FX traders looking for a fix in the new T+1 settlement era

Key Takeaways

• T+1 in the US has a global impact, especially in FX
• Mismatches are expected because of compressed settlement
• Technological solutions aim to facilitate the funding process

As with many new regulations, there are the unintended consequences. The long-heralded settlement cycle, which came into effect in May in the US, is no exception. Although many global regulators applaud the Securities and Exchange Commission (SEC) for making the move, concerns have circled over the impact on FX for non-US market participants, in particular Europe and Asia Pacific.

It is easy to understand why the SEC pushed these new rules through. The shorter duration to T+1 from T+2 has a myriad of benefits, such as mitigating credit, operational, market, and counterparty risks while reducing margin requirements, increasing market liquidity, and permitting more efficient use of capital. However, the criticism is that the new regime is not aligned with the established frameworks and cut-off times across different time zones. This has meant that the window outside the US has become smaller for settlement.

This is not the first time that settlement cycles have been cut. In 2017, the US moved from T+3 to T+2, but the difference this time around is that it eliminates the one-day buffer between trade execution and settlement, which was generally used to fix settlement mismatches. This not only ensured timely funding but also prevented settlement failure.

Less time to source dollars

In a T+1 world, transaction funding may not occur in time as it depends on FX settlement processes involving trade matching, confirmation and payment, all to be completed within currency cut-off times. The issue was flagged in a recent BNY Mellon report, which said the new rules reduced the time foreign investors had to source US dollars to fund their US securities. It estimated that late FX settlement would become more commonplace given that 19.6% of securities and 16% of the equity market are materially owned outside of the US.

In addition, a separate study by the European Fund and Asset Management Association (EFMA), whose member firms manage more than USD 30 trillion in assets, found that 40% of European asset managers’ daily FX trades would have to settle outside the safety of the CLS multi-currency platform, set up in 2012 to reduce settlement and counterparty risks. This would represent between USD 50-70 billion in FX trades on a typical day, with higher volumes when markets are more volatile.

The London Stock Exchange Group also highlighted the regulatory impact for European asset managers, who would be penalised for any increase in the number of settlements under Central Securities Depositories Regulation (CSDR) rules, as well as having capital impacts under Basel III requirements. Moreover, UCITS regulations restrict borrowing, posing challenges for managing liquidity under T+1 settlement.

Spotting the problem and fixing it

It is early days and difficult to predict the long-term impact of the move to T+1, but technology solutions are being developed to facilitate the process for non-US participants. For example, Bloomberg recently launched the Bloomberg FX Fixings (BFIX) value tomorrow outright rates, which for now is the only benchmark on value T+1 basis available to the market.

The product enables users to send FX orders to their executing counterparts for a T+1 fixing. Sell-side banks honour the BFIX T+1 fixing rates inheriting a swap at the BFIX tom-next points.

The initial launch includes 20 deliverable currencies against the US dollar (USD), including Australian dollar, British pound, Czech koruna, Danish krone, euro, Hong Kong dollar, Hungarian forint, Israeli shekel, Japanese yen, Mexican peso, New Zealand dollar, Norwegian krone, Offshore Deliverable Chinese renminbi, Polish zloty, Romanian leu, Singapore dollar, South African rand, Swedish krona, Swiss franc, and Thai baht.

Europe T+1 switch could also be disruptive

The need for solutions may be short-lived, though, as Europe hopes to follow in the US’s footsteps. Timing is unclear, as the European Securities and Markets Authority (ESMA) is aiming for the fourth quarter of 2027, the first quarter of 2028, or the fourth quarter of 2028 as potential deadlines to cut settlement times to one. If it were left up to the trade group’s members, around 70% would like to see the switch happen in 2027.

Whatever the date, the transition in Europe is expected to be more complex and costly because of the fragmented nature of the market and the lack of a unified capital market, although efforts are being made. Asset managers, banks and trade groups are also concerned that settling trades on a T+1 basis could potentially prove disruptive, according to a compilation of responses to an ESMA consultation published earlier this year.

As FX market participants adapt to T+1, those who team up with global and innovative technology vendors that can provide plugged-in and tailor-made solutions to overcome obstacles will gain an upper hand over competitors.