What impact will a shift to T+1 settlements have on market dynamics and liquidity?
At a headline level, a shift to T+1 doesn’t immediately sound the alarm bells for FX markets, given a large portion of funding FX is already traded this way. However, when you delve into some of the timeline changes involved, there are some important considerations to be made from a market dynamics and liquidity perspective. Taking the US market as an example, if an equity buy is traded over the day into the US close, for a non-US asset manager there becomes a very short window to get the equity trade matched, FX generated, and executed in the market in time to meet deadlines to settle on a PvP/net basis. If these orders are sizeable, we could potentially be looking at a lot of one-way traffic into USD in a very tight timeframe – which will almost certainly impact liquidity during what’s currently a very low-volume period of the day (though we should also expect a shift in activity at that time as a result of this change). Another key question though, is if we can access the liquidity we need to get the trade done – at what sort of spreads will this be? Given the dynamics mentioned above, pricing sizeable FX risk at the tail end of the day will very likely have an impact on the spreads we’re seeing, particularly from the likes of eFX pricing engines – though the extent of this remains to be seen. Friday afternoon FX trading is front of mind in this vein, given the weekend exposure to follow. This is why we, and likely other buy-side firms, will be reviewing our spot FX panel to ensure we have access to sufficient well-priced liquidity.
What needs to be done to ensure FX transactions can meet new T+1 rule changes?
Put simply, as a market we need everyone to be doing their bit on this. For buy-side firms such as ourselves, to date this has involved an in-depth review of our trade lifecycle operating model, assessing everything from systems capabilities to meet reduced timelines, to location of our people – which has led us to establishing trading and operations presence in the US, to ensure we can continue to achieve the best outcomes for our clients. Crucially though, we need the help of other market participants to make this change a success for all involved. Coverage is a key ask of our brokers, with the potential need to execute FX orders until 5.30pm EST; whereas for custodians, FX cut-off times to settle T+1 trades on a PvP/net basis will become so important, and we hope these will provide the flexibility needed leading into the 28 May 2024 go-live date. Linked to this, is the deadline involved with settling FX trades on a PvP/net basis. Currently, with the timelines described above, the deadlines are very restrictive and if missed, would result in much-increased volumes of FX settling bilaterally – which would be a step backwards in our ability to mitigate settlement risk, a key principle of the FX Global Code.
What pain points still exist in the build up to the implementation of T+1?
At present, FX cut-off times are our main pain point. In an ideal world, we’d have until at the very least 6pm EST to get any necessary FX executed, matched, and off to custodian banks for onward processing/settlement. As things stand however, the timelines don’t add up. Unless we see an extension of these deadlines from PvP providers and custodians, we’ll be in the unfortunate position where counterparty selection for a trade will have to take into account an increasing number of these operational considerations. As a trader this is frustrating, as we could end up with the most wonderful panel of liquidity providers in the world, but not be able to trade with the one we want due to a cut-off time elsewhere. Again, from a best execution perspective this feels like a real step backwards – however, we’re hopeful that in a world where technology and automation are increasingly deployed to solve similar problems, there’ll be scope for movement here. After all, with T+0 on the tip of the tongue when the SEC announced this change for the US market, it feels like it won’t be long until we as an industry need to take even bigger steps in the efficiency department.
What advancements in the FX space are being made to enhance operational efficiencies and reduce costs?
Increasing use of electronic trading and automation or ‘rules-based’ trading continue to help us as buy-side traders on this topic. The evolution of these types of execution solutions, combined with a huge push in the trading data space, have really helped improve the ‘tool kit’ we have at our fingertips, when assessing what we have on the pad to get done throughout the day. Automation and eFX trading have been invaluable in helping us execute large numbers of smaller ticket-size trades in an efficient manner, allowing time to really focus on executing the larger/trickier orders in the best way possible on behalf of our clients. We know AI-based technology will likely also bring tremendous change in this area, but what that looks like remains to be seen.
Additionally, the time savings have allowed us to begin looking at other asset classes on top of FX, with a view to becoming a more dynamic team of traders who are able to cross-cover each other on the desk. This will become increasingly important as we move to a cross-location team once our US desk is established, as we implement a more follow-the-sun type model. Likewise on the data side of things, we have a trading data analyst who sits with us on the desk – who’s able to both help us focus on execution by addressing any trading-related queries from clients; and also provide us with a plethora of data insights, sprinkled with appropriate challenge, to help better inform our execution decision-making.
How do you expect FX market structure to evolve over the next few years?
This is an interesting one as I think with the T+1 settlement cycle change confirmed and en route for various markets, as well as the T+0 FX conversation well underway, we’re approaching a bit of an inflection point between really testing the boundaries of ‘traditional’ finance infrastructure, versus where there may be a tipping point that only going digital e.g., DLT might be able to solve. There are many strands of conversation which could sprout from there – such as technological lift involved, regulatory requirements, as well as just general comfort level and willingness of the broader industry to head down a more ‘real-time’ road at scale; though it’s likely the decision could be forced down the line, via regulation. I would think we’re still maybe a few years out from there yet, so that’s probably slightly longer term; however, in the meantime, it’s also worth staying mindful that T+0 is a separate (though linked) discussion to atomic settlement, which is an equally interesting prospect coming down the line. I think for now we can expect continued evolution of eFX trading, use of automation to enhance trading efficiencies, and general compression of FX processing timescales. To round off on-topic though, I do think there’ll be various impacts to FX markets as a result of the incoming wave of T+1 settlement cycle moves – some of which we’ll likely not know of until this is live. In the meantime, I look forward to being part of the change.