With this change being implemented across the North America financial services landscape on May 28th, there is a heightened sense of focus across the industry to ensure compliance with the new regulation and adopt infrastructure to support the shortened processing time. The outcomes of the new requirements should benefit investors by mitigating credit, market, and liquidity risks associated with unsettled securities transactions.
Cuesta Partners has extensive experience with the impacts of this new accelerated settlement cycle on workflow and operations, and supporting clients along their implementation journeys. Our deep industry resources have helped clients to assess key processes and technologies to evaluate short and long-term opportunities, establish governance structures, build implementation and integration roadmaps, and select trade automation solutions. All of which are helping to enhance core processes and drive operational efficiencies at scale.
In this point-of-view, we will share our perspective on the looming T+1 regulation and key considerations to maintain and optimize compliance for a resilient future.
A brief primer on T+1 and how institutions will be impacted.
Whenever a transaction occurs around stocks, bonds, exchange traded funds (ETF) or mutual funds, there are two critical dates in play – the transaction date and the settlement date. ‘T’ represents the transaction date, while T+1, T+2 and T+3 refer to the settlement dates of security transactions (which occur on a transaction date plus one day, two days and three days, respectively).
While the transaction date represents the moment in which the actual trade occurs, the settlement date is slightly more complex in that it represents the time at which ownership is transferred. Ownership does not always occur on the transaction date, and it may change based on the type of security in play.
[Note: In the U.S., the Depository Trust and Clearing Corporation (DTCC) provides clearing and settlement services for the financial markets, and notably settles nearly all securities transactions. Its subsidiaries, Depository Trust Company (DTC) and National Securities Clearing Corporation (NSCC), play crucial roles in automating, centralizing, standardizing, and streamlining financial markets.]
Following the implementation of the new regulation (amending Rule 15c6-1 of the Exchange Act) most securities will be required to settle on the next business date from the transaction date (T+1). A key component to adhering to the shortened settlement cycle in the US is ensuring trades are affirmed (done by the instructing party) by 9pm EST on the trade date. This increases the probability of settling during the nighttime DTCC cycle, thereby reducing the risk of failed transactions. The new rule impacts the processing of institutional trades by broker-dealers and select agencies, while also impacting certain recordkeeping requirements for registered investment advisors (RIAs).
In India, a phased switch was completed for their equity markets to T+1 settlements at the onset of 2023 – the U.S. move will have huge global ramifications for both industry participants and other markets, especially those that have yet to adopt T+1 such as UK and Europe. This transition will likely have an impact on stock lending and borrowing – for example, with less time to identify and recall loans, settlement fails and resulting penalties may rise.
Finally, for many institutions, their core technologies and manual operational processes will require upgrades to better support and capitalize on the new requirements, which will certainly demand a series of investments for the short and long-term. Further below we will share some approaches and thoughts on how to best prepare for this and some pragmatic steps business leaders can consider.
A critical transition – with speed, cost savings, risk reduction at the core.
In an increasingly real-time world, T+1 settlements will help keep traditional financial markets relevant and attractive to investors. A shorter rolling settlement cycle means firms incur reduced systemic, operational, and counterparty risk during the trade settlement process, something which could prove vitally important during bouts of volatility.
In a recent interview with Citi, Lou Rosato, director of global investment operations at BlackRock, stated that “with one less day in the settlement cycle, there can be a more efficient deployment of capital and a reduction in risk, which is a benefit to our end clients.”
Previously, several post-trade processes entailed significant manual intervention, which leads to the crux of the challenge and opportunity ahead for financial institutions in accelerating their technology modernization efforts.
The entire execution through settlement phases will need to be considered with supporting automation to enhance straight-through processing (STP) and minimize exceptions, which will ultimately lead to better processes and efficiencies for organizations. This will take investment to strip out manual workflows, but will clearly lead to cost savings and risk reduction across the lifecycle of activities.
With this important change, operational challenges exist in migrating from manual to automated systems – including changes in the relationships with market participants, as well as operational risks such as less time to address process errors or potential fraud incidents.
International investors face even greater challenges. Middle of the night cut-offs will require re-imagining their operating models such as locating closer to U.S. execution teams or having teams work overnight to match U.S. business hours. Additionally, funding and FX (foreign exchange) transactions will have to be reorganized to ensure cash is in the account on time.
Key areas for modernization and tech transformation.
Our work with several institutional clients has positioned them strongly for this critical change by helping to create operational resiliency while modernizing their technology footprints. This work has also ensured compliancy and continuity in their core business processes, which is a table-stakes requirement for success.
While many firms are now well underway in preparing for T+1 and conducting final testing for the initial cutover, the work doesn’t stop there. Organizations should continue to refine their in-house and external capabilities (with the DTCC and other partners like custodians) to strengthen market posture and position for the future. The industry outlook could very plausibly include a full transition to T+0 settlement or even a netted T+0 solution using distributed ledger technology.
Our experts see a handful of clear opportunities that financial institutions can capitalize on and capture benefits around, including:
- Process and technology assessments – Detailed analysis and roadmap to evaluate short and long-term opportunities following cutover. This can further uncover operational efficiencies, eliminate manual processes, and establish a detailed plan for technology investments. More broadly, this should underpin a shift from batch processing to real-time operations. Also, consider tech stack opportunities such as utilizing a central matching platform to automate the trade affirmation process, tools to manage exceptions, and enriching trades with up-to-date SSIs from an online, global, golden-sourced database.
- Front-to-back workflow – Evaluate the number of persisting manual interventions and amount of unautomated processing that occurs in the current workflow to drive straight-through-processing (STP), including changes in trade instructions driving affirmation mismatches (e.g., settlement date, net amount) that lead to trade failure.
- Enhanced integration with DTCC and partners – Complete all testing activities leading up to T+1 and, where applicable, consider use of DTCC’s products to streamline the settlement process such as Central Trade Manager (CTM), Match to Instruct (M2i), and ITP data analytics to measure and compare operational performance against counterparties. Evaluate outsourcing non-core trading functions to a custodian offering a robust and integrated service offering.
- Governance – Establish operational governance structures to develop a roadmap, execute key initiatives and enhance operational processes. This could include switching to a ‘follow-the-sun model’, providing organizational change management, and maintaining vigilance around compliance to the T+1 rule during early implementation.
Prepare today for the fast-approaching transition date.
While a complex and perhaps daunting endeavor for many, the May 28th transition presents a compelling opportunity to re-imagine business processes and drive new levels of efficiencies, all while making a longer-term assessment of supporting technology that can power a strong automation backbone for the future.
Our advice for aspiring players is to create a robust plan to address gaps and opportunities pre-and post T+1 with an emphasis towards automating trade date activities, assessing capital and liquidity impacts and solidifying an approach to support the nuances of ETF trading. Also, we recommend pursuing improvements in corporate action and income distribution processes, proactively and continuously engaging with clients, and considering long-term technology updates for a resilient and sustainable future.
If you need strategic advice or operational expertise to navigate your transition, the financial services experts at Cuesta Partners have in-depth knowledge to help you today and for the long-term.
