Posted: 11/09/2023 | Read time: 3 minutes
AutoRek’s Murray Campbell explains the knock-on effect moving to T+1 settlement for US securities will have on foreign exchange for institutional investors.
From May next year, the settlement cycle for US security trades will shorten from T+2 to T+1 – reducing the two-day window to complete share trades to just one day.
Global financial centres have been shortening settlement times for the past 40 years, so financial institutions will have some idea of what challenges the transition will present. But the world’s biggest and most liquid market moving to T+1 settlement will have huge ramifications for FX.
FX challenges of T+1 settlement
Halving the settlement time to fill orders for US securities will carry a global knock-on effect on FX markets. For example, UK fund managers operating in pound sterling will now have to convert sterling into the amount of dollars needed to buy or sell US-listed companies.
This presents a challenge to fund managers with a significant percentage of their portfolio tied up in US stocks. It means that what would have once been tomorrow’s currency conversion needs to be completed today.
Impact on the back office
Asset managers – particularly those with trillions under management – tend to have back offices comprised of four or five teams. And the people in these teams all have different roles. It’s common for teams to communicate with other teams manually.
Carrying out settlement tasks manually is not only costly but it’s time-consuming. It also leaves firms vulnerable to human error. Because T+1 demands firms to carry out these tasks faster, any existing challenges of inefficient, spreadsheet-based processes will only worsen.
Why FX remains on T+2
The indirect consequences of a shortened settlement cycle for US securities on FX are separate from the direct challenges FX as an asset class faces with settlement. FX is a 24-hour global market (with weekend downtime). It involves many time zones and trading systems – as well as fragmented pockets of liquidity. The T+2 settlement cycle gives firms time to complete the heavy administrative processes of having various countries and counterparties involved in a trade.
Market participants must manage unforeseen risks with FX transactions. For example, the sterling flash crash of October 2016 saw the pound fall roughly £10 billion.
An extra day provides a buffer for market participants to verify and reconcile trade details. This is especially helpful if counterparties are in different regions and have different regulatory requirements.
Remaining on T+2 settlement could also create challenging situations where trades require a currency conversion – particularly for the smaller scale asset managers. For instance, where the asset must be exchanged on T+1 but the required currency may not be available until T+2.
Will the FX settlement time get shorter?
There have been discussions on shortening settlement cycles in FX to T+1 or same-day settlement (T+0). But the reality is that the can is being kicked down the road.
Shorter settlement cycles to reduce counterparty risk in FX sounds great in theory, but it’s much harder to put in place in practice. Major market infrastructure changes would need to occur globally before FX settlement gets the go-ahead to move to T+1. For now, asset managers with funds dispersed across all parts of the world need to focus on overcoming the issue that a shortening of the settlement cycle for US securities has on their FX exposure.
How AutoRek can help with T+1
If you’re preparing for T+1, AutoRek can help you get your operational processes ready for faster settlement times.
Our end-to-end automated reconciliation software allows you to reconcile as soon as your data is ready, minimise failed trades, save time on the pre-settlement process, and tackle exceptions quickly.