The US takes the lead
The market volatility unleashed by both COVID-19 and the meme trading fiasco were both catalysts behind the growing industry calls – led by The Depository Trust & Clearing Corporation (DTCC), The Investment Company Institute (ICI) and Securities Industry and Financial Markets Association (SIFMA) - for a move away from a T+2 settlement cycle for U.S. equities, corporates, municipals, and UITs - in favour of T+1.
“A compressed equity trade settlement cycle would deliver major strategic benefits for market users including reduced risk, lower margin requirements, and improved liquidity – all contributing to increased efficiencies.”
Robert Cavallo, Director, Clearance and Settlement Product Management, DTCC
Conversations with wider market participants about moving to T+1 are gathering momentum. “The DTCC together with SIFMA, The ICI and Deloitte have been hosting meetings with market participants over the last seven months discussing how to make T+1 the settlement standard for U.S. equities, corporates, municipals, and UITs.,” continued Cavallo. Accordingly, Cavallo believes the U.S. equity market would move to a T+1 cycle by no later than Q2 2024 – assuming the regulators give their seal of approval. However, in order for this deadline to be met, testing from a DTCC point of view should commence in Q1 2023 and conclude by Q1 2024. This sentiment was somewhat mirrored in Securities Services Evolution, a recent Citi whitepaper, where 44% of market participants surveyed expect the prevailing settlement timeframe for equities to be T+1 within the next five years.
Nonetheless, a move to T+1 is likely to throw up a number of operational challenges, with some sceptics warning of the growing risk of market fragmentation and issues related to confirmations, allocations and FX management. On FX, transactions will need to be booked on either T or T+1 instead of the current T+2 in what could be quite challenging and risky for some intermediaries. Market participants in Asia-Pacific have been especially vocal on the US’s T+1 plans, particularly given the significant time-zone differences between both regions.
Cavallo acknowledged the transition would be difficult. By moving to T+1, 24 hours was effectively being shaved off the existing settlement cycle. “Time is now the biggest challenge we face. How do you do all of the things you do on T1 today on T? One of the biggest business challenges that we identified was around the DTC and NSCC’s [National Securities Clearing Corporation] night cycle processing schedules, and what that would look like in a T+1 settlement cycle,” said Cavallo.
Similarly, most FMIs interviewed in Citi’s Securities Services Evolution whitepaper indicated that the greatest challenge to achieving a shortened cycle was business process efficiency and alignment, in contrast to market participants of whom only 10% ranked this as a primary key factor. Market participants (31%) instead saw cash, funding and liquidity management as the greatest obstacle.
Despite this, the US will be moving to T+1 from a position of strength. Having only migrated from T+3 to a T+2 cycle in 2017, a lot of the lessons gleaned during that transition can be onboarded and applied when adopting T+1. But will other markets follow suit? While India is pushing ahead with T+1 and Canada openly discussing the prospect, Samuel Riley, Head of Investor Services and Financing and Executive Board Member at Clearstream, doubted there would be a directional move in Europe until TARGET2-Securities is properly bedded down with the T2 cash platform.
T+0 – is it a step too far?
Others go further and are advocating for a T+0 settlement cycle arguing that it too will bring about margin and collateral benefits. However, implementing T+0 is likely to create additional complications that will need to be addressed. According to the DTCC, market participants with legacy operational processes would need to move away from their batch processing processes and adopt more real time processes to adhere to a T+0 end of day settlement cycle. It also added that real-time gross settlement would require that trades be funded on a transaction-by-transaction basis – removing the liquidity and risk mitigation benefits of existing netting features.1
Experts operating in markets which utilise T+0 cautioned against its adoption too. Glenda So, Managing Director, Co-Head of Markets at Hong Kong Exchanges and Clearing Limited (HKEX) highlighted the China leg of Stock Connect – the Hong Kong-China stock exchange linkage – already settles securities and cash respectively on a T+0 and T+1 basis. “When China’s market closes, participants have just two hours to settle all of their transactions - an issue which is again compounded by the time-zone divergences. This is proving to be quite challenging for all participants, especially international ones,” said So.
