The industry has been discussing a move to a shorter settlement cycle for many years, and after extensive preparation the SEC voted to shorten the settlement cycle to one business day, with the implementation date set for 28 May 2024, in February, and European and UK regulators have also been toying with the idea of potentially mirroring the move. Some of our European members have expressed interest and concern at the move, and how it may impact their desk. In this short blog post, we take a look at some of the potential opportunities, challenges and concerns the buy side should be aware of.
Opportunities
The move to T+1 settlement cycle has several benefits, including:
Reduced Risk: The T+1 settlement cycle significantly reduces the risk of market participants, such as brokers, traders, and investors. Shortening the settlement cycle means that trades are settled faster, and the exposure of the counterparties to potential default or counterparty risk is reduced.
Increased Efficiency: A shorter settlement cycle means that trades can be executed and cleared more quickly, leading to increased efficiency in the market. This, in turn, can lead to reduced operational costs for market participants, including brokers, custodians, and clearinghouses.
Improved Liquidity: The T+1 settlement cycle also increases liquidity in the market. As trades are settled faster, the capital tied up in open trades is released sooner, providing market participants with additional funds that can be used for other trades or investments.
Challenges
While there are many opportunities presented by the T+1 settlement cycle, there are also challenges to be considered, including:
Increased Costs: The transition to T+1 settlement cycle required significant investment in technology and infrastructure for market participants. Brokers, custodians, and clearinghouses had to upgrade their systems and processes to accommodate the faster settlement cycle, which led to additional costs.
Operational Complexity: The shorter settlement cycle has also increased operational complexity for market participants. Brokers, custodians, and clearinghouses must manage and settle trades faster, which requires more significant coordination and communication between different parties.
Potential for Increased Volatility: Some market participants have expressed concerns that the T+1 settlement cycle could increase market volatility. With trades settling faster, there is less time to react to market news or events, which could lead to increased volatility and price swings.
Concerns
In addition to challenges, there are also concerns to consider with the T+1 settlement cycle, including:
Operational Risk: The T+1 settlement cycle increases operational risk for market participants. The faster settlement cycle means that there is less time to identify and rectify errors, leading to potential losses for market participants.
Forcing flows away from European trading hours: Traders operating in the European trading period currently benefit from an overlap with the Asia markets at the start of the day and an overlap with the US markets towards the end of the day meaning they can interact with interest from both regions. However, a move to T+1 could make cross-currency transactions more difficult because there is less time to interact with US counterparties – in particular for those asset managers who will have to wait until the end of the trading day to do their foreign exchange hedging making it too late to then trade in Europe.
Legal and Regulatory Risk: The move to T+1 settlement cycle could also increase legal and regulatory risk for market participants. The new settlement cycle requires changes to existing contracts and legal agreements, which could lead to disputes or legal challenges.
Impact on Small Market Participants: The move to T+1 settlement cycle could have a more significant impact on smaller market participants who may not have the same level of resources and infrastructure as larger firms. These firms may struggle to keep up with the faster settlement cycle and could face additional costs and operational complexity.
Conclusions
The move to T+1 settlement cycle offers several opportunities for market participants, including reduced risk, increased efficiency, and improved liquidity. However, there are also challenges and concerns to consider, including increased costs, operational complexity, potential for increased volatility, operational risk, legal and regulatory risk, and impact on small market participants. It is essential for market participants to consider these factors and evaluate the potential impact of the T+1 settlement cycle on their operations and strategies, and for the buy side to work together with regulators to make the transition as smooth as possible should it come to Europe.