FX trading has not shifted due to T+1 as some had predicted

The drama around cut-offs at CLS and custodians prior to the T+1 implementation had many believing the FX market would alter drastically, but so far, it’s business as usual over the first three weeks of the shortened settlement cycle as the first big public holiday – and major test – approaches.

It was billed as being one of the most impacted market practices from the rollout of T+1 settlement for US equities, but over the first three weeks, the FX market is operating BAU, according to leading asset managers and their service providers

Despite the relative ‘non-event’ however, there are two important factors to consider: firstly, that many asset managers are still taking a wait-and-see approach, and secondly, that we have yet to encounter the first US public holiday in a T+1 environment.  

European participants during virtual roundtable discussions run by our sister publication Global Custodian last week were asked if any FX execution was occurring between the 4.00pm – 6.00pm ET window and there was a unanimous ‘no change’ from the speakers. 

In addition, The TRADE understands that as of the end of last week, there had been no evidence in an uptick in bilateral settlement in the markets, while some speakers on the roundtables referenced an external webinar where CLS had said there has so far been “some earlier submissions and some later submissions” but no evidence of a significant change in volumes.

“We’re seeing the continued same averages that we were seeing previously,” said Michael Wynn, managing director, head of execution services, securities services at Citi. “The timing of the requirements from an FX perspective continue to remain as we saw in the past, so we’ve not seen any significant shift in terms of execution, timing, and certainly not later in the day as we first anticipated.”   

Additionally, one major asset management outfit noted: “Speaking to peers, I think there’s still a wait-and-see approach. I’m in that 5.00pm-6.00pm ET as a house, but I’m hearing others are still just holding things back and may not have shifted.

“But if anyone’s thinking about pulling coverage on a Friday, I would advise not to. I don’t think there’s been much stress in the ecosystem, as in around holidays. I know we had Monday [10 June] being an Australia/China holiday, and then we’ve got one next week with US, and obviously 4 July.” 

Holiday worries

With regards to upcoming holidays, many speakers believed this would be a big test, particularly when occurring on a Monday – the next of this kind being Labour Day on 2 September. Another asset manager said the approach is to “wait until these holidays occur and experience it and if there is a fallout, then we’d like to bring it back on the table”. 

Citi’s Wynn noted that before T+1 came into force, some clients moved more into standing instructions, outsourcing their FX execution to the securities services provider from a simplification perspective and removing the funding challenge. 

When asked whether this was a short-term solution, he replied: “The sense I get at the moment is that’s probably not the case. We’ll continue to speak to them and find the right FX solutions for them if they feel that’s not the ultimate outcome they want. Ultimately the conversations thus far feel more certain in terms of continuing that as opposed to it being a temporary measure.”  

When CLS declared it would not be extending its cut-offs just a couple of months prior to the shortening of the settlement cycle, two things happened: firstly, there were concerns that trades might be settled bilaterally also increases the counterparty risk, and secondly, that the ball was firmly put in the court of the custodians to instead shift their cut-off times. 

As we mentioned above, there has been little evidence of change with regards to FX settlement, however one asset manager’s response to this was to credit custodians for extending their cut-offs closer to that of the multi-currency settlement system. 

Despite the praise, the speaker also said: “I think there’s more work to do among the custodian community where there’s still a few more outliers on the later stage that needs to be improved.  

“I would hope… that there’s some standardisation in the custodian world on cut-off times [in the future].” 

Much like feedback from the first week of the War Rooms, so far, no major changes have occurred, however this all appears to be the case of a hyper state of focus and support from the securities services community. Moving past the one-month mark and into a series of public holidays could drastically alter thing. 

The view from Asia Pacific

The feedback from the Asia chapter of the roundtable discussions was similar, despite the issue being even more prominent given the wider time zone difference.

Market experts highlighted how expected challenges, such as reduced market liquidity during T+1 evenings, have been mitigated by earlier FX allocations, easing concerns to some extent. Other anticipated challenges have not materialised as significantly as feared, or perhaps it’s too soon to tell. 

Regarding pre-funding, Phillip Van Dine, APAC head of banks and market infrastructure at Citi, highlighted that most clients are now utilising automated FX capabilities. These solutions typically leverage existing loan balances or intraday credit, facilitating the injection of various currencies beyond just US dollars. According to Van Dine, this process has been operating smoothly without significant issues. 

“We anticipated greater adoption of these automated layers. A primary industry concern was whether third-party FX counterparties could deliver funds punctually to client accounts. However, based on our observations, we haven’t detected an uptick in fail rates or delays in settlements,” Van Dine affirmed. “In Asia, a growing number of clients are embracing these automated solutions or accessing intraday credit, enabling us to efficiently manage settlements where US dollars are sourced from their FX counterparties.”  

From another perspective, a custody product manager weighed in on the term ‘pre-funding’: “From our institutional custodial viewpoint, the interpretation of ‘pre-funding’ can vary widely. Clients typically maintain non-zero cash balances, often holding long positions in US dollars or other currencies like Aussie dollars and Japanese yen. This allows them to leverage custodial FX capabilities or intraday credit for seamless dollar transactions throughout the trading day.” 

The manager noted no significant issues or concerns regarding the funding of trade settlements or the receipt of FX legs. However, granular data to pinpoint specific changes in these practices still remain limited. 

Another expert emphasised that many clients are now aligning their FX bookings with traditional windows used prior to T+1, thanks to early completion of allocation tools within the new framework. 

“I wouldn’t say there’s anything materially different,” they noted, echoing insights shared earlier by another custodian regarding FX strategies. “Clients are actively managing their FX positions, seeking operational effectiveness while maintaining an agile approach. This varies widely from larger institutions to smaller firms, each tailoring their approach to fit their specific needs.” 

Van Dine underscored the importance of understanding discrepancies between spot FX and same-day FX, emphasising the need for comprehensive data analysis. “This has been a crucial area of discussion pre-implementation,” he stated. “Quantifying these differences in spreads and their impact on funding costs is essential for markets transitioning to T+1. Obtaining and analysing such data will provide critical insights into liquidity and spread issues, facilitating informed evaluations of potential challenges.”  

Volatility will provide the big test 

Another expert highlighted that there’s a notion of ‘peacetime’ and ‘wartime,’ noting how certain challenges may only become apparent during periods of volatility, making it difficult to predict ahead of time. However, identifying these aspects could potentially provide firms with more confidence in further transitioning. If they can affirm that they didn’t notice any material deviations during a relatively calm market, it could offer additional reassurance.   

To manage this, Van Dine observed that Asian clients typically have their funds prepared for FX conversions and onward settlements. While lacking direct investor contact, internal discussions indicate no reports of investors requiring additional credit or support due to funding challenges. Clients appear to manage their trading strategies effectively, potentially adjusting positions in other markets to fund their accounts, though specific actions aren’t fully visible. 

He said: “By the morning in Asia time, clients know their obligations for affirmation and settlement instructions. This means they have all day to ensure their accounts have sufficient cash for both the FX settlement and the ultimate settlement that starts happening in our evening.” 

The custody product manager weighed in, saying: “From a custodial perspective, any potential concerns typically revolve around significant client rebalancing, particularly across the markets with longer settlement cycles. Aside from occasional delays in US buy orders, we haven’t observed transparency in underlying client activities as a custodian. 

“We’ve heard brokers extending credit, which has been a useful solution. There’s increased emphasis on active cash management, especially for Japanese clients navigating unique trust bank structures. Overall, there’s heightened awareness and involvement in cash management processes, varying with firm size and capabilities,” said another.