Securities lending a big reason clearing won't get faster soon
Most traders are on track to meet the Sept. 5 deadline for two-day settlement of trades in the U.S., sources said, but some think T+2 is already obsolete before it becomes the norm.
“We don't see an issue with T+2,” said Eric Noll, president and CEO of Convergex, a New York-based agency brokerage. “We've been a proponent of this for some time. Europe has been using T+2 for years, and we all were able to get ready for that. It turned into a non-event. We expect the same here. It's been long overdue in this country. I'd be in favor of moving to T+1 as quickly as we can.”
Added Dayle Scher, senior analyst, TABB Group LLC, New York, “Most managers already do confirmation in T+1. T+2 already is obsolete before it started.” She called the transition to T+2 “kind of a no-brainer.”
But sources said two-day settlement is necessary because it takes longer to settle securities lending transactions as well as to reconcile problem trades, with the back-office work necessary to complete them, which is why T+2 will be the standard.
Securities lending and more difficult trades “remain more manual today than other parts of the market,” Mr. Noll said. “They're not as far along on the technology spectrum as those who do straight-through processing.”
Short selling on the stock loan business “is more manual than most trading,” said Mr. Noll. “It's "call a guy and borrow the shares.' If they have more time to do that and settle, I guess it's more comfortable for them.”
While “nobody's anticipating Armageddon” from the transition, said Greg Korte, principal, head of North American trust/custody and securities lending consulting at Mercer Sentinel, Chicago, “if there will be hiccups from this, they'd be (in the back office).” And among smaller prime brokers, “someone down the list who hasn't spent money on infrastructure, maybe those brokers that struggle today will still be struggling under T+2,” he said.
Ms. Scher agreed. “Settlement in securities lending takes longer than other securities trades,” she said. “They'll be lucky to get settlements in 48 hours. It's possible they would see shortages in lendable securities as a result.”
The Securities and Exchange Commission on March 22 signed off on the move to T+2 in the U.S., in an effort to enhance efficiency and reduce risk, and to align the U.S. with the European Union, which has used a T+2 cycle since 2014.
The impetus to shift to a reduced trade settlement cycle came from the industry: The change was spearheaded by the U.S. T+2 Steering Committee, a panel of buy-side and sell-side representatives. Organized by the Depository Trust and Clearing Corp., a U.S. clearing and settlement service provider, the steering committee included representatives from the Investment Company Institute, Securities Industry and Financial Markets Association and Deloitte LLP.
Broadly, said Martin Burns, chief industry operations officer at the ICI in Washington, “so far, we're all in good shape. There are no participating groups or market participants who've said they're having difficulty in meeting the deadline. The buy side, the sell side, all have said they're in good shape. The DTCC's test routines on T+2 are going well.”
Pressure on firms
However, the change could put pressure on firms that deal exclusively in the U.S., Ms. Scher said, “since they historically wait to the last minute to make changes. They will have to tweak their order management systems, and they won't be able to manually confirm their trades; but to be honest, they better get trades right on the trade date, even for small and midsize books.”
Mr. Burns said a big reason the transition has gone well generally is “many organizations, including those on the sell side, had to retrofit their accounting systems for T+2 in Europe. It's just importing that to domestic trading and not having to build their systems from scratch.”
Robert Walley, advisory principal, enterprise risk services, at Deloitte, New York, said: “T+2 will have an impact” on securities lending. “If you have to cover a position, they'll have to do it on the evening of T+1 to settle T+2, instead of now at the evening of T+2. There typically would be an effect on hard-to-borrow securities,” Mr. Walley said. “That's always been a chokepoint in securities lending. That will have to be managed very closely.”
The change will require pension plan sponsors to adapt to T+2, especially in securities lending and in working with their custodians, but sources said their asset owner clients have known that T+2 is coming and are prepared. The $179.4 billion California State Teachers' Retirement System, West Sacramento, “is operationally ready, with our custodian and with our security lending agents, for this change,” said Ricardo Duran, spokesman.
Mercer Sentinel's Mr. Korte said problem trades are an issue regardless of the duration of the settlement cycle. “That's a possibility today; that will continue to be a possibility in the future,” Mr. Korte said. “That's not so much an issue of the trade but of communication. Everyone has had to communicate efficiently with T+3; that'll be even more important in T+2. That will be the bottleneck. That's not as much an issue with the big brokers or custodians, but the smaller firms with a lack of infrastructure, that could pose some problems. Most prime brokers, especially the large ones, have good infrastructure in place.
Mercer Sentinel, which provides asset owners consulting on investment operations and asset servicing, and assists clients with RFPs for custodians and securities lending agents, is monitoring respondents' ability to adjust to T+2 as part of its due diligence.
Less of a problem
Mr. Korte said custodians that have a direct or one-to-one connection with their prime brokers will have less of a problem adjusting to T+2 than those using a third-party administrator to reach prime brokers.
“I think there will be more of an issue on the administration side,” Mr. Korte said. “Using a third party creates an extra step. ... That can be less efficient. ... Securities that are on a buy-and-hold list, if you're trading those, you aren't used to the rapidity of trading. There could be some hiccups there. Also, providers that have both custody and accounting systems. We've recently seen two different systems for almost everyone. They have to stay in sync. Now, with T+2, you'll have a little less time. That could cause some hiccups.”
ICI's Mr. Burns said all market participants are analyzing the impact of T+2, including custodians and securities lending agents. “The impact of T+2 compliance on securities lending and custodian activities is an important part of firms' overall analysis, and both securities lending providers and custodians are adjusting and testing their infrastructure to meet that timetable. At this point we are not aware of any obstacles to meeting the Sept. 5 implementation date for T+2.”
This article originally appeared in the April 3, 2017 print issue as, "Firms already set for T+2 implementation".