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The ripple effect of US T+1 settlement
The US and Canadian securities settlement cycle is set to be shortened from T+2 to T+1 in May 2024. This change is expected to bring several benefits to market participants including reduced risk, improved capital and liquidity optimization and enhanced operational efficiency. These benefits are more relevant than ever. The market volatility created by recent market stress events, such as the Covid-19 pandemic and the war in Ukraine, raised awareness of the crucial role that market infrastructures play in mitigating settlement risk.
While the move to T+1 in the US and Canada has the potential to bring benefits to financial markets and encourage other jurisdictions to align their securities settlement cycles with North America, it is also important to consider the challenges it may create. A report on T+1 from the Association for Financial Markets in Europe highlighted several potential issues, including: a reduction of the hours between trade execution and the beginning of the settlement cycle; a possible increase in settlement fails; difficulties in identifying and covering short positions in the securities lending industry; and a requirement to review key dates and market practices in impacted corporate actions.1 It is likely that the FX market will also experience other post-trade implications as a result of this transition.
Thus far, market participants, policymakers and industry associations have been most vocal about T+1 settlement in the UK and the EU. Increased levels of standardization and post-trade automation would also benefit settlement efficiency in the EU. However, while the UK has a relatively simple market infrastructure like the US, Europe’s market infrastructure is more fragmented, having 30 central securities depositories (CSDs) compared to just one in the US.
Successful initiatives in Europe aimed at harmonizing market practices indicate that T+1 might not be easy, but it is possible. TARGET2-Securities (T2S), a project in which I was closely involved while at the ECB, brought an end to complex cross-border procedures for securities settlement. With T2S going live in 2015, a common platform for transferring securities against cash was established, relying on harmonized rules and practices. It complemented the EU’s Central Securities Depository Regulation (CSDR) of 2014, which provided common requirements for CSDs operating securities settlement systems across the EU and harmonized their settlement cycles to T+2.
“It is likely that the FX market will also experience other post-trade implications as a result of this [T+1] transition. ”
The UK is also considering the feasibility of moving to a T+1 securities settlement cycle. Its Accelerated Settlement Taskforce comprising industry practitioners plans to make an announcement in early 2024. It is expected that both the UK and EU will follow the US in implementing T+1.
Another ripple effect of the move to T+1 is its impact on the FX market. As 20% of US securities and 16% of US equities are held in foreign portfolios,2 the US T+1 rule will impact many cross-border transactions because the FX component of the transaction must be settled prior to the T+1 settlement of the security.
CLS analyzed its transaction data to understand the potential impact on asset managers and funds that access CLSSettlement through third-party service providers. This analysis shows that a value equivalent to approximately 1% of CLSSettlement’s average daily settlement value is executed on a T+1 basis, comprising volumes where one side is USD and a fund is a party to the trade. Accordingly, the value that may need to move to T+0 after May 2024 is likely to be 1% of CLSSettlement values, assuming no trading or operational process changes by industry participants.
Over the past few months, CLS has engaged extensively with both buy- and sell-side market participants to identify the challenges T+1 securities settlement poses to the FX trade lifecycle. In particular, we are exploring how CLS’s services can support the market in the short term and assessing the feasibility of adjusting CLSSettlement processes to accommodate later cut-off times. Any adjustments must be carefully considered, as our main priority is the stability of the FX ecosystem.
As a central market infrastructure focused on mitigating risk in the FX market, we are fully supportive of market infrastructure initiatives that enhance risk mitigation and operational efficiency. Further, as a systemically important financial market utility (SIFMU), CLS is a strong proponent of global standards and rules that significantly mitigate risk in the financial system, such as harmonized settlement cycles. However, it is important to acknowledge that T+1 implementation in North America will have wider impacts, potentially driving other regions to harmonize their settlement cycles, and may require considerable work from some market participants to evolve their FX post-trade practices. CLS will continue to explore possible solutions to address the FX post-trade challenges in partnership with settlement members, the asset manager community and other market participants.
First published in The Full FX, February 2024.
1AFME_Tplus1Settlement_2022_04.pdf2 Department of US Treasury, “Foreign Portfolio Holding of US Securities”, 30 June 2022