Where are you with your T+1 planning – and what will happen if you don’t meet the deadline? New data suggests that right now, over a third of trades would fail if the switch was flipped tomorrow – while the buy-side is falling behind the sell-side in terms of preparation. But failure to prepare could see some serious consequences – for the wider market as well as for your own bottom line. What’s the worst that could happen – and how can you avoid it?
Preparation
Last month, BNY Mellon analysed its US custody base with regards to T+1 – and found some worrying results. Roughly a third of trades settled by DTCC could face issues in preparation for the settlement cycle reduction – while almost 10% still need to make significant operating model changes to meet the May cut-off point.
“Our data analysis indicates that 34% of transactions could potentially fail if T+1 was instituted tomorrow,” explained Adam Watson, head of commercial product – custody at BNY Mellon, speaking to BEST EXECUTION.
“We look at a baseline of 6.30pm EST, and we say anything received to us prior to that has a high probability of settlement. Anything between 6.30pm and end of day on T has a lesser chance of settlement but is still possible. Then anything that arrives to us on T+1 has a significantly diminished probability of settlement. Using those baselines, our analysis indicates that 34% of transactions are at risk, which further breaks down to 25% needing adjustments (i.e. arriving 6.30pm EST to midnight on T) and 9% requiring significant changes (i.e. the trades arriving after midnight on T).”
Interestingly however, the US settlement rate (while fluctuating), remains quite high relative to global markets – currently sitting at around 97-98%.
“This indicates to us that industry participants are still using the time afforded them in today’s deadlines,” warned Watson. “If there are exceptions in the 34% today, these are clearly being remediated on T+1 to allow T+2 settlement in order to get to a 98% settlement rate. That extra day will no longer exist in 5 months.”
‘Repo’cussion
Settlement failures could impact the entire trade lifecycle: affecting agent lending, cash management, repo pricing and bank balance sheets. Of these, the impact on the repo market could be one of the biggest – and one of the most under-sung so far.
Rather than increasing credit exposure to banks, clients might end up having to borrow in overnight repos to cover any residual balances on their books and settle in the T+1 timeframe, lowering repo availability and driving up costs.
“Our industry engagement indicates we could see a short-term increase in the repo market to either secure funding overnight for short balances, or to invest long balances where another option hasn’t been agreed to,” revealed Watson.
“On the long balance side, we already have a wealth of capabilities to help clients invest long cash. We are hearing at an industry level about the struggle to cover short balances. This will likely remain until fund structures move to a compressed cycle and/or global markets move to a unified settlement cycle.”
Affirmation
Given the potential consequences, market participants urgently need to prioritise their preparations. But what should they be doing?
The obvious adjustment is the affirmation model – akin to the matching process in other markets. An affirmation is an acknowledgement that the trade details of an institutional investor agree with those of its broker-dealer – a process that under T+1 will need to occur by the new DTCC cut-off time of 9pm ET. This affirmation (which by May will be a regulatory requirement in North America) can be done by the investor itself but is often undertaken by an authorised representative, such as a prime broker or custodian. Either way, it must be done – and a process needs to be put in place to do it. But do you have one yet?
“What we have seen and continue to see is client interest in understanding what models are available and what is the best model for them,” said Watson. “We have clients that want to affirm their own trades; we have clients that want us to affirm what auto matches with their brokers and then only look at natural exceptions; and then we have clients that want to book instructions based off what we receive from the broker. The challenge is to understand problem statements and desired outcomes and then help a client move to an affirmation model that works for them.”
Because affirmation is mandatory (for US broker/dealers), missing the 9pm deadline could leave the broker/dealer open to a regulatory penalty – plus the cost of settlement at DTCC is higher for unaffirmed trades.
Automation
Here too, automation is the name of the game. In Q4 2023 Goldman Sachs achieved above 99% same-day affirmation (SDA) rate and a significant improvement in settlement rates for transactions by using DTCC’s central trading matching program (CTM)’s Match to Instruct (M2i) workflow. The firm also reported a 38% reduction in same-day affirmation exceptions and a 64% reduction in US settlement fails by value.
The M2i workflow aims to improve same-day affirmation (SDA) rates through its central matching and auto-affirmation capabilities, which DTCC claims are typically more efficient than local matching and affirmation by custodians. “Today, most CTM investment managers leveraging M2i to match and affirm their US trades achieve a near 100% affirmation rate by 9pm ET on trade date, achieving the level of straight through processing necessary to meet their counterparties’ T+1 SDA requirements and cut-off times,” said the firm.
