T+1: A Double-Edged Sword?
By Uday Singh, Head of Professional Services, Broadridge Financial Solutions
The coming shift to a “T+1” trade settlement cycle represents a critical step for the U.S. financial services industry at a time when markets are changing and accelerating at a dizzying pace. However, for individual firms, the compression of the settlement cycle to 24 hours will also create significant challenges and potential new costs—many of which might not yet be obvious.
When the DTCC issued its call for a 2023 deadline for T+1 in February, the industry largely applauded. That’s the correct response, given the significant benefits the move will create. Shortening the settlement cycle will reduce the depository collateral requirements that put Robinhood and global markets under pressure earlier this year in the GameStop episode—providing relief to market participants in periods of heightened volatility. It will also generate other significant risk reductions, as well as free up capital for other business needs, and increase overall operational efficiency.
However, capital markets firms, asset managers, wealth managers, and other market participants should understand that the shift to T+1 will also impose costs and challenges that could far exceed those associated with past moves to T+3 and T+2. Implications from the move will extend beyond operations and technology, affecting funding practices, revenues, and balance sheets. These impacts will be felt most by smaller firms and organizations still employing manual functions in their trade execution and settlement processes.
Given these sweeping implications, how can you know if your organization is ready? Institutions must create a T+1 Readiness Checklist. Although that list will naturally contain many granular functions, market participants can start their Readiness Audits by assessing three general areas:
- Impact on Technology Infrastructure and Operational Processing
- Impact on Balance Sheet and Revenue Streams
- Organizational Preparedness
Impact on Technology Infrastructure and Operational Processing
Although revolutionary at the time, the industry transition from T+5 to T+3, and even the 2017 move to T+2, can in retrospect be viewed as incremental changes. In many cases, firms could meet the demands of the shortened cycle by speeding up existing processes. Often, this was accomplished by allocating more resources to manual processes and living with associated risks. The move to T+1 will be much different. A 24-hour settlement window leaves no time for manual operations. It will require automation throughout the trade lifecycle and across diverse functions ranging from trade matching/affirmation and batch processing to a variety of functions within stock loan processing and asset servicing. Across the organization, any manual inputs or interventions within reference and static data will have to be eliminated, and processes automated. Even as firms implement these changes, they will have to maintain robust levels of IT investment to incorporate emerging technologies such as AI, Blockchain (DLT), and Cloud, which will drive critical efficiencies in both the T+1 and an eventual T+0 environment.
Impact on Balance Sheet and Revenue Streams
The dramatic changes to operations and technology required to achieve T+1 will affect financial service business models. Some of these effects will be positive for the industry. For example, the compressed settlement cycle will reduce both counterparty risk and capital requirements from depositories. Shorter cycles should also bring a reduction in liquidity risk charges. Other effects will create new challenges. At the top of that list is an erosion of securities lending revenues. But there are others, such as the potential for the tighter settlement window to increase the number and cost of failed trades, and the possibility that firms could be required to hold additional capital to mitigate increasedoperational and technical risks. The upshot for market participants: Planning for T+1 must extend well beyond operational requirements and into business strategy and balance-sheet management.
Given the scope of the coming change and the stakes at play, financial service firms cannot afford to take any chances with the shift to T+1. The only way for organizations to ensure they are prepared is through a rigorous process that systematically identifies and tests every aspect and function of the firm that will be touched by the shift to T+1. To cover everything, firms will need a comprehensive testing regimen that can be created, implemented, and acted upon in the next two years. That’s a tall order for such a complex initiative, which will require extensive planning, scenario development, test execution, and analysis—not to mention any remedial steps required to address issues or shortcomings uncovered in the testing process.
In many ways, the move to T+1 represents the step-change required to someday achieve T+0, which can only exist in a near 100% straight-through-processing (STP) digital environment. However, the full automation of the trading lifecycle will not be easy to achieve in two years’ time—especially for small and under-resourced firms still relying on manual processes. Regardless of size, the effects of T+1 on financial services firms will far surpass anything experienced in past moves to T+3 or T+2. It’s time to get ready now, especially as Boards begin asking the question of how T+1 will impact their companies and executives start budgeting for next year.