Gary Wright
By now, every investor within the USA and Canada should be aware of their capital markets move from trade date plus two settlement (T+2) to trade date plus one settlement (T+1) on the 27th (Canada) 28th May (U.S.).
However, this is not the case internationally. There are knowledge gaps around what operational impacts T+1 will have on investors and, more importantly, at what cost.
It is estimated that about 40 percent of the USA daily transaction volume comes from overseas, with about 13 percent from the U.K., 20 percent from the E.U., and the remaining 7 percent from elsewhere. The key part is exchange-traded funds (ETFs) and other open-ended funds.
Cross-border trades will be affected by increased costs, due to the mismatch between T+1 and T+2 settlement elsewhere, causing a funding gap.
Much has been made about the benefits of accelerating settlement in North America. The SEC vote of 3 to 2, with the deciding vote by SEC Chair Gary Gensler did include reservations on the international impact but was disregarded.
The savings outlined by the SEC of reduced collateral and margin costs, and a reduction of counterparty risk for day traders in North America, materialize as increased costs for international investors. This is due, in part, to the funding gap created by the mismatch in settlement periods.
Prefunding is likely to increase with the need to allocate cash or collateral early to facilitate settlement for T+1. This added cost is compounded where a foreign exchange (FX) transaction is needed, where standard settlement is T+2.
So, why would North America deliberately make its capital markets more expensive for international investors? The answer is simple — either they did not know or factored it in.
Apart from an increase in trading and collateral management costs for ETFs and other funds, there will be other operational costs.
All the capital market firms run batch-processing systems. Some think they work in real time, but they do not! They just send multiple batches throughout the day. The DTCC cut-off time is mandated as 21:30 EST, (02:30 London).
In the U.K./Europe, quite a few major firms outsource their settlement operations to Asia. Due to time zone differences, problems with cross-border trades will require resolution outside of normal working hours and may not have a successful outcome, resulting in a greater number of settlement failures. This is feasibly more than North America has experienced since the early thirties.
The costs of doing business in North America for international investors will skyrocket.
Industry analyst Larry Tabb estimates the cost to USA investors as $30 billion but, internationally, if we include system upgrades or replacement, operational overheads, transaction costs for funding, prefunding, FX, and collateral, $30 billion will be chump change.
It is no wonder that U.K. and E.U. policy is shifting now from the former urgent “keeping up with the Jones’ approach,” to one of let us wait and see.
I have no doubt that T+1 will become an international standard at some point in the future but achieving it without detriment to investors must be the aim.
No other industry has shot itself in the foot more than the capital markets and this move by North America might be the latest example.
Foundations must be laid to create an environment for real-time processing, which not only improves current market processes but will attract new investors and issuers before an SEC Big Bang-style date is instigated to force the issue.
With this move to T+1, North America is risking much, but the rest of the world will watch and learn.
(Editor’s note: The author Gary Wright is the director of industry affairs at ISITC Europe. An industry veteran, Wright has been part of the finance industry since 1969, holding senior positions within several major financial institutions. He was involved in many industry committees including setting the CISI Operations Management exam papers and has been a guest lecturer at Reading University and the ICMA. Wright has also undertaken consultancy assignments and worked in an advisory and industry relationship capacity for leading suppliers, enabling him to understand problems from the buy- and sell-side perspectives. He founded B.I.S.S. Research in 1997 creating the B.I.S.S. Accreditation, which independently benchmarked international financial technology.)
Need a Reprint?
Noone has considered that the misalignment of the settlement cycles may create an opportunity for the regional exchanges in EUR as well as for the collateral agents. Europe becoming the short selling market and the US the one where to buy. Is it realistic?
Yes Andrea , your correct that the USA has inadvertently opened up opportunities to international exchanges. Dual listings has been unattractive to companies in the past but if it means being closer to international investors and in a cheaper market this might be a possible outcome. Unintended consequences abound with USA T+1 some you highlight but there are many more. The costs of FX and Funding has been explored recently and this is only part of the costs for international investors. Liquidity in capital and FX payments all combine. The USA has really not thought this through from a international capital markets perspective and may well pay the price. UK and EU plus other international markets just have to wait and adapt .