US T+2: US Catches Up With Europe

Matt LaPointe discusses what a shorter securities settlement cycle means for US asset managers.

After nearly five years of planning, the securities settlement cycle in the US is getting shorter. In September, the settlement cycle will move from trade date plus three days (T+3), to trade date plus two days (T+2). The change will affect all securities that settle at the Depository Trust Company, which includes equities, corporate bonds, municipal bonds, and unit investment trusts. Securities such as US government bonds and mortgage backed securities that settle at the Fedwire Securities Service will not be affected. The move to T+2 brings the US in line with most major markets, in particular Europe which moved to a T+2 cycle in 2015. Beyond international harmonization, there are two key reasons for shortening the settlement cycle: reduced risk and increased market efficiency.

REDUCED RISK

Reducing the settlement cycle helps to mitigate issues associated with trading counterparties going out of business while trades are still in the middle of their settlement cycle. The impact of counterparty failures can range from the non-receipt of cash or securities to the entire loss of asset inventory held by a counterparty. A shorter settlement cycle also reduces the additional margin and liquidity requirements that occur during times of economic stress.

INCREASED MARKET EFFICIENCIES

The move to T+2 should spur greater use of automation. A surprising number of asset managers still transact manually, primarily because they have the luxury of time. A shorter settlement cycle will make such methods more challenging, thus incentivizing businesses to automate this process.

The increased use of automated instruction methods should also improve an asset manager’s ability to “authorize or match” transactions with their custodian and broker prior to settlement. This eliminates the need for reclamation transactions where repayment of money paid is demanded in the event of a bad delivery of a security. Another area in which improvements are expected is same-day affirmation rates. An increase in the number of trades matched on the same day as the trade takes place will further reduce the chances of settlement issues. The move to T+2 also enables capital to be freed up faster for reinvestment, which means asset managers can more quickly react to movements in the market.

GETTING READY

To prepare for the move to T+2, asset managers need to start reviewing operational processes and ensure that their systems can manage the new settlement timeline. Asset managers should also work with their brokers and custodians to review their current affirmation rates, as well as the impact on cash flows and projections.

Beyond pure settlement issues, all activity that is tied to security settlements should be analyzed. For example, asset managers that engage in securities lending need to ensure these transactions are included in any review process, since they will have one less day to recall any shares that might be part of a securities lending transaction.

As a whole, the industry is well prepared for the move since many asset managers have already shifted to a T+2 settlement cycle in Europe. Despite the work that firms have to do, most industry players are looking forward to the change. The long-term reduction in trading risks and increase in efficiency will be worth the short-term pain.

Part of this article was originally published in the 2017 Regulatory Field Guide. The guide features insights from a number of our experts on important regulatory developments for asset managers in the year ahead. Visit bbh.com/regulatoryfieldguide to explore the guide.