How T+1 Impacts the Global ETF Ecosystem

September 14, 2023
  • Investor Services
A deep dive into the downstream impacts of T+1 on the ETF ecosystem and how participants should be preparing to support primary market activity.

The much talked about change in the U.S. market will impact ETFs globally. While U.S. ETFs will settle on T+1 in the secondary market, which carries its own set of considerations, here we focus on the plumbing that supports the ETF industry, to understand the downstream impacts and how ETF ecosystem participants should be preparing to support primary market activity.

Although the transition to T+1 in the U.S. in May 2024 is a local regulation, it will profoundly impact ETFs across the globe. At the core, it creates the potential for settlement mismatches due to timing discrepancies between ETF shares and the underlying basket trades tied to a creation/redemption order, as well as primary/secondary market settlement mismatches.

These timing challenges will prompt changes to workflows and systems that support creations and redemptions, and an increased use of cash collateral and/or cash in lieu. Ultimately, the differences in settlement timing between the U.S. and other markets could result in an increase in failed trades and wider trading spreads in the secondary market.

A deeper dive uncovers the following impacts on ETFs globally:

  • The timings within the current ETF creation and redemption workflow1
  • The potential for an increase in the number of settlements fails as the market adjusts
  • The need for authorized participants (APs) and ETF sponsors to evaluate individual products, to understand the impact on each across regions
  • A mismatch between European & Asian secondary market trading which will remain on a T+2 cycle and the settlement of the underlying U.S. & Canadian securities in the fund & the potential impact on UCITS cash balance and borrowing requirements2
  • The timing of execution for settlement- related FX, with potential considerations around liquidity and execution windows
  • The compressed trading timeline may challenge securities lending programs, where recalls will need to be processed in a more condensed timeframe

ETF Order Timeline

Trade Date -1

  • PCF published
  • Primary Market: C/R orders placed on T-1 Funds
  • Pre-funding on Asia orders with baskets that settle prior to the Primary Market order
  • U.S. Impacts: TD-1 Primary Market order window required for orders settling on T+0

Trade Date

  • Primary Market: C/R orders placed
  • Secondary Market orders placed
  • Settlement on T+0 C/R orders
  • U.S. Impacts: T+0 settlements more common place to facilitate liquidity in Secondary Market

Trade Date +1/Settlement Date

  • Settlement on T+1 C/R orders
  • U.S./CAD basket securities settle
  • U.S. Secondary Market T+1 orders settle
  • Europe Impacts:
  • Mismatch in settlement: Basket vs. Primary Market order
  • Potential Breach of UCITS 10% Borrowing requirement if fund is overdrawn caused by a mismatch in settlement of ETF shares & Basket
  • Possible impact on AP: they may be funding a position for a night which may result in increased downstream cost to investor
  • CSDR penalties impact if mismatch in Primary vs. Secondary Market order settlements
  • U.S. Impacts:
  • Primary Market orders with a domestic basket will settle
  • Primary Market orders with a global basket will require collateral to settle the ETF leg of the order
  • Asia Impacts:
  • Mismatch in settlement: Basket vs. Primary Market order

Trade Date +2/Settlement Date

  • Non-U.S./CAD basket securities settle
  • Settlement on T+2 orders
  • Non-U.S. Secondary Market T+2 orders settle
  • Europe Impacts:
  • Mismatch in settlement: Basket vs. Primary Market order
  • Potential Breach of UCITS 20% cash diversification rule where large undiversified cash balance due to settlement mismatch
  • U.S. Impacts: 
  • For orders with global baskets, components settle, and collateral will be marketed to market/returned
  • Asia Impacts: 
  • Mismatch in settlement: Basket vs. Primary Market order 

Let’s take a closer look at three regional scenarios.

1. U.S. ETF Settlements

As the driving force behind the move to T+1, the U.S. market will experience the greatest impacts and market participants will need to navigate several potential associated challenges. Since the transition in 2017 to T+2 settlement, ETFs have gained numerous efficiencies that may be further enhanced by condensing to T+1.

Fortunately, the National Securities Clearing Corporation’s (NSCC) Continuous Net Settlement (CNS) mechanism, which supports the clearing and settlement of ETFs with U.S. securities, will greatly streamline the process, due to the inherent operational efficiencies and settlement guarantee.

Creation and redemptions will become more complex for U.S. ETFs with global holdings, which settle outside the NSCC’s CNS infrastructure.

Additionally, where secondary market trading requires creation activity to support shortened settlement, ETF sponsors and APs will need to support a T+0 creation process. This will allow for ETF shares to be created in the primary market and onward delivered to satisfy secondary market trading obligations.

2. European ETF Settlements

In Europe, trading and settlement happens across 35 exchanges and 31 central securities depositories. Since most exchanges settle ETF share activity on a T+2 cycle, primary market activity - ETF creations and redemptions with the fund - may need to consider a move to T+1 settlement if a majority of the securities held in the portfolio are from the U.S. or Canada 3

UCITS rules restrict how much cash a portfolio may hold with any one institution to 20% of net assets and borrowing is limited to 10% of net assets. Mismatches in settlement may result in breaches of these UCITS rules where a substantial portion of the basket settles on T+1 and primary orders settle on T+2.

How this impacts AP’s and Market Makers needs to be considered. They may be faced with additional costs and increased risk where there are differences between primary and secondary market settlement cycles, ultimately impacting their pricing model and hence the spreads on the funds.

3. Asian ETF Settlements

The shift to T+1 will be most impactful in Asia for regional asset managers that lack U.S. time zone coverage. Many regional asset managers are familiar with shortened settlement cycles when investing into markets like China where the standard is T+0 settlement. As a result, many firms have already adopted practices like pre-funding to manage the settlement mismatch between the underlying investments and the primary market.

Asia-based managers will need a coverage model which accounts for U.S. business hours, where they can monitor and amend their trade instructions during the Asia evening of T+1, if the trades are not matched with their counterparties.

The use of pre-funding will likely expand, as ETF baskets with U.S. or Canadian securities will now come into scope.

Action steps to take

In preparation for U.S. T+1, ETF managers should review their current workflows and timings around order settlement and portfolio trading. Some areas of focus include:

  • Assess the impact of the condensed settlement timeline on investment tasks such as reconciliations, trade, and FX settlement instructions
  • Evaluate the implementation of trade affirmations, to reduce the risk of fails
  • Engage with APs and Market Makers on any product-specific considerations
  • For all non-U.S. ETFs, assess on a fund-by-fund basis the impact on primary market order activity of Canadian and U.S. securities moving to a T+1 basis – to identify where a move to T+1 settlement is required for creations and redemptions
  • Where identified, plan for European prospectus supplement amendments to reflect changes from T+2 to T+1 for primary market orders
  • Update U.S. prospectuses to reflect T+1 on create/redeem orders
  • Consider how to support T+0 create/redeem activity in the primary market in the U.S.

For more information and practical insights contact Antonette Kleiser, Chris Pigott, John Hooson, or your BBH Representative.

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The ability to create and redeem shares keeps an ETF’s price in line with its underlying net asset value and ensures that the liquidity of an ETF derives from the underlying securities held within the fund.
Regulation 103(3) of the UCITS Regulations provides inter alia that a UCITS may borrow not more than 10% of its assets provided that such borrowing is on a temporary basis.
Canada will move to T+1 on May 27, 2024.

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