T+1 planning has continued to progress since we first assessed the impact on the FX market in April 2023. Asset managers have now made some important workflow decisions and their strategies for adapting FX solutions are taking shape.
In this latest article, we explore these differing strategies, the associated costs and benefits, as well as the challenges that still lie ahead as we approach May 2024.
Building an FX Workflow: No One Size Fits All
While the T+1 change is happening in the U.S. and Canada, the implications due to the time zone difference are most severe for those managers in the U.K., Europe, and Asia. How they have approached solutions for the T+1 settlement transition and plan to adapt their workflow has differed depending on their individual priorities.
When making the important decision of how they will trade their security-related FX in a post T+1 world, managers have carefully considered and balanced key factors including: liquidity, latency, settlement, trading off matched security trades versus pre-funding, competitive dealing, and their appetite for automation and outsourcing of FX execution.
Broadly speaking, managers have focused on several approaches to solve for T+1:
- Open a North American FX trading desk. Staff accordingly to trade FX in the New York time zone (specifically 4-5 p.m. ET)
- Automate or outsource their FX workflow so they can execute FX closer to U.S. equity trades without human involvement
- Trade a larger percentage of their volume direct with their custodian(s), negating same day third-party cut-off times
- Pre-fund trades instead of executing FX from a matched security
Let’s take a closer look at a few of these strategies.
Opening a North American FX Trading desk
Several of the larger U.K. and European managers have decided to open FX trading desks in the U.S. to solve for T+1, while others are looking at running night desks to achieve the same goal.
Despite significant costs, the benefits are obvious. The U.S. and Canadian equity markets close at 4 p.m. ET, so having FX traders in North America allows managers to execute FX late in the U.S. afternoon for T+1 settlement and before the deadline to utilize CLS.
However, with FX end-of-day (EOD) at 5 p.m. ET and CLS cut-off so far remaining at 6 p.m. ET (midnight CET), conducting a significant portion of U.S. equities market-on-close (MOC) will require a quick turnaround time. Managers will have just one hour to match security, create, and then execute the FX trade, with an additional one hour post execution to settle via CLS.
There has also been much discussion in the market of what that one-hour FX trading window - named the “Golden Hour” between 4 and 5 p.m. ET - will look like post T+1, with more Real Money market participants choosing to trade during that time.
Liquidity has been historically poor in late U.S. afternoon, especially on Fridays, but this is expected to improve with the anticipated additional flow. The extent of such improvement however will be of keen interest for those looking to trade FX during this time, as well as others assessing the 24-hour FX liquidity paradigm.
It also raises the question of whether we will see U.K./European Real Money names notably buying USD during this “Golden Hour” window. In addition, there is potential for other wider participants in the FX market with USD to sell to view this window as a natural offset and also change their execution behavior accordingly.
Overall, this solution to T+1 will not be for everyone. Managers need to consider the additional head count costs of having FX traders in North America, alongside the necessary support infrastructure that comes with it across operations, systems, and oversight. There may also be additional regulatory and tax implications that would need to be considered and these will differ for each individual manager.
Outsourcing FX Workflow
Some managers have looked to outsourcing to solve for T+1. A benefit of this approach is that they can set up automated execution sweeps during the U.S. afternoon and Asia session without physically having FX traders in those regions.
This approach could also have the added benefit of future proofing your FX program, not just for the pending T+1 change, but also for any proposed future changes in other markets or to potential T+0 simultaneous settlement.
For many managers this will be the first time they have looked to outsource their FX execution. Therefore, it’s critically important to research and evaluate your options in this segment while partnering with a firm with a long-standing history and reputation in the space.
Client control, comprehensive reporting, and operational efficiency is of the essence, backed up with market expertise and a strong desire to uncover new sources of value for those clients.
Important considerations for evaluating an outsourced FX program include:
- Client customization
- Third party capabilities to net/aggregate FX flow across all accounts and support multi-custodians
- Ability to include all security and corporate action related FX
- Ability to support select Restricted Markets
- Trading expertise
- Dedicated relationship management and product development teams
Trading With Custodians
While opening a North American trading desk and outsourcing are likely to be the two most high-profile solutions for T+1, some managers have indicated they will trade more of their FX flow direct with their custodian(s).
With U.S. and Canadian equities moving to T+1, the knock-on effect for those looking to trade the following European morning is that the associated FX will need to be executed with same day T+0 value.
Trading FX T+0 requires consideration of third-party cut-off times and precludes settlement via CLS. Managers will also need to prepare to accommodate for non-U.S. and Canadian FX holidays, and potentially pre-fund in certain circumstances.
Managers looking to adopt this approach of trading FX for T+0 settlement will likely look to trade third-party across bank partners where they can. However, they ultimately may need to increase their flow to their custodian(s) where third-party cut-offs don’t apply.
As such, while this solution could save managers the upfront costs of amending an existing FX workflow, the trade-off could include a reduction in execution efficiency, especially in terms of latency and netting capabilities. For those managers with multiple custodians, this also may increase trader workload.
For more information and practical insights on FX and T+1, contact Ricky Ellis, Brendan Burke, Mark Whitehead, Munenori Yoshihara, or any of our FX team globally, and follow BBH Investor Services on LinkedIn.
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