Implications of T+1: Assessing Your Firm’s Readiness 

Technology preparedness is at the heart of a successful T+1 transition

On May 28, 2024, T+1 takes effect for U.S. investments, cutting settlement cycles from two business days to one. The rule applies to stocks, bonds, munis, ETFs, certain mutual funds, and limited partnerships that trade on an exchange. For some investment managers, one-day settlement cycles may mean greater convenience. For others, T+1 may require closer attention to how shorter settlement times might affect investment, trading, and tax decisions. 

A successful transition to T+1 hinges on access to high-quality, real-time data on trades, affirmations, securities custody, cash positions, and more. The cutoff for the pre-matching affirmation process that is currently on settlement day minus one at 11 a.m. ET will shift to T+0 at 9 p.m. ET – leaving a short window to pre-match trades. To meet the accelerated cutoff, both U.S. and non-U.S. institutional investors will need to adopt a variety of new processes. 

The new T+1 rule supports market integrity

The move to T+1 in the U.S., while a long time coming, was finally precipitated by two events, according to the SEC¹: (1) market volatility sparked by the Covid-19 pandemic; and (2) the surge in interest in meme stocks and subsequent trading restrictions that highlighted potential vulnerabilities in the U.S. securities market and undermined confidence in market integrity. Both events highlighted potential liquidity and counterparty risk vulnerabilities that regulators and participants felt could be mitigated by shortening the settlement cycle. 

Clean and accurate data will lead your firm into the future

As the financial industry adopts T+1, understanding the significance of data governance will be key to staying ahead of the curve. When it comes to T+1, it’s not just about the tech; it’s the data that will lead your firm to a successful transition. To meet the new standards, firms should consider how they manage and access data on six key components: 

• •Custody of positions
• •Cash balances
• •Trade files and allocations
• •Affirmations
• •Stock borrow transactions
• •Corporate actions

RELATED READING: The Key to Success in T+1? Mastering Data Governance

Little room for error in a shortening settlement cycle

Shorter equity settlement cycles bring unique challenges to market participants, and technology will be at the heart of the solution. From here on in, it’s clear that data will drive the continued evolution of the settlement cycle. And with only one day to settle trades, firms have little room for error.  

A thorough and strategic approach to these challenges will be necessary for a smooth and successful implementation. It’s important for market participants to proactively address these challenges through comprehensive planning, collaboration with industry stakeholders, and a phased approach to implementation. 

The change to T+1 will support: 

• •Risk reduction: A shorter settlement cycle reduces counterparty risk, that one party may fail to meet their obligations in a transaction. This increased speed enhances the stability and security of the market.
• •Liquidity efficiency: T+1 settlement allows capital to be freed up more quickly, making it available for other investments or uses. This improves the overall liquidity of the market.
• •Technological advancements: Advances in financial technology have made it easier to process and settle transactions more quickly and securely.
• •Global standardization: The rule aligns the U.S. and Canada/Mexico with global settlement practices, promoting stability and harmonization across international markets. This will allow cross-border trading to be more easily facilitated.  

Making the necessary behavioral changes

Although firms will have to recalibrate their operations and technology to accommodate T+1, it’s possible the biggest changes will be behavioral. Are the operations teams ready? What activities need to be moved to either earlier in the day, or T+1 or even trade date. For instance, if a firm is not affirming transactions, then they need to do it now. The same applies if they are not sending trade files before 5 p.m. ET. The good news is that shifts in behavior can be made ahead of the T+1 deadline. 

Along with behavioral changes, financial institutions will have to make substantive adjustments to their operations and technology practices to ensure a smooth switch to T+1. Moreover, regular testing will be essential for firms to iron out errors in a timely fashion and reduce the risks involved in the transition.  

Leaning in to operational and technological change

Global markets have been adapting to shorter settlement timelines for decades. Most large firms today require cash or adequate margin prior to entering any securities order for efficient settlement. And unlike times past, investors typically hold securities in accounts electronically.  

