The Cost of FX in T plus 2

T+2 settlement looks like it’s on its way to a market near you in the next few years and although I accept that in many markets its not much of a problem in some financial instruments in domestic markets, the problems intensify considerably for cross-border investing.

It’s not really a Eurozone issue, as we all know that London is the biggest international financial market in the world and already transacts a massive amount of euro settlements and trades. As the Eurozone looks to work its way out of the current economic climate, the key will be to attract foreign investment and that inevitably will entail foreign exchange (FX) dealing to cover risk exposures.

Arguably, there is less FX trading today than of yesteryear, simply because of the introduction of the Euro. However, in reality since the Eurozone was created, there has actually been a massive growth in international trade around the world, especially with the introduction electronic trading or should I say gambling, on miniscule currency movements, which has introduced greater levels of volatility.

Against this backdrop, a shortened settlement cycle in securities, of T+2, looks to me like this will cause an increase in FX dealing for cross-border international investors. Increased FX dealing to cover T+2 positions and settlements in the securities world will surely increase risks and costs, if FX settlements do not marry up exactly to the underlying securities transactions.

Indeed, failure to settle on the contracted date in the securities market will create increased risks and costs through exposure of the FX transaction. To eliminate risks and costs for both securities and FX the two must operate in tandem.

Today, the securities settlement structure in Europe but also internationally, is a hotch potch of disparate clearing and settlement processes and organisations, leaving contracted date settlements difficult, expensive and risky at best. At worst, impossible for various reasons and therefore significantly increasing costs and risks for the unfortunate investor.

Moving to T+2 on paper looks a reasonable step, certainly from a counterparty risk reduction aspect. But in reality we may see the risks switched from counterparty risk into settlement failures with a potential huge escalation in overall risks, in both the securities and FX markets.

There will be penalties for not settling on the contracted date in the securities market via a buying in process. This is the most expensive form of covering failed settlements and ultimately the costs will be passed back to the investor. So the investor is going to be paying through-the-nose for the a change  that is ill advised and has a single risk focus, whilst the overall risks and costs of which I have described boundlessly increase.