T+1 settlement has arrived! How we got here, adapting to new realities

Key Takeaways

• T+1 benefits could cut costs and risk, foster more workflow automation
• Firms now face more jurisdictional divergence, operational hurdles
• Leveraging tech and straight-through processing will be key

After much anticipation, and not a little global concern, the shorter settlement period for securities transactions, or T+1, is now deployed in the US. Driven by investor demand, technological advances and regulatory requirements, the road to T+1 has been long and well-advertised.

In this report, ION will briefly describe the journey to compressed settlement, recap its benefits and challenges, and remind market participants that automating and simplifying forex trading, risk management and operations is key to thriving and scaling efficiently, not merely a means to survival.

What is T+1 settlement?

The settlement cycle refers to the period between the trade date execution and the settlement date, when ownership and payment of the securities are exchanged.

Regulators have long considered that the gap between acquiring and taking possession of a security is filled with risk. Market participants mitigate the risk of a trade falling through by posting margins (collateral) with clearinghouses, the intermediaries in transactions who play an essential role in ensuring the stability and efficiency of global financial markets.

Until 1993, the period between acquiring a security and taking possession of it in the US was five days. The Securities and Exchange Commission (SEC) cut this to three days, where it remained until 2017, when it was reduced to two.

US, the largest capital market in the world, officially moved to T+1 on 28 May, one day after neighbors Mexico and Canada. India, the world’s 4th largest stock market, led the way, completing its transition to T+1 in 2023 and is already on its way to same-day (T+0) and eventually real-time settlement. The UK and European Union have launched consultations on if, when and how to transition.

The benefits

A shorter settlement cycle brings multiple advantages to financial markets, including:

• Cost reduction: It should bring down the costs related to collateral and trading operations.
• Diminished risk: By reducing the time between trade and settlement, there’s less exposure to credit and counterparty risk.
• Enhanced capital use: This change promotes the more effective use of capital and the reduction of margin requirements.
• Quicker fund availability: With faster settlement, funds become accessible more quickly.
• Streamlined operations: Adopting this standard is likely to streamline operations by eliminating delays in the trading process.

According to a report last year by the Depository Trust and Clearing Corp, whose National Securities Clearing Corporation (NSCC) settles most securities trades in the US, “risk model simulations have shown that the volatility component of NSCC’s margin could potentially be reduced by 41% by moving to T+1, assuming current processing and without any other changes in client behavior.”

And in India, securities regulator SEBI said in its 2022/23 annual report that the transition to T+1 in equities trading in January 2023 had increased efficiency and reduced the risk of outstanding trades to be settled.

The challenges

The benefits are clear and lauded, but challenges exist. Foreign currencies, cross-border transactions, jurisdictional and time-zone differences accentuate the difficulties, which include:

• Complexity and costs: Transitioning to T+1 might mitigate some risks but also introduces others, as firms adjust to new timelines and misalignments in settlement cycles.
• Operational difficulties: The compression of post-trade processes could lead to rushed settlements and increased chances of incorrect payment terms.
• Regulatory compliance: The T+1 regulation in the US will impact international transactions, requiring firms to navigate a complex landscape of global regulations.
• Settlement failures and short positions: The reduced time between trade execution and settlement start could result in more settlement failures and difficulties in managing short positions.
• Technological challenges: Liquidity providers may face integration work to shift from T+2 to T+1 settlement. This includes managing different settlement cut-off times for various currencies.

Adapting to T+1

To adapt to the new settlement cycle, FX traders and Institutional and commercial sales desks from Asia to Europe are implementing various strategies, including opening North American FX trading desks, trading directly with custodians (thereby avoiding same-day third-party cut-off times), and pre-funding trades.

The fundamental component though to succeeding in compressed settlement cycles — and being prepared for eventual real-time transactions — is leveraging technology and having as much straight-through processing as possible. Fewer manual interventions mean less human-induced error being introduced. That saves time and money.

Market participants must adopt a holistic approach to their operations, coordinate workflows, from front-office to the back, and harmonize the execution of FX and equity trades to ensure settlements are executed on time.

Maximum operational efficiency is critical, and to achieve it operators must either outsource their FX workflow to third-parties who possess the technological solutions and set-up to handle T+1 (or T+0) and ensure compliance, automate as much of their processes as possible, or both.

This is where ION can help. Whatever the size of your business, our solutions automate and simplify your trading, risk management, and operations in one, easily scalable platform. We enable you to track and monitor your operations in real time with our fully automated and flexible confirmation, clearing, and payments solution.