‘Tea for two’
Brian Godins, Global Head Equities Operations, HSBC, looks at the incoming T+2 regulations, and its consequences for market participants.
At the time of writing there were twelve European countries focused on moving from a T+3 to a T+2 settlement cycle on Monday 6 October 2014. Another dozen or so European countries are considering a similar shortening of settlement cycles either at the same time, or at some point in the not too distant future. Markets such as Germany, Slovenia and Bulgaria already trade on a T+2 basis, as do other markets around the world, so just how revolutionary is this change?
A number of articles have been written over the last year in which T+2, Central Securities Depository Regulation (CSDR) and TARGET2-Securities (T2S) have been commented on in the same breath. Clearly the industry is moving forward in its thinking and approach to the clearing and settlement operating model. That said, one could argue that T+2 is yet another initiative in an already congested regulatory arena, that will eat away at Operations and Technology resources in 2014, and leave the discretionary budget pot for each participant relatively bare. Each participant has a ‘shopping list’ of revenue-enabling, revenue-protecting, clientfacing, operational risk and strategic transformation programmes of work. As T+2 looms how much should we worry, and does T+2 actually complement some of those ‘shopping lists’ and the wider demands of the community? Could T+2 be a catalyst and a vehicle for creating mutually palatable benefits?
Sizing the challenge
The size and scope of T+2 implementation cover many different areas; varying in complexity and difficulty depending on the weighting an organisation gives any one of a number of drivers. The following are the most pertinent, but do not represent a comprehensive list.
What type of market participant are you? The answer to this question defines the implications of T+2, and the next steps that need to be taken. The range of participants includes broker dealers, custodians, third party outsourcers, exchanges, central counterparties (CCPs), prime brokers, and a host of different buy side institutions; including asset/investment managers, funds, corporates, banks, retail, private and wealth management clients. There is a general consensus that the change to T+2 will be easier for broker dealers, CCPs, exchanges, Central Securities Depositories (CSDs) and custodians; whereas for the remainder there will be an increased level of complexity based on the DNA of those participants and client requirements. They will require more detailed scrutiny and analysis of their operating models to understand the implications and functional requirements for their underlying client base; driven by reporting, transparency, regulation and general client demand.
This is not the time to breathe a sigh of relief if you are in the first group however, as this will not be as easy as ‘simple configuration and static data changes’. It is painfully obvious that all broker dealers, exchanges, CCPs, custodians and CSDs will need to play an important and leading part in influencing, educating and helping all participants make T+2 a seamless implementation. This is not a programme of work we can all do in isolation, and its success will be determined by the collective sum of the parts working in unison.
Another challenge will be the global implications of T+2. The global client base of European markets means that this really is an initiative that has far reaching implications. Nowadays most broker dealers offer distribution channels where their executing entity is often very different from the contracting entity. Managing these cross border transactions, with the obvious time zone challenges they present, definitely puts extra scrutiny on the ability to settle these trades only two days after the trade date. This puts the spotlight on the quality of the trade date processes.
Clarity on product scope is another current focus for participants. As mentioned, T+2 is not a new concept and given we have CSDR text to lean on, you would think that the clarity on which products are in scope for shorter settlement cycles would be clear. However there are still multiple views as to what is in scope, or potentially in scope; as well as questions around dual-listed securities, fixed income cash bonds, and clarity on whether an over the counter (OTC) client transaction has to be T+2. The last point is an in interesting one. From a purist’s perspective for cash equities traded on a RIE/MTF or OTF from 6 October, these will be executed on a T+2 basis. An OTC client transaction on the back of this is expected to settle with the same cycle. CSDR and harmonisation are words often used in the same sentence. A fragmented market side versus client side settlement cycle is not one that lends itself to harmonisation. We can say with some confidence that the focus and communication will be on settling all these European in scope settlement market transactions on a T+2 basis. Experience has shown us that in existing T+2 markets, it is not unusual to get a fair number of mismatches between a marketside T+2 trade and a T+3 client-side trade. The wider European market focus on T+2 will hopefully add additional scrutiny on these nonstandard settlements and push the market to treat these client-side transactions as very rare.
There is much open discussion in forums, announcements and FAQs, which raises these and other questions in sizing the challenge and impact T+2 presents for firms and the industry. One of the most commonly raised questions is the potential operational risk with so many European countries going live on the same trade date, 6 October 2014; and more significantly the concern around 8 October as the last T+3 settlement date and the first T+2 settlement date. Operational risk in the form of liquidity concerns, failures, operational resource bottlenecks across participants are all genuine concerns, although difficult to quantify in the grand scheme of things. They tend to take on a subjective tone although one that does have some credence and does resonate with most participants in some shape or form.
