A Move to T+1 Settlement: What it Would Mean for Funds and Their Administrators
By Jason Kane, CPA, Supervisor, Alternative Investment Group
As rumored throughout the financial industry, there is currently a push to move securities trade settlement to a trade date plus one day (T+1) cycle on American stock exchanges. The proposal was recently discussed in a joint report by the Depository Trust & Clearing Corporation (DTCC), the Securities Industry and Financial Markets Association (SIFMA), and the Investment Company Institute (ICI) (article here, report here). The transition would occur in 2024. The last transition was made in 2017, when the exchanges went from a T+3 to a T+2 cycle. It has proven to be successful.
When a security, such as a stock, bond, or derivative, is bought or sold, the date the broker-dealer executes the transaction is known as the trade date. However, the buyer does not receive the security and the seller does not receive the cash until the trade has settled, the date of which is known as the settlement date. Between the trade and the settlement many middle and back-office operations occur, including reconciling the trade with brokers and recording the transaction on the company’s books and records, including at any intermediaries. Due in part to advances made in the FinTech industry in recent years, it is now possible to shorten the time between trade and settlement—a welcome development.
Benefits, Risks, and Drawbacks
Aside from speeding up and streamlining the transaction process, there are other benefits to a shorter cycle. Once proper infrastructure and processes are in place to support T+1, having fewer open trades, especially during market volatility, will reduce market risk and exposure. For example, the DTCC estimates that a T+1 transition will decrease the volatility component of the National Securities Clearing Corporation’s (NSCC) margin by 41%. (Source). Quicker settlements will also create more transparent and accurate data across the financial system. Investors will enjoy faster access to their cash or securities and reduced margin requirements, allowing them to take advantage of more investment opportunities than they could in T+2 settlement.
Impact on Operations and Fund Administration
Fund administrators and fund operations personnel should be prepared for shortened timeframes to complete their work and plan for changes to some of their procedures in a T+1 cycle. With one less day to complete all necessary steps on a given trade, there is an increase in operational risk that has to be considered. The risk that trades fail and do not settle are greater when there is less time to thoroughly review for trade errors. There will also be required changes to processing corporate actions to reflect the T+1 settlement date, and a potential alignment of the date of record and the ex-dividend date.
To mitigate these risks, fund administrators and operators alike should add extra precautions to their reconciliation process. Hiring additional back-office resources or utilizing new software and technology service providers may be necessary.
Different settlement timeframes around the world could create other issues. American stock exchanges moving to T+1 does not mean all exchanges globally will stop using T+2 or other settlement timeframes. This could create a situation where a trade could settle in one stock exchange but fail in another. Especially during periods of high trading volume, fund administrators and investment firms could struggle to properly account for all of their trades.
Impact to Prime Brokers and Clearinghouses
Prime brokers and clearinghouses will also have to adjust to the shortened settlement timeframe. Trade affirmations (when the counterparty confirms trade details) and disaffirmations will need to happen on a compressed timeframe. Per the ICI report, in a T+1 environment the goal would be for more trades to settle on time due to the affirmation process. Trade affirmations will need to be completed by 9 p.m. ET on the trade date. (The current deadline is 11:30 A.M. ET on T+1).
There will also be a regulatory effect to consider. There are numerous Securities and Exchange Commission (SEC), Financial Industry Regulatory Authority (FINRA), and stock exchange rules that are written to support T+2 settlement. They would have to be updated to reflect the new timeframe. For example, SEC rule 15c6-1 states that a trade must deliver securities or payment of funds within two business days of the contract. If this rule is not amended, T+1 settlement will not be enforceable and there could be systemic breakdowns.
Regulators and financial services providers must work together to re-write these rules. It is a necessary hurdle, and fund administrators and investment firms should be prepared to update their operational and compliance systems, internal controls, and processes to comply with any new rule changes. Because a potential transition is still 2-3 years away, there is enough time for all parties to prepare.
The move to T+1 is expected to happen in the first half of 2024. An industry steering committee was established in the winter of 2021 to coordinate and oversee the efforts to make the transition successful. The ICI is encouraging investment firms to actively engage with key third parties (including regulators and fund administrators) as well as the industry steering committee.
The change to T+1 settlement will help modernize the financial industry and streamline the settlement process. A lot of preparation will need to occur over the next few years to ensure that all parties, including investment funds, their fund administrators, and prime brokers are ready for the adoption. To ensure success, the switch should be rigorously tested and the transition should happen gradually.
After T+1, the next advancement would be a transition to same-day settlement, which would require an even more significant infrastructural and procedural overhaul. Consequently, once T+1 settlement is instituted, it will likely remain for many years to come.