Following the announcement that the US market plans to move to T+1 equity settlements in the first half of 2024, there have been the expected cries of horror or approval, depending on where the impacted party fits into the market ecosystem.
This is a major event for the US market, which accounts for 46% of global market capitalisation and 55-60% of world equity markets. For equity markets alone, the global value amounts to a staggering $111 trillion. The latest surveys also indicate the value of foreign holdings in US traded securities to be just over $27 trillion, of which $13.7 trillion are in US equities. This understates values as the survey date was June 2021, but the critical issue is that overseas investors own around a quarter of all US equities. The move to T+1 will affect them all and thus has truly global reach.
The move, with only just over a year to the target date, appears precipitous for the domestic market, let alone the non-US players. There will also, inevitably, be moves by other markets to the T+1 standard. Their timeframes for implementation will be different, but despite initially negative vibes from markets such as the EU, the risk benefit of the move will encourage regulators to push for progress or, in ever more volatile markets with increasingly risky investment counters, they will need to place higher capital requirements on open settlement positions.
This multi-market development programme is likely to lead to conflicting operational and technology requirements although, hopefully, standards set for the US will be mirrored across the board by most major markets.
The impact of a delinquent US transition would have serious liquidity, credit, and operational consequences. It is no wonder that many informed voices are calling for a less aggressive timeframe. The US has been out of sync with global markets in the past, but this is the first time it will be a leader in settlement time frames rather than a laggard and so the impacts will be different. The challenge is not only one of automation versus manual processing but also one of time zones, cross currency liquidity, exception processes and the growing list of peripheral process impacts. And that ignores the inevitable unexpected consequences of the change!
The challenge for proponents of the migration is that age-old problem of cost and benefit. The major beneficiaries are the broker dealers and traders, for they carry the largest risks. Although they manage their counterparty risk, they must align this with the needs of portfolio risk as they seek to offset their open positions. They will thus expect a major reduction in capital needs when the settlement gap is reduced to a single day. The buy side selects brokers for many reasons, but financial strength is a key driver, and their open positions are relatively modest by comparison to the broker population.
I have not seen any cost analysis for the change, and it will vary according to the level of automation at each entity, but I would expect it to absorb a higher proportion of investment spend at the buy side than the sell side. Intermediaries, such as global custodians, will also have a challenge as they look to automate internal processes to avoid manual processing breaks but also to ensure that they have the data they need from clients to complete settlement in a timely fashion. Perhaps those with long memories will even consider resurrecting something like the unlamented GSTPA initiative of the early days of this millennium!
The issue that would concern me most is cash and stock liquidity. Logically T+1 will lead, at least in the short term, to an increase in the number of fails. Same day stock lending is no big issue, but it does create a challenge around the cost of operations and the return available, especially if the average loan is for a shorter term. But cash is also an issue.
The need for same day foreign exchange becomes acute in a T+1 environment. It is technically feasible but, liquidity is poor in all but the major currencies. The markets cannot afford anything other than an efficient cash market to support their needs, but there is a risk that prefunding will need to be the norm unless same day foreign exchange becomes a standard option, and, more importantly, all markets move to the standard to avoid the need for prefunding on cross border switches.
I will not go into the different operational challenges of T+1, but speed and accuracy of data transmission and quality of standard databases across the transaction life cycle is critical. T+1 gives a limited window for repairs. And T+1 in the US is likely to followed by different markets, and as already noted, unless they follow the US standard, we could easily end up with an awkward squad of markets that require distinct development needs and potentially conflicting norms according to location.
How to resolve these issues is best debated in a wider form. But, as I noted, the US is the most global of markets. Hopefully US participants with global clients, as well as the global buy side and their intermediaries will work with the US authorities to ensure robust and globally acceptable standards. And hopefully economic nationalism will not lead to multiple standards.
The reality is that the US timetable is likely to slip with September 2024 being the potential likely US start date. Some smaller markets may seek to steal a march on the US, but the major markets are not able to do so. Their migrations are more likely in 2025/6 onwards. That means the market has a challenge to minimise future developments, and especially unnecessary ones. Is investment of time in the US too much to ask for? Who is going to volunteer to be the catalyst for such action?