Whether it is a ‘big bang’ or a phased approach, each market has made its own decision that the 6 October works for them. The markets in scope will definitely be looking on in interest at any guidance from the European Central Bank (ECB) working group or other bodies around the comfort level and viability.
The opportunities that T+2 presents
Over the past 18 months I have had the pleasure of working with the Association for Financial Markets in Europe (AFME) as part of the Post Trade division, chairing the Transaction Management Committee (TMC). At the time I joined the broker dealer committee they were already actively working on a set of deliverables in the post trade services space. More specifically, they were working on a set of standards and documentation around same day affirmation (SDA), matching, allocation and confirmation for the securities product; with a focus on cash equities and CFDs. The aspiration was, and is, to influence, guide and move the industry forward in addressing the inefficiencies and lack of completeness in the T0 processing space. The percentage of trades being affirmed, matched, allocated and confirmed on trade date with executing/prime brokers and buy-side participants was too low. At the time there was general acceptance in the market that a good chunk of essential trade date processing would happen on T+1. If you were trading with a counterpart in another time zone, affirmation may not even happen until T+2.
If we pause for a second and think about the real drivers for a change in mindset and approach to SDA, there were two heavily-focused agendas. Firstly, the broker dealers wanting to address and reduce their average and marginal cost of doing business in a revenue challenged environment. Secondly, and unsurprisingly, to mitigate/eliminate any trading or operational risk as soon as possible in the trade lifecycle, namely trade date. By working as a broker dealer community to create standards and expectations, it allowed the industry to focus on collaboratively and actively pushing the creation of a mature set of trade date securities processes, protocols, message formats and engagement.
If we fast forward to today, we find ourselves at the start of 2014 with significantly higher SDA, matching, allocation and confirmation rates. The standards put forward gave opportunities to vendors and industry utilities to fill a gap, as it allowed them to know with relative clarity what the community was demanding at a service level. There is always room for improvement and the time zone challenge will always be there, but the momentum is such that we are moving in the right direction. One could argue that T+2 has arrived at the perfect time to provide the added stimulus to remind us that the drive for trade date processing excellence has never been more important.
On the face of it we think about T+2 as a settlement change. In reality for a large number of the participants impacted, if we get the trade booked (and booked correctly) on trade date, enriched with the appropriate data attributes in the right format, then allocated, affirmed, matched and/or confirmed on trade date, the challenge of meeting and adhering to T+2 becomes significantly easier. In essence it is predominantly about the quality of the trade date process across the industry. Get it right and settlement efficiency is one of the rewards.
To add one point on data attributes, historically we tend to think about matching of trade date fields as being focused on financial-related attributes. Naturally it would make even more sense if the level of settlement instruction matching also increased on trade date as well. Mitigating trading risk is clearly a key requirement, and if we can mitigate settlement risk at the same time then that is a pretty impressive trade date process. The quality of settlement instructions, and access to settlement instructions, has come into sharper focus in the industry over the last year, and it is taking its rightful place at the top table as a key driver of efficiency and risk mitigation. Each broker dealer and custodian runs its inventory and depot management processes with varying degrees of capability and forward-looking functionality. The need to look ahead, or react quickly to mismatches in ICSD versus CSD choices for settlement, for example, places an unnecessary pressure on operations and the stock loan (and repo) desks of our firms. Getting this right on trade date will benefit a number of participants and reduce the noise and pain that would naturally arise if T+2 does not coincide with higher trade date matching rates across a number of trade attributes including settlement instructions.
Needless to say, this also dovetails nicely with the harmonisation and opportunities that T2S will bring to the market from 2015.
Tea for two
The wide range of regulatory programmes spanning several geographies and asset classes is sure to make this a fascinating year. T+2 is a key part of this evolution, and should, for the securities industry, allow us to take another leap forward in the maturity of our operating models.
As an optimist, I tend to see these initiatives as opportunities to help push the marketplace forward with one approach; a consistent set of priorities and expectations from all participants and the opportunity to leverage the current environment to access funding to improve processes and platforms that otherwise may not get the investment spend that operations continue to require. Yes, some discretionary initiatives will not see pen committed to paper for functional requirements and design, but I wonder whether all the current investments in platforms and solutions would have materialised without the backdrop of the current environment.