The US’s shorter trade-settlement cycle – its impacts on market participants and strategies for broker-dealers

Published on May 28, 2024 by Venkatarao Bodapati and Mayukha Perera

The US transitions to a T+1 settlement cycle

The US Securities and Exchange Commission (SEC) has announced a major shift – a reduction in the settlement cycle from T+2 days to T+1 days, with the new rule coming into effect on 28 May 2024. This adjustment will affect the vast majority of securities traded in the US, including stocks, bonds, municipal securities, exchange-traded funds, certain mutual funds and limited partnerships listed on an exchange¹. These financial instruments, currently settled on a T+2 basis, will move to a T+1 settlement timeframe. This update will bring the settlement periods of these products in line with those of options and government securities, which are already settled on a T+1 basis².

The modification will profoundly affect management of the entire trade lifecycle, including both pre- and post-trade market infrastructure. Additionally, the move to T+1 may serve as a catalyst for increasing levels of automation and standardisation in post-trade processes.

The SEC's move to implement a T+1 settlement cycle has gained widespread approval from participants in the US markets. Industry consensus is that transitioning to a T+1 cycle will enhance the efficiency of the securities markets, reduce the risk associated with counterparties and improve capital utilisation. This transition to a shorter settlement period is a testament to technological progress that enables faster trade settlement.

The global shift towards the T+1 settlement cycle

When one market shortens its settlement cycle, others have historically tended to follow suit. Within five years, most global markets have shifted from a trade-settlement period of three days after the trade date (T+3) to two days (T+2). China has adopted same-day settlement (T+0), while Singapore, Japan and Australia are considering instant settlement. In January 2023, India adopted a next-day settlement cycle (T+1); Saudi Arabia has also started using T+1 settlement for some transactions³.

The US is set to migrate to a T+1 settlement cycle on 28 May 2024. In line with the US market, Canada and Mexico are scheduled to transition to T+1 on 27 May 2024, although final approval for Mexico is still pending. The UK and the European Union have established task forces to evaluate a move to T+1, and Brazil and Colombia are currently discussing plans for a transition to a T+1 settlement cycle⁴.

Opportunities and challenges facing market participants

Understanding how the T+1 settlement cycle will affect existing pre- and post-trade processes is essential for industry players to be ready for the change. The reduced interval between trade execution and settlement is expected to lower the volume of unsettled trades, decrease exposure to these trades and diminish the risk associated with price fluctuations in the securities involved. Moreover, with a T+1 settlement cycle, investors will be able to access funds from sold securities a day sooner than with the current T+2 schedule. However, this also means that investors must be prepared to have the necessary funds available a day earlier to cover the costs of purchasing securities.

Furthermore, global clients holding foreign currencies will need to initiate foreign currency exchange conversions earlier if they intend to use those proceeds to purchase USD-denominated securities and vice versa.

The anticipated date for North America to shorten its settlement cycle is attracting significant attention from investors and industry stakeholders, considering the region's substantial influence on global markets, investors and firms. For those involved in the Asia Pacific markets, adapting to North America’s T+1 settlement cycle presents challenges, primarily because of the significant time-zone differences³. Trades will be initiated after the trade date due to the time difference through global trade platforms, such as the SWIFT network. Current settlement data from SWIFT suggests that Asia Pacific customers’ late settlement rate may increase by three times after the transition if the industry does not proactively take measures.

The time difference between Europe and North America poses fewer difficulties for European financial institutions than for their Asian counterparts. However, Europe's intricate financial landscape, characterised by a variety of currencies, depositories and legal frameworks, coupled with the stringent financial penalties imposed by the Central Securities Depositories Regulation, elevates the risk and potential expenses for firms due to failure to settle³.

Success of T+1 will depend on achieving 90% affirmation by 9:00 pm ET on trade date

As we transition to a T+1 settlement cycle, market participants will lose the luxury of a full day and will have only about five hours to manage exceptions. This significantly narrower window necessitates that both buy-side and sell-side participants affirm trades much sooner than they currently do.

Under the current T+2 timeline, approximately 90% of all trades are affirmed by 11:30 am ET on T+1, according to the Depository Trust and Clearing Corporation (DTCC). To maintain existing levels of settlement efficiency under T+1, the industry would need to affirm at least 90% of all trades by the 9:00 pm ET cutoff on the trade date⁵.

Firms that do not have adequate capabilities to handle settlements in these reduced time periods may see a rise in delayed settlements due to the move to T+1. Under the existing T+2 system, 5 out of every 100 securities transactions processed through the network fail to settle on the intended date, according to statistics from the SWIFT network, leading to considerable expenses for the industry. Those firms that fail to make the necessary preparations for the shift to T+1 could encounter even more significant difficulties.

Acuity Knowledge Partners' global market solutions enhance efficiency and cost-effectiveness for broker-dealers during the T+1 transition

In dynamic financial markets, trading desks play a crucial role in executing buying and selling of stocks. With the new settlement cycle set to take effect on 28 May 2024, trade allocations, confirmations and affirmations must be completed swiftly, no later than 9:00 pm US ET. Pressure to meet this deadline, while ensuring accuracy, could strain internal resources, leaving little to no time to focus on more critical tasks. Consequently, US broker-dealers may need to increase their resource capacity to accommodate extra working hours and complete the process within the stipulated timeline.

In this context, our global market solutions are particularly beneficial for broker-dealers. They can use our strategic solutions to smoothly navigate the challenges of the transition, enhance efficiencies, reduce costs and streamline processes, including operational activities of trading desks. Time is of the essence in this shortened settlement cycle, and we can provide the necessary bandwidth to global market teams or trading operations teams by leveraging the time-zone advantage to execute pre- and post-trade operations seamlessly.

We have 15 years of experience in providing trade lifecycle management support to broker-dealers to ensure trades are executed efficiently, risks are managed and regulatory requirements are met. We set up dedicated teams (resources with Series 7, Series 99 and Series 24 certifications, if required) for global markets and client sales and trading desks, based on their needs, at our delivery centres in India, Sri Lanka, China and Costa Rica.

We provide support across trade lifecycle management functions including trade desk research (IG/HY/DD support, stress-testing and scenarios, cap structure reviews, index and ETF, etc.) and trade operations across pre-trade and post-trade operations, compliance (KYC, remediation and periodic reviews, trade surveillance, etc.) and technology support including robotic process automation to enhance efficiency and accuracy.

We enable the smooth functioning of trade desks by taking ownership of tasks of medium to high complexity so onshore resources could dedicate more time to high-value-add and revenue-generating activities. We typically assume full responsibility for trade enablement, legal-entity mapping, trade validation and confirmation, trade settlement, reconciliation, trade surveillance, transaction cost analysis, commission-sharing agreements and regulatory reporting.

Sources:

• https://www.sec.gov/oiea/investor-alerts-and-bulletins/new-t1-settlement-cycle-what-investors-need-know-investor

• https://www.finra.org/investors/insights/understanding-settlement-cycles

• https://www.swift.com/news-events/news/preparing-t1-global-impact-north-americas-move

• https://www.acuitykp.com/blog/the-shift-to-t1-settlements-in-us-financial-markets/

• https://www.dtcc.com/dtcc-connection/articles/2024/february/26/the-key

---

---