In response to heightened market volatility during the COVID-19 pandemic, the US Depository Trust & Clearing Corporation (DTCC) issued a white paper in February 2021 advocating for a transition to T+1 settlement. Collaborative efforts in 2021 and 2022 produced recommendations spanning post-trade processes, aiming to enhance investor benefits and mitigate credit, market, and liquidity risks.

The transition to T+1 settlement cycles in the US, scheduled for May 28, 2024, is a significant change with global implications. Let us explore the topic together and try to find out whether the transition to T+1 will be beneficial and what challenges it may bring.

What is T+1

Before we go deeper it is worth reminding some basic terms to get a clear understanding of what T+1 is. T+1 (T+2, T+3) are shorthand expressions indicating the settlement date for security transactions. In these terms, "T" represents the transaction date when the transaction occurs. The numbers 1, 2, or 3 specify the number of days following the transaction date when the settlement, involving the transfer of money and ownership of securities, occurs.

The T+1 (T+2, T+3) settlement date considers only stock market open days. For instance, in T+1, if a transaction occurs on a Monday, settlement must happen by Tuesday. The settlement date affects dividend payments, determining who receives them. 

The transaction-to-settlement period is fixed, and it's crucial for dividend-related considerations. In the past, manual security transactions involved waiting for physical certificate delivery, and setting a period for delivery due to varying times and price fluctuations. The electronic system has streamlined this process, and now we are gradually transitioning to the T+1 system, which means that settlement of securities transactions will occur one business day after the trade date. With T+1, there is a shift towards real-time processing, requiring increased automation and system enhancements to meet the compressed settlement timeframe.

Investors and market participants will need to adapt to quicker transaction settlement, ensuring timely funding, and adjusting operational models to accommodate the shortened processing window. On one hand, this transition fosters a more dynamic and responsive financial ecosystem, and on the other, stakeholders will have to navigate the challenges and opportunities presented by the T+1 settlement cycle to maintain operational efficiency and seize the benefits of this change. Now I will shed some light on what and when is going to happen and the changes that already occurred.

Implementation Dates

The United States is scheduled to undergo the transition to a T+1 settlement cycle on May 28, 2024. Simultaneously, Canada and Mexico are poised to implement this change on May 27, 2024.

The journey toward T+1 in the UK and EU is in its initial phases, requiring ongoing assessment. In the United Kingdom, a Task Force report is anticipated in early 2024 as part of the Edinburgh reforms, to be succeeded by a Technical Group. 

Benefits

Key industry benefits include risk reduction, lower liquidity requirements, infrastructure modernization, and cost reduction. The US Securities and Exchange Commission subsequently adopted rule amendments to implement the T+1 settlement cycle. The new rules entail a shorter settlement cycle, unless otherwise agreed, encompassing various securities eligible for DTCC settlement. Additionally, there are provisions to enhance institutional trade processing and facilitate straight-through processing through requirements for broker-dealers, registered investment advisers, and clearing agencies acting as central matching service providers.

Challenges

While the move aims to enhance market efficiency, reduce risk, and attract investors, it comes with certain challenges and costs. Shortening the settlement cycle is expected to decrease pre-settlement risks, improve capital efficiency, and lower costs. However, the compressed post-trade time may pose operational challenges, especially for cross-border trades and investors in different time zones. 

The shift may impact stock lending and borrowing, potentially increasing settlement fails and penalties. In my opinion, the overall impact of T+1 remains uncertain, with potential benefits and challenges to be realised as the financial industry adapts to this major change.

The shift to T+1 in the US will notably affect the allocation/confirmation process, FX transactions, and lending activity. Recent surveys indicate potential low readiness levels among certain actors. The scope should encompass ETFs, posing challenges for those comprising both "T+1" and "T+2" securities.

United States and Canada

The announcement of the T+1 settlement date on May 28, 2024, for the US and May 27, 2024, for Canada also poses the following challenges. Participants have limited time for required process and system changes. Post-trade processing, such as affirmation by 21:00, demands automation and significant industry investment. The move has global implications and impacts international investors facing operational challenges, particularly with European cut-offs occurring overnight.

