T+1 risks a surge in fails for FX-dependent trades, says GFMA

Report by the association has found that T+1 could put pressure on funding of securities transactions involving FX.

A paper from the Global Foreign Exchange Division (GFXD) of the Global Financial Markets Association (GFMA) suggests the move to a T+1 settlement timeframe poses a risk to the funding of cross-border securities settlements, and explains how existing systems and infrastructures can navigate the challenges posed.

The US Securities and Exchange Commission (SEC) voted to move the settlement cycle from T+2 to T+1 from 28 May 2024, effectively halving the time available to complete the settlement process.

Theoretically, the timeframe reduction minimises the risk of default as transactions are completed more quickly – it also has the capacity to improve liquidity in the market and should lead to an increase in trading volume and potential cost saving thanks to reduced margin requirements.

However, these advantages are dependent on risk mitigation as the market adapts to a T+1 process. The GFXD report claims that settlement fails are possible if related FX trades cannot be completed in the same timeframe, leading to general increased cost of trading.

According to the report, the impact on front office trading desks boils down to the risk that transaction funding which is dependent on FX settlement may not occur in time, and the fact that securities transactions with a related FX trade will require advanced execution of the latter. Additionally, ensuring that trade matching, confirmation and payment all occur within local currency cut-off times is key, as well as awareness of local market closures.

Speaking to The TRADE, Alex Knight, head of global sales and EMEA at Baton Systems, a DLT-based platform for the post-trade processing of assets and wholesale payments, emphasised that “although FX does not fall under T+1, those trading in US securities from outside the US need to factor in time for FX settlement to ensure they have the cash to settle their securities transactions”.

Knight added: “With a shorter settlement window, post-trade processes need to be completed faster, and there is less time to remediate breaks.”

Another factor which the report highlights could adversely affect the ability for trading desks to settle T+1 is an increase in demand for multi-asset trading and settlement capabilities. To combat this, simultaneous execution is proposed, increased process automation of equity and currency trades which together work to expedite the confirmation and settlement process to meet deadlines.

Additionally, the increased risk of executing FX trades against unconfirmed or unmatched equity trades which stems from T+1 timelines will have to be weighed against the operational risks of increased trade amendments or cancellations, according to the report.

The paper suggests that the buy-side should adopt a strategic approach to managing FX risk, in particular highlighting outsourcing currency management – specifically “to specialists who have trading/operations in the major trading time zones, alternate passive or active currency strategies, and 24-5 market access to wholesale FX pricing and liquidity management to assist with best execution.” It also suggests utilising CLS where possible to help lower market settlement risk.

Technologies including DLT, ML and AI are highlighted as contributors to finding solutions to the T+1 US challenge. Knight emphasises how DLT is already making headway in this space: “Automated, safe, and scalable settlements utilising DLT are already in use by some tier 1 banks, helping them to address the roadblocks to efficient trading that will be thrown up by this monumental shift in market structure.

“DLT is already proven as the means to accomplish risk-proof FX settlements for cross-border transactions, bringing the speed, transparency, choice, auditability, and non-repudiation required by market participants today.”

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