Mapping the impact of T+1
T+1 is expected to significantly reduce the amount of time organisations have to complete their post-trade processing. A recent Citi article — “T+1: A Race against Time” — highlighted that firms operating in different time-zones to the US may need to start pre-funding their FX transactions when T+1 makes its debut. The requirement to pre-fund certain trades could be an issue for financial institutions in Asia, whose markets are anywhere between eight hours and 16 hours ahead of Eastern Standard Time (EST).
Other activities that might face disruption when T+1 takes effect, include securities lending, corporate actions and the cross-border settlement of exchange traded funds, American Depository Receipts and dual listed securities. Furthermore, firms with operations in both the US and Canada should be especially vigilant in the early stages, as Canada is adopting T+1 a day ahead of the US.
T+1 could also result in an increase in the number of trade fails leading to firms facing more frequent cash penalties or even higher Basel III risk weighted capital requirements. Although there are no clear-cut rules for penalties for trade fails in the US like there are in the EU, financial institutions may be hesitant about dealing with counterparties suffering from high fail rates.
To date, however, industry preparations for T+1 can best be described as mixed. “The tier one firms — especially in the US — appear to be well prepared to begin industry testing in Q3 2023. As we consider tier two and tier three firms, we are hearing that firms are less advanced in their preparedness. Not surprisingly, the levels of awareness and readiness in the US seem to be ahead of what we currently see in Europe and Asia,” shared Michele Hillery, General Manager of Equity Clearing and DTC Settlement Service, Depository Trust & Clearing Corporation (DTCC).
This is echoed in a recent survey conducted by The ValueExchange, which found 41% of global financial institutions had yet to begin their T+1 preparations, while just 46% said they expected to be ready for the changes. The ValueExchange study revealed that 61% of the buy-side are unprepared for T+1, a problem which appears to be especially acute among mid-tier and boutique firms.
“I think there are a lot of misconceptions circulating amongst our clients about whether they are impacted by T+1. Some non-US firms believe they are not affected because the T+1 transition is a SEC [Securities and Exchange Commission] rule, and as such they assume it does not apply to them. Others simply think their custodians will handle everything for them, but providers can only do so much,” said Michele Pitts, Custody Product Head for NAM Strategic Initiatives, Securities Services, Citi.
12 months and counting
With less than 12 months until T+1 goes live, financial institutions have been urged to start preparing for the switchover. So what has to happen?
Firstly, firms should conduct gap analysis to ascertain what they need to do ahead of the implementation date. “From a project management office [PMO] perspective, there are several workstreams firms need to be focusing on, covering technology, regulation and communications,” shared John Ferrara, Vice-President, Risk and Compliance at Fidelity Investments. “Firms should be going through their documentation and making the appropriate language changes to reflect the T+1 move. At Fidelity, we have different business lines, focusing on institutional and retail clients, and how we communicate these changes will differ across our client segments.”
The T+1 move may require firms to make substantially more investment into technology and automation than they did during the adoption of T+2 in 2017. “There are some technology changes which were not necessary back in 2017 but would be necessary now. For example, stock plan services were not impacted when the US shifted from T+3 to T+2, as TAs [transfer agents] were sending the shares in a timely manner. Now we are shifting to T+1, the TAs will need to make technology enhancements,” said Ferrara.
While some financial institutions are improving their in-house technology systems, others are leveraging existing industry solutions to assist with trade matching, affirmation, delivery and performance benchmarking ahead of T+1.
Operational changes may need to be implemented to facilitate T+1 compliance as well. Some of the largest financial institutions currently adopt a so-called “follow the sun” model whereby their operations teams are located across multiple time-zones, enabling them to provide international clients with rolling 24 hour support for T+1. “Some of our global clients are starting to open up East Coast offices to ease the T+1 operational burden,” shared Pitts.
These options may not however, be available to smaller or mid-sized firms. If financial institutions cannot reallocate resources to different time-zones, then they may have to adopt shift working patterns to meet their T+1 requirements. Nonetheless, there is growing concern among custodians and brokers about whether to provide out of hours support for those US clients, who will not be ready for T+1 next May. In particular, some providers are looking to put an end to the one-off accommodations they make for certain clients, especially if it forces their operations teams to perform workarounds.
End to end testing ahead of T+1 will be critical too. “DTCC will have its test environment ready for industry participants from the middle of August. While we do not anticipate that all market participants will begin testing in August, we expect a large number of firms to begin testing in Q3. A lot of firms are dependent on their service providers, so these institutions will likely be amongst the early wave of testers,” said Hillery.
Each of DTCC’s tests will run over a two-week cycle, before being reset, enabling firms to conduct multiple dress rehearsals ahead of the T+1 deadline, including on public holidays. “We do not expect firms to get everything right the first time. Therefore testing often, early and using different scenarios is very important,” continued Hillery.
Thorough testing will be critical if financial institutions are to have a smooth T+1 transition. By carefully documenting the testing process, firms will have useful reference points across multiple scenarios when the implementation date finally does arrive. While DTCC’s testing environment is robust, it is limited to the functions offered by DTCC. “DTCC handles an estimated 50% of the testing requirements related to the move to T+1. However, there is a lot that happens outside of DTCC’s four walls that will also require comprehensive testing, including FX for firms with a global footprint, testing with service bureaus and vendors, and any internal operational workflows,” said Hillery. Firms also should assess the resilience of their systems in all areas and perform adequate resiliency testing.
Turning a corner
Although firms will have to recalibrate their operations and technology in advance of T+1, some of the biggest changes will be behavioural. “We are looking at our operational processes and how they function in T+2, and assessing what activities need to be moved back to either earlier in the day, or T+1 or even trade date. We are then evaluating what behavioural changes — be it on the client or the vendor side — will need to be made. 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 4pm. The good news is that behavioural changes can be made well ahead of T+1,” said Ferrara.
Along with behavioural changes, financial institutions will have to make substantive adjustments to their operations and technology practices if the switch to T+1 is to be frictionless. Moreover, regular testing will be essential if firms are to iron out errors in good time, and reduce the risks involved in the transition. Firms should take full advantage of DTCC’s testing facilities when they open in the summer.
With more markets — including a handful of LATAM countries, the UK and potentially the EU — contemplating shortening their settlement cycles over the next few years, there may still be a long road ahead on this T+1 journey.
