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T+2 unlikely to be a walk in the park

Complex issues surround adoption of shortened trade settlement cycle

Tony Freeman
Tony Freeman believes the move to T+2 settlement will affect many parts of the trading landscape.

What a difference a day could make.

As T+2 trade settlement in the U.S. moves closer to reality, there's far more to the change than just knocking 24 hours off the settlement cycle, sources said. And while there's almost universal praise for the move, there are complex issues to be faced on both the buy side and the sell side to make T+2 work.

“This will have multiple impacts,” said Tony Freeman, executive director of global industry relations at Omgeo LLC, a post-trade service provider and subsidiary of the Depository Trust & Clearing Corp., London. Among them: back-office technological changes that will be necessary to meet the new settlement cycle, the alignment of third-party providers such as subcustodians and broker-dealers, and the reduced time available to execute trading orders from the front office and to correct post-trade errors.

The move to trade plus two days, which has an implementation target of the third quarter 2017, would cut by one day the time allowed for settling trades of equities, corporate fixed income, municipal bonds and unit investment trusts. The U.S. has been working under T+3 since 2003, and the move is seen as the lynchpin for the rest of the world to move to two-day settlement. European markets shifted to T+2 last year.

Benefits of a move to T+2, sources said, would be reduced counterparty risk, further harmonization of global settlement times — notably between the two largest markets, the U.S. and Europe — along with easier trade-data matching among parties involved in the settlement process, cost savings that are expected to quickly offset compliance costs and increased short-term liquidity.

The shift has the backing of the SEC, with Chairwoman Mary Jo White in September endorsing recommendations of the T+2 Industry Steering Committee, an industry group with representatives of both the buy side and sell side. She also assigned SEC staff to craft proposed T+2 rules that could be issued for public comment by the end of December, a goal set by the committee.

One big issue with a U.S. move to T+2 is the loss of time to correct errors in complex trades. “If (brokers) can't settle, even if the back office has made all changes to T+2, it won't necessarily achieve the result that's expected,” said Jason Valdez, managing director and global head of equity trading at Penserra Securities LLC, Orinda, Calif. “In a perfect world, it wouldn't matter. But with T+2, you're taking away a day for me to solve problems. We've created efficiencies, but I've seen e-mail chains from traders talking about settlement issues caused by technological glitches. We still will have issues if T+2 is implemented. I'm not saying it can't be done, but there will be a lot of work needed to get those trades settled sooner. “

That's a legitimate concern, added William R. Atwood, executive director of the $19.3 billion Illinois State Board of Investment, Chicago. “Tightening of the settlement time, day in and day out, should increase efficiency and reduce seepage,” he said. “However, one concern would be in periods of stress, or when trades break, the tighter regulatory threshold may make it more difficult to manage or solve a problem.”

Marty Burns, Investment Company Institute chief industry operations officer and co-chairman of the T+2 Industry Steering Committee, agreed there could be problems with settling trade issues in a tighter time frame, but such issues have always been the exception — not the rule.

“Those aren't necessarily negatives,” Mr. Burns said. “In every circumstance in trading, there are going to be exceptions; for example, someone might type in the wrong account number when executing a trade. Those issues have to be corrected now; it just means they'll have to do it a little faster.”

And while many money managers — especially those who trade on European markets — already have the infrastructure for T+2 settlements in place, that doesn't mean they can flick a switch and make it work on U.S. securities, said Ryan Burns, senior vice president of global fund services at Northern Trust Corp., Chicago. “One side of the trade (using T+2) doesn't mean the industry is doing the same,” Mr. Burns said. “It's not just all on the buy side, but the sell side must agree in order to match. If they don't, you still have the difference in settlement.”

More than a "tech thing'

ICI's Mr. Burns said the harmonization of the U.S. with Europe and other markets using T+2 might seem more like a “tech thing” than something that will impact investing, but it can have a positive impact on money management. “Bringing the U.S. in line with other nations will help asset managers,” he said. “Most of those managers aren't (only) buying NYSE-listed securities. They're buying in Europe, Asia. When those places have different settlement cycles, such trades become more complex. This would relieve some of that.”

The cost savings are also important, said Chris Gizmunt, head of product management, equity trading at financial services software provider Linedata, Boston. “The industrywide cost of complying with T+2 in the U.S. is estimated at $550 million,” Mr. Gizmunt said. “The estimated savings of T+2, around $170 million a year, means in three years, the costs will be recouped.”

According to the T+2 steering committee's latest white paper, issued in September, 65% of the world's 10 largest exchanges based on market capitalization use T+3 now; when the U.S. moves to T+2, only 13% of those exchanges will use T+3.

“Once the U.S. moves to T+2,” said Omgeo's Mr. Freeman, “we suspect the world will converge to that cycle, which would benefit everyone.”

The shorter cycle also will mean asset owners will get their money one day sooner, added ICI's Mr. Burns. “For asset owners, the difference is that one less day,” he said. n

This article originally appeared in the October 19, 2015 print issue as, "T+2 unlikely to be a walk in the park".