T+2: the time has come
30 September 2014
Chris Smith and Camille McKelvey of Trax look towards 6 October and how markets will react to the new settlement cycle
Image: Shutterstock
With T+2 on the horizon, the market is confronted with how best to manage efficient settlement processes and reduce operational risk.
Over the next two weeks, firms will need to put the final pieces of the puzzle together ahead of the market migration date of 6 October to T+2 settlement. Teams across trading, risk and operations are being forced to think about how they will address some of the key aspects of Article 5 of the Central Íø±¬³Ô¹Ï Depository Regulation (CSDR) before the cash markets move to T+2 and the repo market moves to T+1.
For many, this has meant an increase in operational cost. To ensure this doesn’t result in a long-term increase in operational risk, it is necessary that the infrastructure to support the post-trade workflow is both automated and scalable and that the workflow is carefully reviewed both intra-firm as well as across the industry to maximise efficiency.
Scope of CSDR T+2 and how to handle it
With T+2 just around the corner, firms should be putting the finishing touches to the scope of securities they are migrating by default. Defining instruments migrating to T+2 has been a tough one, at least for fixed income where some industry participants continue to question the scope of instruments included in the move to T+2 versus those remaining on T+3.
Trading venues are converging towards keeping US ISIN prefixed bonds on T+3, but with some of these instruments settling in European international CSDs, firms may consider some of these instruments part of the European market and so have a preference to settle them on T+2.
Additionally, questions continue to be raised regarding treatment of 144A and Reg-S bonds, which under an ISIN prefixed-based implementation will have a combination of T+2 and T+3 default settlement. Questions are being asked about the rationale for different settlement dates of different tranches of the same issue.
Implementation of defined scope
Once you have decided what securities are in and out of scope for migration, there are internal operational issues that must be considered, and it is at this point that inconsistencies could prevail. Different systems may take different data feeds from different providers that may not necessarily all have the same interpretation of scope. An example could be a difference between pricing engines and settlement engines.
If your firm identifies this as a potential operational issue, you will need to address how to deal with the reconciliation of these different data feeds. If these processes are not managed appropriately, we would expect to see an increase in the volume of operational exceptions. These exceptions will need to be resolved quickly to mitigate risk and profit and loss implications.
Different settlement preference across the market
Anecdotal evidence suggests that dealers are embracing T+2 settlement while some investment firms managing global funds may have challenges in fully migrating to T+2. This could lead to a smoother migration in the inter-dealer market than the institutional market. Dealers will need to think about who their clients are and to what extent they need to support non-standard settlement dates.
There is then the further consideration of the funding implication to the market, where one party is buying on a T+2 basis and the counterparty of the trade is selling on T+3. It’s very likely that the repo market will help cover the additional funding requirements for the one-day lag, but the cost of operating under this kind of structure will be quite significant—who will be responsible for bearing this cost?
Although the answer to that question remains to be seen, it’s clear that repos have the potential to become even more important in the market to ensure that cash positions are properly funded and stock lending/borrowing is likely to increase as firms search for assets to meet disconnected delivery timeframes.
A solution to help reduce operational risk
While many questions still need to be resolved, and when combined with the effect of other new regulations due to hit the industry in the coming years (such as Basel III), it’s clear that operational processes will need to be modified to accommodate the new reality of shorter settlement cycles, while ensuring operational risks are managed effectively. Trade date affirmation is key to stopping dependent activities being affected at a significant cost to firms. In fact, the industry shouldn’t stop at same-day affirmation, but should strive to adopt a sub-15 minute trade match of transaction details following execution, including place of settlement.
Over the next two weeks, firms will need to put the final pieces of the puzzle together ahead of the market migration date of 6 October to T+2 settlement. Teams across trading, risk and operations are being forced to think about how they will address some of the key aspects of Article 5 of the Central Íø±¬³Ô¹Ï Depository Regulation (CSDR) before the cash markets move to T+2 and the repo market moves to T+1.
For many, this has meant an increase in operational cost. To ensure this doesn’t result in a long-term increase in operational risk, it is necessary that the infrastructure to support the post-trade workflow is both automated and scalable and that the workflow is carefully reviewed both intra-firm as well as across the industry to maximise efficiency.
Scope of CSDR T+2 and how to handle it
With T+2 just around the corner, firms should be putting the finishing touches to the scope of securities they are migrating by default. Defining instruments migrating to T+2 has been a tough one, at least for fixed income where some industry participants continue to question the scope of instruments included in the move to T+2 versus those remaining on T+3.
Trading venues are converging towards keeping US ISIN prefixed bonds on T+3, but with some of these instruments settling in European international CSDs, firms may consider some of these instruments part of the European market and so have a preference to settle them on T+2.
Additionally, questions continue to be raised regarding treatment of 144A and Reg-S bonds, which under an ISIN prefixed-based implementation will have a combination of T+2 and T+3 default settlement. Questions are being asked about the rationale for different settlement dates of different tranches of the same issue.
Implementation of defined scope
Once you have decided what securities are in and out of scope for migration, there are internal operational issues that must be considered, and it is at this point that inconsistencies could prevail. Different systems may take different data feeds from different providers that may not necessarily all have the same interpretation of scope. An example could be a difference between pricing engines and settlement engines.
If your firm identifies this as a potential operational issue, you will need to address how to deal with the reconciliation of these different data feeds. If these processes are not managed appropriately, we would expect to see an increase in the volume of operational exceptions. These exceptions will need to be resolved quickly to mitigate risk and profit and loss implications.
Different settlement preference across the market
Anecdotal evidence suggests that dealers are embracing T+2 settlement while some investment firms managing global funds may have challenges in fully migrating to T+2. This could lead to a smoother migration in the inter-dealer market than the institutional market. Dealers will need to think about who their clients are and to what extent they need to support non-standard settlement dates.
There is then the further consideration of the funding implication to the market, where one party is buying on a T+2 basis and the counterparty of the trade is selling on T+3. It’s very likely that the repo market will help cover the additional funding requirements for the one-day lag, but the cost of operating under this kind of structure will be quite significant—who will be responsible for bearing this cost?
Although the answer to that question remains to be seen, it’s clear that repos have the potential to become even more important in the market to ensure that cash positions are properly funded and stock lending/borrowing is likely to increase as firms search for assets to meet disconnected delivery timeframes.
A solution to help reduce operational risk
While many questions still need to be resolved, and when combined with the effect of other new regulations due to hit the industry in the coming years (such as Basel III), it’s clear that operational processes will need to be modified to accommodate the new reality of shorter settlement cycles, while ensuring operational risks are managed effectively. Trade date affirmation is key to stopping dependent activities being affected at a significant cost to firms. In fact, the industry shouldn’t stop at same-day affirmation, but should strive to adopt a sub-15 minute trade match of transaction details following execution, including place of settlement.
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