Life after T+2

The US' successful move to a shorter settlement cycle was the culmination of a major industry-driven effort and a significant step in aligning T+2 as the global standard. 

By Tony Freeman and John Abel, DTCC editors@globalcustodian.com 

The transition to T+2 demonstrated that the meticulous preparations, coordination and testing undertaken by infrastructure providers and market participants, as well as regulators, paid off.  Given the sheer size of the US market, not only did the development signify a tectonic shift toward the global harmonisation of settlement cycles to T+2, it also has meant that due to the amount of cross border investment in to the US, the full impact and benefit of T+2 can finally be felt globally. The move also will likely reignite the debate on whether the next shift in settlement cycles should be to T+1 or T+0.

Adopting a T+2 settlement cycle alongside the US were Canada, Mexico, Peru and Argentina. Now that these markets have all implemented T+2, the only significant global player left to migrate to this model is Japan. The planned sequence of T+2 implementation in Japan calls for the Japanese government bond market to move first in 2018, followed by the equities market in 2019. This sequencing has been determined by the truly international nature of Japan's bond market where between 40-50% of trading volume is non-domestic and hence has a greater need than the equities market to operate on a T+2 settlement cycle in order to be harmonised with the rest of the world. Once Japan is on T+2, this settlement cycle will become one international standard.

As the US' move to T+2 was such a significant achievement it will likely initiate conversation around whether T+1 is now achievable. It is undeniable that the benefits of shortened, harmonised settlement cycles are clear: reduced credit and counterparty risk, operational process improvements, cash deployment efficiencies, increased market liquidity and lower collateral requirements. The drivers of the US' move to T+2 is a good example of this. The initial objective was counterparty and credit risk mitigation; however, as market participants began to prepare for the change, they began to realize that the efficiency benefits of shortened settlement cycles are highly compelling. So, if the advantages of shorter settlement cycles are clear, why not aim to increase these benefits by further shortening settlement cycles?

While the infrastructure to support a T+1 settlement cycle – and even a T+0 settlement environment – is certainly already there today, current business processes would need to evolve. For example, market participants would need to provide 24-hour operational support.  This is achievable for large global market participants, but regional market participants would need to change their current operational processes. This is particularly true for the buy-side which, in most cases, operates regionally.  

Furthermore, in order to move to a T+1 environment there would also need to be changes to adjacent markets, like the Foreign Exchange Market (FX). Of note here is that the majority of FX volumes are driven by international trade and the trading of FX for the creation of alpha; they are not a by-product of cross-border securities trading. To help assess the business case and the feasibility of T+1, the US Securities and Exchange Commission (SEC) has commissioned a study to understand the costs and benefits of shortening the settlement cycle even further. The results of this analysis are due in 2020 and it will be interesting to see what it delivers. There is no doubt that a global harmonised settlement cycle delivers both risk mitigation and greater operational efficiency to market participants. This is particularly applicable to global organisations for which harmonisation delivers significant cost savings. While the market infrastructure capabilities for T+1 are in place for many market participants, for others considerable work need to be undertaken before T+1 could become a reality.

Moreover, with new regulations such as MiFID II nearing implementation deadline, market participants have more urgent priorities in the post-trade area. Perhaps after this latest slew of market reform has been implemented and if some early conclusions on the benefits of moving to a T+1 environment from the SEC become apparent, the industry will consider a move to T+1.