Research from EFAMA has found that the upcoming US move to T+1 will increase settlement risk for an estimated 40% of daily FX flows.
EFAMA’s report notes that a “significant part” of trading takes place on market close—4pm EST. Once an asset manager has confirmed the trade and is ready to execute FX, there is only a brief window before CLS cutoff—6pm EST.
As such, access to CLS in a T+1 environment will be considerably reduced. A Q1 2024 survey of EFAMA member firms found that more than a third of FX trades will have to be settled outside of CLS, based on estimates of fund managers.
The report goes on to advise for more consistent alignment between European custodians regarding cutoff times. Currently, cutoff times are broadly split between 6pm CET and 10:30pm CET, indicating a self-imposed European business day cutoff and a cutoff of around 4:30pm EST respectively.
European fund managers currently settle in excess of several hundred billion USD on active trading days. If 40% of FX trades can no longer access CLS, EFAMA’s report asserted that 50-70 billion USD—potentially more than double this figure on active trading days and in volatile markets—would be put at risk.
Alternatives to CLS include prefunding, “operationally complex” FX on trade day (with a ‘true up’ the following day against the confirmed trade) and bilateral settlement, with the counterparty bypassing CLS entirely. These methods all increase cost and risk, EFAMA said.
The report stated that: “T+1 implementation today does not represent an absolute reduction of risk in the system. From where asset managers sit, it looks more like a shift away from credit and market risk to an increase in operational and settlement risk.”
It goes on to encourage central banks and regulators to “take a more active role in understanding impacts on settlement risk”, advocating for an extension of the official CLS cutoff time and the adoption of later cutoffs by the custodian community.
©Markets Media Europe 2024
