The move to T+1 in the US – who really benefits?

While the Depository Trust and Clearing Corporation (DTCC) has recommended[1] moving the US Settlement process from a two-day settlement cycle (Trade date +2), to next-day settlement (Trade date +1) to reduce risk, and strengthen and modernize securities settlement in the U.S. financial markets, the question is, is the industry really ready for such an impactful change and the potential upheaval that such a change will bring?

The move to T+1 for US Settlements, which will likely start in the first half of 2024, from a market and counterparty risk perspective, is great news. While the move from T+3 to T+2, in 2017, was deemed a success, the move to T+1, removing half of the time allowed for settlement, will mean a more profound need to ensure everything is instructed correctly first time. The opportunities to make changes to resolve any exceptions during the settlement cycle will inevitably be limited. Hence, firms need to urgently assess if they are truly ready for this market change, as the impacts are likely to be much more significant than just a reduction in time.

As the DTCC initiates the process of rolling out T+1, the market needs to appreciate, and be cognizant, that the last 2 years have put unforeseen challenges in front of all financial firms.

• Covid-19 has rigorously tested firm's business continuity planning (BCP) efforts over the last 10 years. While most firms pivoted to fully remote working, not all could, as some firms required staff on premise, to enable their 20th century processes, e.g., [2]faxes, to be sent. T+1 could be the catalyst that finally shifts the focus for these firms to the back-office, to ensure that systems are automated, efficient and ready to cope with scalability and unexpected volumes.
• The trading in meme stocks, such as Gamestop & AMC, pushed up DTCC margin requirements significantly at brokers like Robinhood, which led DTCC to suspend trading in these volatile stocks. T+1 would lower the capital requirements at these brokers, but the increase in volume would still need to be handled.
• And lastly the growth in Digital Ledger Technology (DLT) & digital assets is now becoming more mainstream, as Central Banks look at implementing Central Bank Digital Currencies (CBDCs), enabling these new asset types, backed by Central Bank money rather than crypto currencies, to promote a T+0 settlement cycle posing the question is the move to T+1 enough?

So, is the back-office ready?

T+1 will remove some market risks, but risk doesn't go away, it simply moves to another area and, right now, it looks like that area will be back-office operations.

Compressing the settlement cycle to T+1 will demand that operational risk is mitigated. Any manual processes will immediately come under pressure, as automation is a prerequisite for a T+1 environment to ensure exception management is limited and there is as little risk as possible. Technologies such as the humble fax machine need to be retired for more automated tools, with operational controls built-in, as staff focus on exceptions and correcting transactions. Furthermore, firms should be looking at the root causes of exceptions to amend any obsolete or outdated processes to ensure those exceptions are avoided going forward. Existing systems need to be able to support real-time processes due to time limitations. Batch processing simply won't work. The use of application programming interfaces (APIs) will be crucial to enable data to be accessed and shared in real time to resolve and understand any exceptions.

But these are obstacles the back-office can mitigate and overcome by putting controls in place. However, other areas outside of pure technological changes need to be considered:

• Foreign exchange (FX) transactions traditionally settle on a T+2 basis. For international participants wanting to buy US securities, prefunding the transaction with USD or arranging for a short-dated T+1 FX settlement will be required. The effect of prefunding could potentially impact other investments, as clients need to sell a day earlier to have the USD available, resulting in an investment manager out of the market for 1 day.
• Corporate Actions customarily have ex-date one day prior to the record date, enabling trades to settle in advance of the record date cut off. The US market change will mean that the ex & record dates will need to be the same day which will undoubtedly lead to more reconciliation issues and subsequent market claims.
• A market disconnect will now prevail, where the majority of markets will still settle T+2, but the US, which has the latest market close time of the developed markets, will settle T+1. Any cross-border transactions will now be operating across two different settlement cycles resulting in further operational risk and staff pressure.
• A time constraint on securities lending where the lender will either need to get the original securities back from loan or substitute the lender with another party will bring challenges where the security has been sold late in the day on T+0 in order to effect settlement the following day.

These additional risks and issues will potentially offset some, or maybe even all, of the gains made from the decrease in market and counterparty risk. Whether it is more risk overall, is really a question operations managers need to monitor closely as they prepare for tomorrow.

So, what's the answer?

US banks, brokers and investors need to initiate an assessment of their current post-trade technologies and processes, from the front-office to back- to ensure that they are ready both from a technology and an operational standpoint for T+1. Foundational account and standing settlement instruction information needs to be 100% accurate and available to counterparties, as there will be no margin for error in a T+1 settlement environment. If firms are ready to embrace the challenge, they could gain or maintain their competitive advantage, achieve market differentiation and accelerate business growth. If they are not ready, or do not have the optimal post-trade processes, they could be in for a difficult journey once T+1 goes live.

The decision for clients to replace legacy technologies and processes with a holistic open platform and integrated post-trade framework must now be considered to future-proof the organization. This also needs to include planning for digital assets as well as traditional asset classes. The timeline is short, which may be a challenge for some, but also an opportunity for others. Real-time processing will need to be the standard and it will need to operate 24/7 to ensure the best outcomes.

Whatever the current state of your post-trade infrastructure, there is no time to delay, an urgent review is needed now to ensure you are ready for T+1 in 2 years' time.

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At IHS Markit, our post-trade Securities Processing solution provides the foundation for supporting T+1. Our team of industry experts collaborate with clients to deepen our understanding of their requirements so that when T+1 arrives, they are equipped with an integrated solution, offering automated features that maintain efficiency and transparency.

S&P Global Market Intelligence and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Consult your own tax, legal or accounting advisors before engaging in any transaction

[1]Accelerating-the-US-Securities-Settlement-Cycle-to-T1-December-1-2021.pdf (dtcc.com)

[2]What's the DTCC and How Did It Stop GameStop Mania? (bloombergquint.com)

Posted 06 May 2022 by Bill Meenaghan, Director, Product Management, IMSecurities, S&P Global Market Intelligence

S&P Global provides industry-leading data, software and technology platforms and managed services to tackle some of the most difficult challenges in financial markets. We help our customers better understand complicated markets, reduce risk, operate more efficiently and comply with financial regulation.

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.