T+1 - why settle for anything less?

On 28 May 2024 the US will reduce the standard settlement cycle for securities transactions from T+2 to T+1, as a way to lower the risk in clearing and settling securities.

11 Mar 2024 . 3 min read

The reduction will have a knock-on impact on FX settlement times where cross-border security transactions are in turn dependent on FX transactions. And, where FX trades do not meet the deadline for CLS [1] clearing (for eligible currencies) they will need to settle bi-laterally, potentially increasing counterparty and / or operational risk.

One mitigant, especially for non-US entities e.g. in Asia or Europe that need to meet these compressed FX settlement timelines, is to consider implementing greater automation within their FX portfolio.

In this article we consider the upcoming changes, and what the buy-side can do to help lessen the operational impact. And although current changes are limited to the US (& Canadian) securities market, both the UK and EU are considering whether similar changes might be applied in their jurisdictions as well.

The impact on FX

US securities settlement will move from T+2 to T+1 effective 28 May 2024.
Shortening US security settlement window raises the risk that transaction funding dependent upon FX settlement may not occur in time.
Cross-border US security transactions with a linked FX trade will mean expediting execution of both trades to enable settlement to be completed within the shortened T+1 window.
FX settlement involves trade matching, confirmation and payment all being completed within local currency cut-off time.
Cut-off time for CLS-settled FX trades (in 18 eligible currencies) is midnight CET on T0 if they are to be in time for T+1 securities settlement the following day.
FX trades that miss CLS cut-off, or are not eligible for CLS, can still be settled bi-laterally (with netting of trades between counterparties if enabled), although this adds credit and operational risk.
Consideration should be given to the potential impact on transaction costs, either as a result of pre-funding securities transactions where there are time zone challenges, or as a result of late payment fees and interest charges.

There are varying levels of concern across the market about the severity of the impact of T+1, ranging from rolling on as usual to geographic shifts of operational teams to ensure trades are processed correctly. The most consistent theme is the level of confidence of funds being available in time for settlement, together with concern about additional costs and settlement risk, especially across non-USD based funds.

Further details on FX considerations for T+1 US Securities Settlement can be found in the GFXD [2] paper from May 2023.

The broader context

With the US & Canada moving to T+1 in May, focus will inevitably switch to the plans in the UK and EU. The latest news from the UK was a letter from the chair of the UK Accelerated Settlement Taskforce in December 2023 noting the "broad consensus that the question is how and when the UK moves to T+1 and not whether it should do so". In the EU, ESMA [3] has published a call for evidence on shortening the standard settlement cycle.

As set out in a recent paper by GFXD, within the wholesale FX market there is greater scrutiny on how to execute and when to settle FX transactions, driven by technology, a desire for increased operational efficiencies and reduced settlement risk, and of course by changing regulation.

Add to that the continued obligations for best execution and a need for greater transparency and better data, and the pressure is on to find innovative solutions.

Primary and secondary impacts

We’ve focused here mainly on second order impacts of the upcoming changes from the perspective of a UK bank with clients outside the US operating in the US securities market, and the implications for FX settlement. However, of course the primary impact will be with the US securities market itself. The general consensus seems to be that the SEC's decision will reduce counterparty risk across the ecosystem and may act as a driver for further automation and standardisation.

That said, there are potential implications... How might the move impact DCM [4] re-issuance, does the reduced timeline stress the issuance process? If there is an increase in non-standard settlement, will funding markets bridge the gap and will that have cost implications?

How can automation help?

A requirement for shorter execution and settlement windows can be facilitated by a move towards greater automation. Automation can operate around the clock irrespective of where teams are located and can be leveraged as a replacement to operational teams processing settlement trades or as a last minute safety mechanism should funds not be available. For more information on NatWest’s automation tools please see our website.

Are you ready?

All eyes are on the end of May and how the industry will respond to the settlement changes in the US - depending upon the success of these measures in the US and globally, expect to see more change in this space as other jurisdictions fall in line, and execution & settlement timelines tighten.

Glossary

[1] Continuous Linked Settlement

[2] Global Foreign Exchange Division

[3] European Securities and Markets Authority

[4] Debt Capital Markets

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