The world of settlements is speeding up, literally. May 2024 marked a significant milestone as the Securities and Exchange Commission (SEC) introduced the shift from T+2 to a T+1 settlement cycle. Reducing the time it takes for trades to settle from two business days to one, to an outsider at least, seems like a small change. However the concerns around its impact flooded the market.
One month later, I was keen to assess the reality of the fallout.
Expectations versus reality
The move towards T+1 was driven by several key factors, including reducing risk and promoting operational efficiency. With faster settlements, financial institutions can free up capital and liquidity that was previously tied up in unsettled trades, improving cash flow and potentially lowering costs. By ensuring a swifter exchange of assets, it strengthens the overall stability of the financial system and boosts market confidence.
However, the transition wasn't without its concerns. The shorter settlement cycle was expected to place a burden on financial institutions to adapt their back-office operations. The shift would require changes mainly to several post trade processes with these processes having to be executed in less time.
There was also potential for increased risk in the short term as it would cost financial institutions money to get used to the shortened settlement runway; but fortunately, this hasn't been the case. From conversations with our network, we’ve gathered that, in general, most firms had already addressed previous operational and systemic inefficiencies which has led to lower failure rates and released tied-up working capital related to unsettled trades.
Another potential challenge was the impact on liquidity management. With less time to settle trades, financial institutions would need to leave liquidity on hold or sitting around in case they haven’t planned or forecast correctly. This could have led to opportunity costs, where the held capital could have been used elsewhere in that time. However, once again, evidence suggests minimal impact in this area, indicating organisations were already on top of these preparations!
Perhaps the most anticipated consequence of T+1 was a rise in market volatility. The assumption was that institutions scrambling for liquidity in a shorter timeframe might trigger market fluctuations. Thankfully, this hasn't materialised. Instead, faster settlements can actually improve liquidity by freeing up capital sooner.
All of this circles back to the primary goal of T+1: creating a more unified and efficient global market in the long term.
Innovation and future developments
Altogether, the volatility expected with the move to T+1 has been less severe than anticipated. That being said, every move towards faster settlement times has spurred innovation through improved technology, systems and processes, and the industry cannot afford to take its foot off the pedal. Financial institutions will continue to be forced to adapt their systems and processes, leading to technological advancements throughout the value chain. The transition to T+1 settlement is just the beginning.
It’s clear that the global market has its sights set on the eventual move to T+0, driven by growing customer demands for faster, more efficient transactions and mounting regulatory pressure for greater transparency and risk reduction. This shift will require more extensive preparation and bring a whole new level of challenges, with potential impacts on trading strategies like short selling and established processes like stock lending and FX funding.
The transition to T+1 has been a success so far it would seem, and while initial concerns existed, the market has adapted well, with minimal disruption and potential for long-term benefits. It won’t be long before other major markets follow suit and embrace the T+1 cycle.
