Navigating the evolving settlement landscape
27 September 2022
David Taylor, product manager for ION Markets' Secured Funding solutions, urges industry participants to innovate and future proof their technology, noting that firms that invest early in effective solutions will be well placed to take advantage of T+1 settlement
Image: stock.adobe.com/Golden Sikorka
Settlements are set to change. From the first half of 2024, the move to next-day settlements in the US and Canada, recommended by the Depository Trust and Clearing Corporation (DTCC), will modernise and bolster securities settlement, alongside reducing risk.
The DTCC believes that the move to T+1 will significantly reduce the volatility component of the National Securities Clearing Corporation’s (NSCC) margin requirement, estimated to save member firms billions of dollars. It also estimates increased operational efficiency, as industry standards improve and operators move to straight-through processing (STP) and to increase their levels of automation.
The upcoming move to T+1 settlement will radically impact the processing of repo and securities lending transactions. Participants on both buy and sell sides of the market, including dealers, prime brokers, agent lenders and asset managers, will be affected by these changes to settlement and trade processing.
Today’s securities finance outlook
To understand the impact of this new market standard, it is important to review the current securities finance environment. While securities finance has undoubtedly become more standardised, driven in large part by recent regulations — for example, the Securities Financing Transactions Regulation (SFTR) and Central Securities Depositories Regulation (CSDR) — and automation has increased, thanks to advances in electronic trading and technology, manual processes remain prevalent throughout the operating environment.
Pre-trade negotiation and execution is commonly agreed and confirmed through email and chat. Post-trade lifecycle and settlement management is almost entirely managed through email, phone, chat, and even fax. The collateral management process, from identifying and reconciling exposures and issuing margin calls, to selecting and agreeing acceptable collateral, is still a largely manual and complex task for the middle office. Billing reconciliation requires the use of dedicated services and breaks that must be manually investigated by the middle or back office. Finally, the impact of corporate actions on existing trading portfolios typically requires manual assessment and updates.
Time’s up for T+2
As the ICMA European Repo Council’s Operation Group stated of the move from T+3 to T+2 settlement, “unexpected cash and securities positions will have to be covered same day, adding to the volume of overnight repos. Funding and short-covering requirements will therefore fluctuate widely during the day before the intended settlement date”.
The move to T+2 restricted the time available for repo and lending desks to address those funding requirements. Manual management of repo and securities lending trades is still possible, albeit with little or no margin for error. Even if trades executed today for settlement on T+2 are not incorporated in the positions until the next day, traders still have until the morning cut-off to identify and issue any recalls or returns that need to go out, and they have a full day to source alternative borrowers or lenders to deal with the changes in their books.
However, even in a T+2 environment, relying on manual processing remains risky. For example, if the desk fails to issue recalls or returns in time for the morning cut-off, there will be more manual work required to manage the resulting short or over-borrowed positions. Over-borrowed positions that cannot be returned in time result in increased borrowing costs. Errors in trade execution or post-trade events must be caught immediately, or they may require further work to address, or they may lead to settlement failures. In times of market stress, when there is excess demand on liquidity and trade volumes spike, the impact can be outsized. Front office and middle office teams, that are already working at capacity to process the impact of the upcoming T+2 settlements on a normal day, can struggle to cope with the increased volumes.
Moving to T+1
The move to T+1 will further reduce the time available to manage changes to the internal and client positions of repo and lending traders. Relying on manual processes will become even more risky. Repo and lending traders will need to see the impact of today’s activity on tomorrow’s positions in real time. That means it will no longer be possible to wait until the next day’s positions are processed. The window available for dealing with trade and lifecycle booking errors will shrink, increasing the importance of automation and system validation.
Agent lenders will need to recalculate client trade allocations in real time based on intraday client sales. Furthermore, they can no longer rely on a start of day batch reallocation process. Recalls will need to be issued as and when positions are sold to ensure returns can be processed in time.
Participants have until 2023 to test industry processes, develop and build solutions.
Will the industry settle at T+1?
If the move to T+1 is eventually followed up with a further contraction to T+0, real-time automation will no longer be an option but a necessity.
To allow sufficient time to plan and prepare for T+1 industry testing at the end of the year, there is no time to delay reviewing solutions and systems. This is especially the case for those using solutions designed when settlement was T+5, batch processing was the norm and trade processing was almost entirely manual. While these systems have grown organically and enhanced over time as the repo and lending markets have matured, the move to T+1 and then to T+0 will be a bridge too far.