Moving into the future – a digital world
Although there is widespread scepticism about whether T+0 is achievable using the industry’s existing operational architecture, a handful of FMIs are looking to leverage innovative technologies to further expedite settlements. The DTC’s Project Ion initiative, for instance, is a standalone, alternative equity clearance and settlement platform which utilises distributed ledger technology (DLT) to support a T+0 settlement cycle [and also T+1 and T+2]. The platform prototype is expected to go live in Q1 of 2022 and will serve as a parallel book and infrastructure to the DTC for limited bilateral transactions on DLT.2 Cavallo also highlighted that DLT can solve a number of problems arising from settlement activities by helping the industry move away from batch processing and legacy technology towards something more real-time.
Similar initiatives are underway at the HKEX. HKEX Synapse is a settlement acceleration platform designed to automate and streamline post-trade processes and solve some of the operational problems that occur on the Northbound Stock Connect due to mainland China’s T+0 securities settlement cycle.
“Synapse is addressing the issue of sequential processing and is expected to go live in 2022. We have a tool on Synapse where all of the participants in the trade flow can see all of the data at once, and can establish rules so records can be processed simultaneously. It provides a golden source of data instead of relying on multiple record sources. This ultimately helps enhance efficiency and transparency.”
Glenda So, Managing Diretor, Co-Head of Markets, HKEX
Riley shared that Deutsche Börse, Clearstream’s parent company is also embracing innovative technologies having launched D7, a digital post-trade platform that leverages DLT, in what will enable market participants to digitalise financial products and support same-day issuance.
“All of the processes which happen during the life-cycle of a security – namely issuance, custody, settlement, payment and asset servicing – will be fully automated as a result of D7. We will have the ability to fully digitalise 80% of German securities by mid 2022, and we will expand into further asset classes within the German market.”
Samuel Riley, Head of Investor Services and Financing & Executive Board Member, Clearstream
While Riley was optimistic about the future use of distributed ledger technology, he agreed with So that the technology needs to evolve in terms of the settlement platform. “While we will continue to use our current platform, over time there will be a gradual migration onto the new DLT-enabled platform. There will be a co-existence of 2 environments for the foreseeable future and the question will be for how long?”
Clearstream has also invested heavily into HQLAx, a platform designed to help market participants overcome challenges related to collateral fragmentation in Europe. By utilising R3’s DLT Corda Enterprise, HQLAx enables market participants to transfer ownership of securities easily across disparate collateral pools at precise moments in time. By doing so, market participants will be able to optimise their liquidity management and collateral management, facilitating operational efficiencies and capital savings.3
Moving forward, some believe that digital assets such as Central Bank Digital Currencies (CBDCs) or digital fiat money will be used to support settlement processes, potentially leading to instant or atomic settlement if used in conjunction with DLT and smart contracts. While acknowledging there was a general alignment in the EU on digital assets, Riley highlighted that this was not the case on a global level. Unless common standards are developed around digital assets, it will take time for them to be incorporated into the settlement process.
With the U.S. driving ahead with T+1, it is likely to set off a chain reaction in other markets. While there will be logistical barriers, those making the case for T+1 believe they are manageable – especially with the emergence of new technologies supporting a more seamless settlement experience.
“It is clear that major changes in global settlement processes are likely to unfold following the announcements in the US, Canada and India about shifting to T+1. We are going to see some very significant changes in the structure of markets over the next few years. We have some very exciting times ahead.”
Bryan Murphy, Global Head of Banks Sales, Securities Services, Citi
1 DTCC [February 24, 2021] DTCC proposes approach to shortening US settlement cycle to T+1 within 2 years
2 DTCC [September 15, 2021] DTCC’s Project Ion platform moves to development phase following successful pilot with industry
3 Clearstream (January 11, 2021) HQLAx secures EUR 14.4M series b funding