The primary goal of the T+1 shift is the acceleration of trade settlements to de-risk the system. However, as industry continues to discuss the various impacts, several misconceptions have continued to arise across industry discussions. Let’s assess (and dispel) some of these.
1. No Big Deal – U.S. Trading is All Automated and Processed Straight Through Already
Even in today’s environment, U.S. securities trades can and do fail despite being supported by a sophisticated trading infrastructure. This is primarily due to:
- Inaccurate standard settlement instructions
- Failed securities delivery despite matched instructions
- Unknown trade (DK’d) or not matched by the counterparty
Focusing solely on the post-trade settlement of U.S. T+1 overlooks impacts from the compressed timeline across end-to-end lifecycle management, which range from trade funding and cross currency foreign exchange execution to synchronizing fund investor and securities settlement cycles. Technology, outsourcing, and industry utilities will all play a role in meeting the T+1 challenge as any non-automated link in your chain will put you under increasing operational or timing pressures.
2. SEC Didn’t Include Penalties, so I’ll Just Settle Late – There’s Minimal Downside to Settling Late Anyways
Unlike the imposition of CSDR in Europe, the SEC did not incorporate fail penalties. This has led a cohort to believe there is less incentive to comply with same day affirmations and to remain relaxed about missing T+1 settlement deadlines. This is simply not true: fails can create downstream liquidity issues, reputational and financial risks, and the SEC has hinted that if failures spike, they might intervene.
3. I Can Already Trade T+1 Today Without Any Issue
Many custodians currently allow Asian, U.K., or European based asset managers to instruct U.S. equity trades on settlement day. However, that’s a natural consequence of the U.S. market still being open and available for a few hours after markets east of the Atlantic have closed. The compressed T+1 deadlines reduce late instruction opportunity for non-U.S. traders and are the reason many firms are considering setting up U.S. desks to ensure coverage.
4. My Bank or Custodian Will Fill in My Liquidity Gaps and Contractual Settlement Risk
A liquidity mismatch occurs for funds where the settlement cycle of the fund and the underlying portfolio securities are misaligned. The impact of this mismatch is that investor funds are received or must be paid away on a different cycle to the underlying fund securities trades. This creates a cash flow mismatch which can leave the fund with excess cash balances where the U.S. securities settle T+1 but the investor only receives on T+3. This may also result in overdrafts where the investor subscribes but funds won’t be received until both T+3 and the U.S. securities trades settle.
Participants assume banks/custodians will fill these gaps by affording fund credit or sweeping excess cash to counterparties for the two days before being paid away. In the case of funds requiring an overdraft to finance U.S. security purchases, a custodian or broker will front the cash since the investor money will be there soon to cover it.
However, given their own increasingly onerous balance sheet and regulatory requirements, it shouldn’t be assumed that all banks, brokers, and custodians will cover the excess cash balances or overdraft requirements of funds on an ongoing basis. If it continues to happen frequently, regulators will likely take an interest. It is expected that excess cash balances or overdrafts will occur more often on UCITS funds with U.S. securities and international investor inflows and outflows. A “follow the sun” global service model becomes imperative to manage the complexities of this compressed timeframe and natural liquidity mismatching.
5. I’ve Got Time – Implementation Will Be Delayed, It Always Is
As the saying goes “sometimes, it’s the hope that kills you.” It is unlikely that the May 2024 deadline will be extended, especially given industry's rejected efforts for a September 2024 implementation. With reports of industry preparedness and testing going well, it would be short-sighted to plan for any date other than May 28th, 2024.
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