At ION, we recommend that industry participants both innovate and future proof their technology. By simplifying complex processes, boosting efficiency, and empowering better decision-making, we continue to work with our customers as they navigate the evolving settlement landscape. Clients that invest now in solutions — like Anvil, ION's Trade Processing solution — that have been designed from the ground up for real-time processing, automation, STP, and exception-based management, will be well placed to take full advantage of the benefits of the move to T+1, and ready for any further contractions.
The DTCC believes that the move to T+1 will significantly reduce the volatility component of the National Securities Clearing Corporation’s (NSCC) margin requirement, estimated to save member firms billions of dollars. It also estimates increased operational efficiency, as industry standards improve and operators move to straight-through processing (STP) and to increase their levels of automation.
The upcoming move to T+1 settlement will radically impact the processing of repo and securities lending transactions. Participants on both buy and sell sides of the market, including dealers, prime brokers, agent lenders and asset managers, will be affected by these changes to settlement and trade processing.
Today’s securities finance outlook
To understand the impact of this new market standard, it is important to review the current securities finance environment. While securities finance has undoubtedly become more standardised, driven in large part by recent regulations — for example, the Securities Financing Transactions Regulation (SFTR) and Central Securities Depositories Regulation (CSDR) — and automation has increased, thanks to advances in electronic trading and technology, manual processes remain prevalent throughout the operating environment.
Pre-trade negotiation and execution is commonly agreed and confirmed through email and chat. Post-trade lifecycle and settlement management is almost entirely managed through email, phone, chat, and even fax. The collateral management process, from identifying and reconciling exposures and issuing margin calls, to selecting and agreeing acceptable collateral, is still a largely manual and complex task for the middle office. Billing reconciliation requires the use of dedicated services and breaks that must be manually investigated by the middle or back office. Finally, the impact of corporate actions on existing trading portfolios typically requires manual assessment and updates.
Time’s up for T+2
As the ICMA European Repo Council’s Operation Group stated of the move from T+3 to T+2 settlement, “unexpected cash and securities positions will have to be covered same day, adding to the volume of overnight repos. Funding and short-covering requirements will therefore fluctuate widely during the day before the intended settlement date”.
The move to T+2 restricted the time available for repo and lending desks to address those funding requirements. Manual management of repo and securities lending trades is still possible, albeit with little or no margin for error. Even if trades executed today for settlement on T+2 are not incorporated in the positions until the next day, traders still have until the morning cut-off to identify and issue any recalls or returns that need to go out, and they have a full day to source alternative borrowers or lenders to deal with the changes in their books.
However, even in a T+2 environment, relying on manual processing remains risky. For example, if the desk fails to issue recalls or returns in time for the morning cut-off, there will be more manual work required to manage the resulting short or over-borrowed positions. Over-borrowed positions that cannot be returned in time result in increased borrowing costs. Errors in trade execution or post-trade events must be caught immediately, or they may require further work to address, or they may lead to settlement failures. In times of market stress, when there is excess demand on liquidity and trade volumes spike, the impact can be outsized. Front office and middle office teams, that are already working at capacity to process the impact of the upcoming T+2 settlements on a normal day, can struggle to cope with the increased volumes.
Moving to T+1
The move to T+1 will further reduce the time available to manage changes to the internal and client positions of repo and lending traders. Relying on manual processes will become even more risky. Repo and lending traders will need to see the impact of today’s activity on tomorrow’s positions in real time. That means it will no longer be possible to wait until the next day’s positions are processed. The window available for dealing with trade and lifecycle booking errors will shrink, increasing the importance of automation and system validation.
Agent lenders will need to recalculate client trade allocations in real time based on intraday client sales. Furthermore, they can no longer rely on a start of day batch reallocation process. Recalls will need to be issued as and when positions are sold to ensure returns can be processed in time.
Participants have until 2023 to test industry processes, develop and build solutions.
Will the industry settle at T+1?
If the move to T+1 is eventually followed up with a further contraction to T+0, real-time automation will no longer be an option but a necessity.
To allow sufficient time to plan and prepare for T+1 industry testing at the end of the year, there is no time to delay reviewing solutions and systems. This is especially the case for those using solutions designed when settlement was T+5, batch processing was the norm and trade processing was almost entirely manual. While these systems have grown organically and enhanced over time as the repo and lending markets have matured, the move to T+1 and then to T+0 will be a bridge too far.
At ION, we recommend that industry participants both innovate and future proof their technology. By simplifying complex processes, boosting efficiency, and empowering better decision-making, we continue to work with our customers as they navigate the evolving settlement landscape. Clients that invest now in solutions — like Anvil, ION's Trade Processing solution — that have been designed from the ground up for real-time processing, automation, STP, and exception-based management, will be well placed to take full advantage of the benefits of the move to T+1, and ready for any further contractions.
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