From Tuesday, US trades of stocks, bonds and ETFs will need to be settled within a single day, not two, presenting significant challenges to European funds dealing in US securities. Insiders warn for a “tough ride” for traders to meet the tighter timeframe. For investors, the transition will likely be smooth, and cash and securities will end up in their accounts a day earlier.
Securities and Exchange Commission Chair Gary Gensler, who has been pushing the rules, said the change “will make our market plumbing more resilient, timely, and orderly,” according to an SEC statement.
The new rule mandates that broker-dealers can’t engage in a contract for the purchase or sale of a US security that allows for payment and delivery later than the first business day post-contract, a requirement commonly known as the “T+1” rule.
If investors sell shares of a stock on Monday, the transaction will settle on Tuesday. This change means that investors with physical securities certificates may need to deliver them to their broker-dealer sooner or through different means than currently practiced. Broker-dealers will now need to deliver the securities on behalf of investors a day earlier.
Similarly, for investors buying securities under the “T+1” settlement cycle, payment for the transactions must occur one business day earlier. Additionally, the “T+1” settlement cycle may impact certain provisions of margin agreements for margin accounts.
Short-term cash balances
This shift requires short-term financing for trades when switching from European to US equities to accommodate the shorter settlement cycle. Conversely, switching from US equities to Europe will create short-term cash balances as American trades settle more quickly, requiring immediate placement.
Foreign institutions aiming to acquire US assets must secure dollars in advance to ensure timely transaction completion. Failure to do so could result in aborted trades.
The European Fund and Asset Management Association, Efama, representing firms managing 28.5 trillion euro, has warned that up to 70 billion dollars in daily currency trading might be at risk due to the accelerated US settlement cycle, according to Bloomberg.
Timezone challenges
Settlement processes are traditionally manual, adding complexity for European firms operating on a T+1 basis due to differing time zones. “It’s going to be a tough ride with a lot of stressed people working longer hours to meet these new, tighter timeframes,” said Alex Knight, head of Emea at post-trade fintech platform Baton Knight
Knight pointed to the market’s dependence on outdated post-trade processes: “On the whole, the market has been relying on post-trade processes that require manual intervention for way too long. While far from ideal from a cost and efficiency perspective, that worked when there was plenty of time to fix things, but now that we’re moving to much shorter timelines, the pressure is well and truly on,” he told Investment Officer.
In response to the new regulations, several funds have implemented strategic measures. Baillie Gifford is relocating some of its traders to the US, while Jupiter Asset Management is pre-purchasing dollars to meet settlement requirements. Some funds are considering outsourcing their foreign exchange trading to adapt to the accelerated timelines.
A survey sponsored by the Depository Trust and Clearing Corporation, DTCC, last year found that over half of European financial firms with fewer than 10,000 employees are planning to either move staff to North America or hire overnight workers, Bloomberg reports.
Knight asserts that while the market is somewhat prepared, the transition will be challenging. More firms are expected to streamline, automate, and simplify post-trade workflows as manual handling will become unsustainable, particularly during periods of high market volatility.
Legacy systems will struggle
According to Sabine Farhat, head of securities financing, lending, and repo product management, at Murex, the primary issue is clients’ outdated electronic trading systems.
“Clients with legacy systems will struggle,” she said. “Clients understand it won’t be possible to follow new funding needs and achieve timely settlement without the appropriate technology. We may see a lot of settlement failures. We urge market participants to do a dress rehearsal. Once you’ve updated your technology stack and systems, test your settlement process,” she told Investment Officer.
The coming changes will require significant adjustments across the board, as financial institutions grapple with the new realities of a faster-paced trading environment.
“There are several technical challenges that exist for T+1 settlement. One is the need to have a centralised inventory—clients can locate the appropriate security to use in a repo transaction. A shortened settlement timeframe makes it even more important to make sure you can locate securities quickly and efficiently.”
Farhat: “For clients using products like total return swaps to meet hedging mandates, being able to settle within a T+1 environment is particularly important. If they fail to meet the 9 p.m. cutoff time, they face hedging issues alongside settlement risk. Therefore, it’s really important that clients can overcome technical challenges and avoid settlement and hedging delays. Many clients are updating and customizing trading schedules for products like total return swaps to execute and settle trades in time for the new settlement timeline as in the repo space and not the cash trading.”
Further reading on Investment Officer Luxembourg:
- LuxSE launches new post-trade settlement model
- Spuerkeess ditches transfer agents in Euroclear outsourcing