The move to T+1 settlement promises to deliver greater market efficiency, but market participants may face some bumps in the road as they work to adapt operations to meet the shortened settlement cycle. Outside the U.S., firms have the added challenge of managing time zone differences while completing the foreign exchange (FX) transaction within the shortened time frame.
Val Wotton, DTCC Managing Director and General Manager, Institutional Trade Processing (ITP), joined a panel of speakers at Funds Europe’s virtual event, FX Trading: How exposed are you to T+1 settlement?, where the panelists outlined some of the challenges they expect – and put forward ideas on how participants can best manage them.
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The following are some key points shared by Wotton:
“The time frames in the upcoming T+1 environment will be particularly important for clients outside the U.S.,” explained Wotton. “When the EU moved to T+2 while the U.S. remained in T+3, this gave market participants in Europe more time. This time, it will be the opposite experience. They will have less time to process trades with the added complexity of also having to settle FX in a shorter cycle.”
Wotton noted that most funds in Europe are denominated in other currencies, usually British pounds sterling (GBP) or euros, which means an additional step is needed to convert U.S. dollar (USD) proceeds to local currency to complete a U.S.-based sale or to purchase USD investments.
“That said, there are many things clients can do to manage the time zone differences,” added Wotton. “For example, rather than waiting until the end of the day to submit batch allocations, consider sending allocations on a real-time basis, as soon as they are available. Another tactic is to work with custodians on revisions to their cut off times.”
Speakers pointed out that custodian banks may play a pivotal role, depending on how much they are willing to adapt their practices to support T+1 trade settlement.
For example, trades executed from Asia Pacific towards the end of the day on a Friday could face a challenge in meeting the FX requirements as custodian banks there may close FX operations for the weekend – although end of day on a Friday in Asia is first thing in the morning Friday in the U.S. Unless the bank handling the FX leg of the transaction is willing to process transactions over the weekend, that could cost traders in Asia an extra day.
Similarly, a fund denominated in GBP may face challenges if a buy trade is placed just before a U.K. bank holiday, as the bank may not be open to convert GBP to USD to pay for the trade.
“You have to know your cutoff times,” noted Wotton. “Each custodian bank may have different procedures and cutoff times, and each currency may have a different trading cycle. Talk to your custodian banks now to find out what they can do, and what they cannot do, to manage T+1. Have those conversations now so you can plan for when T+1 comes.”
When asked about the role innovation may play in supporting the transition to T+1, participants mentioned how several tools are already available.
Wotton commented that some firms aren’t maximizing solutions already out there. For example, Wotton explained how firms who aren’t already, can increase timely settlement by automating their post trade processes. This would include adopting best practices like utilizing ALERT, the industry’s largest online standing settlement instruction (SSI) database as well as CTM’s Match to Instruct (M2i) workflow which links trade allocation, confirmation and affirmation into one workflow.
Additionally, “we may see firms adopt a global desk approach,” noted Wotton, where institutions with a global reach, could, for example, have trades from Tokyo hand off to their desk in New York, and from New York to London, effectively creating a 24-hour processing capability. We may also see some of the bigger firms match their FX needs across different transactions and different transaction types to take advantage of netting, that’s another solution. The point is, there are many existing solutions, firms should start there rather than looking for new technology.”
Indeed, when asked to name which aspect of the move to T+1 concerns them most, 64% of participants chose “operational challenges” while only 5% named technology infrastructure updates as the chief concern.