“Automation is a key enabler of operational efficiency and enhanced client experience. We were pleased to validate through our analysis that our settlement efficiency strategy, supported by CTM’s M2i workflow, has resulted in a significant reduction in settlement fails for our clients,” added Risa Lederhandler, global head of equities and securities services Operations at Goldman Sachs.
“We found that M2i’s process increased affirmation rates by 9pm ET on T, a key objective as we prepare for the move to T+1. In addition, the M2i platform’s enhanced SSI enrichment capabilities resulted in more settlements occurring without additional input from our operations teams.”
Integration
Other areas of workflow that could need a deeper dive include ancillary elements such as FX execution, securities lending, inventory management, cash management and operational support. Given the breadth of updates needed, firms should be focusing on the earliest possible integration of data and analytics into their workflows.
“You want to complement the client’s existing operating models, but layer in escalation of potential exception areas much closer to the point of execution,” recommended Watson.
“The biggest knock-on impact is going to be prevalent if clients don’t look at their operating models, don’t assess the need for data (real-time or macro level trend analytics) and ultimately don’t assess who can help mitigate risk of failure through the trade lifecycle to provide them with the highest settlement finality at point of execution.”
Execution
With just four months to go till the final deadline, the clock is ticking – and while there has been a lot of noise about what firms need to do to get ready, there has been less focus on the potential consequences of a failure to prepare once May 28th has passed. So what’s the worst-case scenario for a buy-side firm that doesn’t quite manage to get its ducks in a row before the deadline?
“Of the hundreds of thousands of buy-side firms out there, what is their level of preparedness? There is certainly an opinion I’m starting to hear, that the sell-side is more prepared than the buy-side,” warned Danny Green, head of international post-trade at Broadridge. “That’s one of the more uncontrolled elements at the moment, and the buy-side really needs to be focusing on that and working closely with their brokers and partners to think about what the implications of T+1 might be for them.”
“We’re running out of time now and there is a limit to how much firms can realistically get done between now and May. I’m steeling myself for what might happen in July, August, September, when organisations begin to see the impact,” agreed Pardeep Cassells, head of financial products at Access Fintech. “We’re expecting a spike in fail rates – if you’re looking down the barrel of a 25-30% fail rate, as the BNY Mellon data suggests, that’s a horrendous position for any organisation to be in.”
Resolution
In the first instance, the downside of not being prepared is likely to be higher operational costs. If you haven’t been working systematically to make yourself as efficient as possible in your settlement process and to reduce friction, then you’re going to have to hire additional headcount pretty quickly. But you’re also going to have to look at your end investor impact as well.
“Your clients will very much want to see a settlement rate. If you’re failing to deliver that, there will be consequences,” warned Green. “And then later down the line, there will be more traditional sales costs which will hit your bottom line.”
Firms also need to be looking in detail at their data now, to establish how they are going to prevent fail rates from spiralling out of control. “There are usually some fairly simple issues that can be resolved, that would make a big difference – but if you don’t know the problem, you can’t fix it,” said Cassells.
Complication
Against the backdrop of all the job cuts and redundancies that are happening across the buy and sell-side, an increased settlement failure rate is likely to make things increasingly complicated, especially for mid-sized asset managers with limited resources who are already seeing significant fund outflows and bottoming share prices.
“To my mind, those at the biggest disadvantage will be the small and medium-sized firms on the buy-side. They’re already under cost pressures, fee competition, and while the bigger players have the budget to prepare, this is definitely going to be an additional competitive pressure on the smaller ones,” noted Green. “We might even see a shift away from North American equities for a while, as they struggle to adjust.”
“It’s hard to see how a higher fail rate is not going to make your firm less competitive, especially if you don’t have automated processes yet,” agreed Cassells.
“Don’t forget that the industry has done this to themselves – this wasn’t a regulatory initiative at the start, it was a market-driven one. It’s a change that has been made with a risk mitigation mindset. So if you can’t turn these trades round quickly enough, are your investors going to start thinking that their money is at more risk with you than with the lower fail rate next door?”
But don’t get too disheartened. The clock might be ticking, but there is still time.
“I’m an eternal optimist. I think if we get to June, July and people start seeing this impact their bottom line, they’re going to start scrambling to fix it, and they’ll find a way of getting there,” concluded Green.
“In the long run, T+1 is here to help the market, not hinder it – it’s designed to reduce the overall cost of trading. It might take some short-term adjustments, but it will have long-term benefits.”
©Markets Media Europe 2024
