The US shift to T plus 1: What Next?

The US market successfully moved to the T+1 settlement cycle on May 28, 2024, after three years of effort. According to a Depository Trust & Clearing Corporation (DTCC) report, more than 94% of the transactions were affirmed before 9:00 PM ET on trade date, a significant improvement over the affirmation rate of 73% in Jan 2024. Prime brokerage affirmation rates exceeded 98% whereas investment managers leveraging central matching services achieved same day affirmation rates of over 97%. Custodian or investment manager self-affirmation rates stand at above 84%.

T+1 migration has been more challenging and complex than the earlier T+2 migration, mainly due to significant impact on operations.  In T+2 migration, allocation, confirmation, and affirmation processes could be performed during the business day across most geographies active in the US markets, whereas for T+1, 9:00 PM ET is the deadline for affirmations for all participants across the globe. This requires market participants to automate post trade processes as much as possible and offer operational support to process exceptions.

While the US market has largely achieved compliance with the T+1 mandate, here are some points to ponder on potential next steps: 

• Efficiency and automation: High rates of real-time affirmations by prime brokerages as well as automatic affirmations and settlement instructions by central matching engines bode well for the long-term efficiency of the industry. However, some industry players may have adopted an operations-intensive approach or quick-fix solutions to meet the aggressive timelines for T+1 migration. Now, it is imperative to automate such processes to improve efficiency as well as reduce operational risk. Increased use of artificial intelligence (AI) can enhance straight-through-processing (STP), lower settlement fails and reduce the burden of exception management in shorter timeframes. Industry participants can also evaluate central matching engines and utilities for automated affirmations and settlement instructions to enhance efficiency and reduce settlement failures.

• Measuring the benefits: A key benefit of shortening the settlement cycle for members is the reduction of risk exposure to central counter parties (CCPs). Shortened settlement cycle reduces the total exposures to one day’s trading volume instead of two days’ trading volume earlier. Reducing the risk exposure will lower the quantity of collateral to be submitted to the CCP. CCPs accept only high-quality collateral, which is a precious resource and can be redeployed more profitably. Industry players should measure and benchmark these savings.

Thinking beyond immediate compliance

Given the push to shorten settlement cycles, here is our take on a few themes that are relevant to the shift.

Trading across markets:

Global markets are in a transition phase as far as shortening the settlement cycle is concerned. India and China have already moved to the T+1 cycle and are experimenting with T+0 whereas Canada and Mexico have moved to T+1 along with the US. Europe and UK still follow the T+2 regime and are yet to make a final decision on the move to T+1. As more and more markets move to shorter settlement cycles, global players will need to contend with the coexistence of varied settlement cycles across different markets, which will require a reconfiguration of their systems and processes to accommodate these differences.  

T+0:  

T+0 is at least a few years away and needs a strong driver for regulators and the industry to move in that direction. It is unlikely that markets will move from T+1 to T+0; we believe that T+0 will be offered as an optional feature. Hence, T+0 or instant settlement will coexist along with T+1. There are two broad approaches that are being explored. The first is to settle the trades at the end of the trading window to ensure that the movement of cash and securities occurs on the same value date. The second approach envisages instant trade-by-trade settlement with potential pre-funding of cash and securities. Learnings, best practices, and success stories from markets that are ahead in this journey can be very helpful.

Extended trading window:

Some markets like FX and index futures, without underlying delivery obligations, trade 24 hours a day, five days a week (24 x5 window). Securities are traded in shorter windows to enable post trade processes. A shorter settlement cycle, automated post trade processes, and higher STP can enable extended trading windows in securities markets. Extending the trading window opens new opportunities and fuel vibrancy in capital markets.

DLT for shorter settlement? 

According to one school of thought, tokenization using distributed ledger technology (DLT) can enable instant settlement. However, experiments reveal that DLT/ tokenization is not mandatory for instant settlement. A World Federation of Exchanges research report reveals that using DLT for faster settlement initiatives will compromise liquidity and push up transaction costs.Institutional trade processes that include allocation, confirmation, affirmation and give-up / take-up arrangements between investors, broker/dealers and custodians is the primary reason for a time gap between trade and settlement. Given the substantial investments in complying with the T+1 program, we believe the market is geared for future initiatives aimed at even shorter settlement cycles.

This article was co-authored by Ambareesh Sinha, Business Unit Head, Capital Markets, Tata Consultancy Services, North America.