Europe

T+1 discussions have already begun in continental Europe, with AFME initiating a cross-industry task force to assess the cost-benefit analysis and the feasibility of transitioning. 

Unlike the US, Europe lacks a harmonised legal framework and faces complexities due to diverse markets, multiple CCPs, and CSDs. Balancing upstream processes before settlement requires extensive industry collaboration. The risk of increased settlement fails brings complications, conflicting with CSDR's objectives of improving EU market efficiency.

United Kingdom

The UK is actively exploring T+1 settlement as part of the Edinburgh reforms, too. The Accelerated Settlement Taskforce, launched in December 2022, aims to publish its final report in autumn. The political push suggests T+1 is inevitable. Stakeholders are mapping internal processes, considering funding and FX challenges, and assessing the impact on settlement discipline regimes and the existence of physical certificates.

As already said, the T+1 transition is viewed as a significant challenge across regions, requiring extensive collaboration, automation, and adaptation of existing processes to meet compressed settlement timeframes.

Asia Pacific Region Precedent

Following Mark Wootton, Regional Head of Local Custody and Clearing, Asia Pacific, India's successful transition from T+2 to T+1 settlement cycles in January 2023 serves as a positive precedent, showcasing efficiency gains and minimal issues. However, the broader Asia Pacific (APAC) region maintains a predominantly T+2 settlement cycle, with potential considerations for adopting T+1 spurred by developments in the Americas and the UK, as well as ongoing discussions in Europe. Despite this, unique challenges arise due to significant time differences across the diverse APAC markets.

In India, initial plans for a pre-funded market faced complexities for offshore investors, leading to adjustments in the FX process to accommodate European and US clients. Similar adaptations may be necessary for other markets in the region contemplating a move to T+1. The potential adoption of a comparable model, where FX processes are extended to the end of the trade date, would facilitate smoother transitions.

Australia and New Zealand, being nearly a day ahead of major global regions, present distinct challenges in adapting to a T+1 settlement model. The potential need for additional settlement batches, particularly in Australia where settlements currently occur in a single batch at 11:30, raises questions about operational feasibility. The time zone disparities could affect the synchronisation of cash components and funding trades in various currencies, posing challenges for market participants.

The impending shift to T+1 in the US has ramifications for APAC investors, urging them to be more proactive in managing FX and hedging processes, especially when dealing with domestic currencies for US transactions. For instruments like American Depositary Receipts (ADRs), the misalignment in settlement cycles between ADRs (T+1) and the underlying foreign shares (T+2) introduces complexities that require careful navigation.

Conclusion

T+1 settlement provides a great opportunity for financial ecosystem participants to have quicker settlement processes and further reduce settlement risks. In my opinion, it is yet another step on the path towards real-time settlement, a framework that would provide accelerated transaction lifecycles and more frequent exchange. 

Financial systems have a simple mission: bring together those that are seeking capital with those that can provide it, with minimal risks and costs. T+1 settlement takes care of the former - advancing settlement by a day further reduces risk. 

What about the cost? This remains to be seen - as with any such regulation, only through time has the overall impact been more clear. Some costs are relatively easy to estimate such as advancing systems to recognise and address a T+1 settlement. Other costs, such as for partial trade settlement, fail resolution, and the pressure built on a historically underinvested area in financial ecosystems, are unclear. The move from T+3 to T+2 provides us with some guidance from which to estimate, but there are unknowns, particularly how the intervening period is navigated, where the financial ecosystem will be grappling with 3 settlement cycles across countries (some with T+1, others with T+2, and few countries that continue to be on T+3). 

It may happen that potential disadvantages may outweigh the benefits, especially in terms of marginal gains. AFME proposes a unified move across the EU, the UK, and Switzerland.

Covering both T+1 and T0 models, trade associations express concerns about the challenge of T+1 in the EU and question its impact on the region's attractiveness and competitiveness.

Besides, while the success of India's transition offers a positive example, the diverse characteristics of APAC markets, coupled with global developments, highlight the need for careful consideration and potential adjustments in adapting to a T+1 settlement cycle.