The impact of T+1 settlement on asset managers will depend on their specific strategies and operations, but the rule change will undoubtedly put increasing pressure on in-house operations teams. A significant benefit is that T+1 will align the settlement date for options and equity trades, thus reducing credit, liquidity, and market risk, as well as freeing up capital. The move to T+1 will also reduce systemic, counterparty, and operational risk across the settlement ecosystem, potentially reducing margin requirements for market participants, particularly during periods of heightened market volatility.  

Investment firms that haven’t upgraded their systems to manage a transition to T+1 may find themselves stretched by the day-to-day complexities of their current processes, in addition to the heavy lift of running their businesses. They will need help making sense of the impact on their workflows and the changing deadlines and cutoffs.  

Special concerns for equity, global macro, and multi-strategy funds

As settlement times are compressed, asset managers operating across global trading regions will have to accelerate trade processing workflows to compensate for the loss of a day and potential lack of harmonization of settlement cycles in different regions of the world. Market participants engaged in cross-border and cross-asset transactions may need to hedge risks stemming from mismatched settlement cycles in different time zones. Firms that trade ETFs will have to pay attention to the potential misalignment of global securities transactions.  

Challenges bring opportunities

Investment firms will need to ensure that their back-office systems can handle the volume of trades and settlements that will occur daily with T+1 settlement. This will likely require investment in new technology and processes that ensure timely and accurate settlement of trades. But firms will also see opportunities for more efficient trading and settlement processes, reduced costs, capital efficiency, increased transparency, and more effective risk management.  

Why do some asset managers still process trades manually?

The simplest answer is: because they can. In an industry that makes money on performance, operational tasks that occur post-trade aren’t seen as adding value. For that reason, some asset managers have been content to rely on old-fashioned post-trade communications and push as much of the operational burden as possible onto their executing brokers and prime brokers. Until now, prime brokers have largely been willing to take on those tasks to attract trading volumes. All of that will change with T+1. 

Compressed settlement times will require automation and system enhancements wherever possible, which will ultimately lead to significant industry investment in a short period. For firms that don’t want to direct resources toward revamping their entire middle- and back-offices, it’s too late to start building a new operational platform from scratch.

Review your tech stack and your processes

To meet new regulatory demands, asset managers should evaluate their existing technology infrastructure and operations to ensure their processes are up to date. Today, firms have access to an array of third-party solutions built expressly to automate middle- and back-office functions and deliver something close to straight-through processing for trades.  

Firms should look for systems with sophisticated features that monitor and report on the status of trades and proactively send alerts to all parties if a trade has not matched within a set timeframe. In the new environment, every minute will count. If the trade operations team doesn’t spot a problem trade until the afternoon of T+1, it will probably be too late to rectify in time to meet settlement deadlines. Automated notifications and full transparency about trade status will be essential. 

Asset managers should also be working to ensure that the technological investments they are making today are positioning their firms not only for the T+1 transition, but for a data-heavy future. Outsourcing partners should provide a solid foundation for the fully automated straight-through processing that will be required when markets eventually accelerate to T+0, as well as the transparency and data management capabilities needed to support increasingly powerful AI applications. 

A great partner will smooth the transition to T+1

Although full automation of most middle- and back-office functions is the ultimate goal, the quality and scope of a partner’s service will help determine how challenging or smooth the implementation process will be, how well the system integrates with the existing tech stack, and how hard or easy it is for back- and front-office staff to learn the system and get the most out of its features. These factors are important for any new technology initiative, but they are critical considerations for firms rushing to upgrade operations in time for T+1. 

The adoption of a T+1 settlement by the SEC marks a significant step toward a more efficient and competitive financial market. This change reflects not only the evolution of technology, but also the commitment of regulators to adapt to the needs and demands of the industry. 

With T+1 coming up fast, now is the time to map out your tech stack transformation. You’ll also want to get budgets in place and begin project management to meet this quickly approaching deadline. 

Arcesium has years of experience helping firms transform their tech stacks. To learn more, to read our article T+1: To Work Smart, Work as a Team, which outlines the importance of having advanced technology and an experienced financial operations team working together to handle the shortened settlement cycle.

Sources:  

1 SEC Finalizes Rules to Reduce Risks in Clearance and Settlement, SEC, February 15, 2023