The shift to T+1 in the US can largely be described as a success – affirmation rates remain comfortably high, fail rates have stayed reasonably low and FX trades don’t appear to have shifted to bilateral settlement as feared.
Despite worries in the lead up to the monumental shift, many have managed to adapt their workflows to evade issues across the ETF market, securities lending and FX alike, while adapting to affirmation and central trade matching platforms to achieve straight through processing.
However, while many buy-side have hailed the migration as considerably smooth, there are some unexpected patterns emerging in how expensive it is to trade on certain days thanks to misalignment with other regions that have not shortened their settlement cycles, and this is leading to a lack of liquidity.
Presenting the Thursday conundrum.
Given that the settlement cycle is now shorter in the US trading volumes on a Thursday have dropped off significantly thanks to funding requirements that require brokers to fund a position for an additional three days on Friday, Saturday and Sunday given the slightly longer settlement cycle in Europe, the UK, and most of Asia Pacific.
The issue has been flagged by participants in various arenas, most recently on stage at the inaugural CMX conference held by the Finance Hive last week. When quizzed on their views of how the market was handling the transition to T+1, the issue around trading on a Thursday was raised several times by buy-side speakers.
Thursday volumes were noted as “muted” thanks to what some were claiming was an extra five basis point charge on trading for orders made on that day thanks to broker funding requirements over the weekend.
Jim Goldie
“The impact on a Thursday is that brokers need to fund for another three days. Additional funding over the weekend will manifest itself through wider spreads. A few bps matter,” said Jim Goldie, EMEA head of capital markets, ETFs and indexed strategies, Invesco.
“Brokers are pricing two different levels, one for T+1 settlement and one more expensive option for T+2 settlement. We’re in a suboptimal place with global misalignment. Depending on the day of the week or the settlement cycle used it’ll be more expensive to trade.”
“It’s not just Thursdays but the day prior too thanks to the funding issue. From a basket perspective, banks have been willing to do extended settlements but they charge for that. Somewhere in the system someone is picking up the tab. These are the complexities that go away with alignment.”
Highlighted by many is the fact that the industry is yet to go through a public holiday falling a Monday or impacting the end of a week in a post-T+1 environment and this will likely exacerbate many of the patterns we are seeing emerge.
“We’re in a wait and see phase. There is the Friday the 5 [July] issue but we’ll have to wait until September for a three-day weekend. There’s a hyperfocus now but what does business as usual look like? Will the SEC [US Securities and Exchange Commission] start to implement fines?” said Callum McPherson, dealing manager at Evenlode Investment, also speaking at CMX.
Elsewhere, several banks have reportedly sent notes to clients letting them know that they intend to pull liquidity currently being provided between five and six pm on a Friday NY time given that they have seen zero executions in this window since the shift to T+1 and given that everyone is now pre-funded.
Europe and the UK must move together
With the UK and Europe on a misaligned settlement cycle to the US, some have urged the UK to move on with its own shortened settlement cycle plans now that it is no longer part of the EU.
Callum McPherson
However, as noted by buy-side speakers at CMX, this would leave UK traders at the mercy of the same misalignment-related issues as seen currently between the pan-European markets and the US.
“The UK should move in step with the EU,” said Huw Gronow, head of dealing and implementation, Newton Investment Management.
This was corroborated by Goldie: “If the UK followed strict timelines it could be there by 2026. UK market structure isn’t that complicated. But the UK Government and regulator listened to the industry. We would see the same pain points in Europe. The UK and Europe need to move together otherwise it’s just more misalignment.”
The UK put together a taskforce in 2022, releasing its first report in March of this year that confirmed that the UK should move to T+1 no later than December 2027. Its final report will be published at the end of this year.
Meanwhile in Europe, the European Securities and Markets Authority (ESMA) is set to publish its own report at the end of this year, latest in January 2025, Nina Suhaib-Wolf, director market practice and regulatory policy at ICMA confirmed.
She added that there would be a public hearing on the subject on 10 July and that it had become a question of “how not if” in Europe.
Real time settlement
When asked about the benefits of real time settlement, speakers on stage at CMX were unanimous that both the UK and European markets should focus on the move to T+1 before beginning to tackle a move to T0.
Nina Suhaib-Wolf
“It isn’t something we have time to talk about. We’ve been preparing for T+1. T0 would remove a lot of legacy systems and the custodian function. The regulatory environment would need to change. We’ll get there after alignment on T+1,” said Goldie.
“If building the system from scratch now it would be like the digital asset system with instantaneous settlement. The final step will need to be blockchain related,” added McPherson. “The advantage of real time settlement would be that the investor gets their investment back the same day.”
So long as Europe and the UK maintain a misaligned settlement structure to the US, snags in the workflows of the industry will continue to show themselves. Many institutions have done well to accommodate the change – it’s smooth but it’s not optimal. The industry is also yet to experience a major liquidity event under the new regime and this will surely put it to the test and reveal any major cracks left unidentified.