By Rich Lee, Head of Program/ETF Trading and Execution Strategy, Baird
As the industry prepares for the shortening of the settlement cycle in the US from T+2 to T+1 in May of 2024, the din of chatter around this is topic is steadily increasing. Firms on both the buy and sell side, as well as vendors and technology providers are in the midst of testing and preparing their workflow assumptions for this new settlement regime.
Anecdotal feedback from brokers and clients has been that most have their testing and implementation either in process or in place from a workflow and technology perspective. One topic that has been in discussion but there does not yet seem to be consensus around is the approach to how cash balancing and cash management will work with regard to global trading. Managing and settling a global program with non-concurrent settlement dates, FX, and corporate actions across multiple market markets requires thought and expertise.
For instance, imagine a large quarterly global rebalance in which the trade is dollar neutral, however, the US portion of the trade is a large net spend. On implementation date, with the closing price as the benchmark, Asia and European markets will be closed before the US market for that day’s trading session. Additionally, the bulk of Asian and European markets settling on a T+2 basis. When the US implements a T+1 settlement cycle, you can see the potential for settlement mismatch. You’ve net sold securities in Asia and/or Europe in which you will not receive the cash until T+2 but you’ve bought securities in the US which will require funding on T+1. A similar scenario to this could exist with regard in the creation/redemption process of ETFs with global components.
There are several potential options that might address this. Asset managers could:
1. Utilize shortened settlement in markets that do not settle T+1 to align settlement of cash proceeds with payment for settlement of US stocks. Barriers to this may include ID markets and markets that do not allow for short selling or shortened settlement. In this scenario, it would be critical to ensure that markets that do allow for this, raise enough cash proceeds to offset the cash spend in the US. With interest rising off their history lows, there is an increasing non-trivial cost to this.
2. Utilize extended settlement in the US to T+2 to align with the receipt of funds from other markets. This eliminates the issue of having to discern which of your non-US market allow or disallow shortened or short settle but also eliminates the benefits of moving to a shortened settlement cycle. The issue of financing also remains in this scenario.
3. Incorporate Cash or cash management as a tool in the trading process. If asset managers decide that they do not want to use brokers to facilitate shortened or elongated settlement as tool to align cash, then they might consider utilizing their cash on hand to self-finance the lag in settlement cycles. The use of this cash then requires an opportunity cost analysis on the return on cash.
This scenario highlighted above is not just a workflow or logistical issue that needs to be resolved but an investment implementation challenge that needs to be solved. Tackling this challenge will require collaboration and communication with the buy and sell side as well as stakeholders in the investment to settlement process engaging everyone from traders to the middle office, and PMs in this conversation.
