structure, working with T+0 and almost instantaneous settlement – so firms need to be thinking about how to future-proof their operations and systems to move beyond T+1 towards real-time, intraday digital capability.
Moving to T+1 is a real reminder that it’s time to modernise how financial firms operate, which requires significant technology change. Why is this a benefit for everybody? It lowers risk, it’s more efficient, and it’s ultimately cheaper for the industry. Beneficial, not just for the sell-side, but also for the buy-side and retail clients. A more efficient securities market with lower risk is an important and exciting goal for the whole industry to be focused on, and a big part of achieving that goal is moving beyond the significant amount of legacy batch technology still running many firms. T+1 and digital assets represent a tectonic shift in this industry that will drive a fierce competitive shakeout. Who said the back-office was boring?