The Daily Update: T+1: A Day Early, A Dollar Short

Earlier this year, the US Securities and Exchange Commission (SEC) voted to shorten the settlement cycle for most US dollar assets to one business day (T+1), halving the current standard of most US markets where trades are settled two business days after they are executed (T+2). The move will aim to reduce liquidity risk arising from unsettled transactions, margin calls, and collateral requirements. With the shortened settlement cycle, allocation and confirmation must happen on trade date, impacting all institutional trades that clear and settle through the Depository Trust and Clearing Corporation’s (DTCC) various services. We went from T+3 to T+2 the year Donald Trump became the leader of the free world.

However, the switch, due to take place on the 28th May next year, will put dollar assets out of sync with the world of foreign exchange, where the vast majority of trades are settled on the second working day after execution (T+2). So, the new rule halves the time non-USD and overseas institutions trying to buy dollar assets will need to secure dollars in advance to ensure they can settle trades.

As Ricky Ellis, Head of BBH FX Sales EMEA puts it, since the US equity market closes at 4pm ET (9pm UK/10pm CET), this will leave very little time on T+1 to match the equity trades and to then generate and execute the FX required to settle the equity trades. For those managers who prefer to execute the FX on T+1, close to the equity trade, it may require a local presence to manage that activity in the US trading day, or the use of an automated or outsourced solution that can support the required trade management and FX execution in a very streamlined and robust workflow.

So, the knock-on effect will be that FX desks may need to adjust not only their trading hours but also their procedures. This means longer hours for FX desks in New York, rising volumes in Asia’s notoriously thin liquidity mornings, and the possible relocation of staff out of Europe. For the FX market, along with asset managers and financial institutions around the world, the time zone differences will make their FX trickier to manage.

Of course, questions are being asked both here in the UK, and more importantly in Europe, as to if and when this side of the pond will follow suit. The debate has intensified in Europe with the publication of a new paper from the Association for Financial Markets in Europe (AFME) entitled “T+1 Settlement in Europe: Potential Benefits and Challenges”. In Europe, the current settlement cycle for most transactions in equities and fixed income markets is two business days.

However, the fragmented nature of European financial markets means they are not as homogenous as in the US. In fact, the AFME paper clearly calls out the additional complexity: “Quite simply, there is more to consider, more to change, and more actors to coordinate”.

Just to give you an example of the fragmented nature of the European trading markets, in the US there are 3 Listings Exchanges, in Europe (EEA, UK, Switzerland) we have 35. Trading Exchanges, US 16, Europe 41. Central Clearing Counterparties (CCPs), in the States just the one, this side of the pond 18. Central Securities Depositaries (CSDs), US 2, Europe 31 and lastly, Local Currencies, it’s the dollar versus 14 in Europe.

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