Push for T+1 settlement cycle gaining momentum

The movement to accelerate the U.S. securities settlement cycle is gaining momentum with backing from major industry groups and the chairman of the Securities and Exchange Commission.

A report published Dec. 1 from the Securities Industry and Financial Markets Association, the Investment Company Institute and the Depository Trust and Clearing Corp. said shortening the settlement cycle to T+1 — settling a trade one business day after it is executed — from T+2, or two business days, will enhance efficiency and reduce risks and costs for the industry.

"Shifting to T+1 will strengthen the financial system and offers tangible benefits to investors by reducing their risk exposure and enabling them to more quickly leverage investment opportunities," said Eric J. Pan, Washington-based president and CEO at ICI, an association of regulated funds including mutual funds, exchange-traded funds and closed-end funds, in a statement.

Following a white paper on the shift to T+1 published in February by DTCC, a U.S. clearing and settlement service provider, the U.S. financial industry formed an industry steering committee and industry working group to develop a consensus for an accelerated settlement cycle. The report unveiled earlier this month summarizes their work and recommends a path forward.

Reducing the settlement time benefits all market participants "because you're taking risk out of the system, regardless of what your business model looks like," said Marty Burns, Washington-based chief industry operations officer at ICI and one of the report's contributors, in an interview. "For an asset manager, it's helpful not just to remove risk, but it also provides flexibility in managing the investments because things are happening more quickly."

BlackRock Inc., the world's largest money manager with $9.46 trillion in assets under management as of Sept. 30, supported the move to T+1 in a statement to Pensions and Investments. "As outlined in the industry report, there's consensus around the benefits of shortening the U.S. securities settlement cycle, despite any potential near-term challenges," the statement said. "BlackRock supports policies that help reduce risk and increase efficiency for market participants, so we are in favor of the recommendation of moving to a T+1 settlement cycle."

Thomas F. Price, New York-based managing director of technology, operations and business continuity at SIFMA, a trade group that represents securities firms, banks and money management companies, said in an interview that "risk is the square root of time, so the more you compress that time, to an extent, the less risk you're going to have in a system." Mr. Price also contributed to the report.

SEC Chairman Gary Gensler has made a similar point in public appearances and in testimony before Congress. "The longer it takes for a trade to settle, the more risk our markets assume," Mr. Gensler said in May during a House Financial Services Committee hearing.

Pension funds, like other investors, will reap the benefits of reduced risk and the ability to conduct transactions more quickly in a T+1 environment, Mr. Burns said. "Being able to transact more quickly will offer additional investment flexibility, especially in time of high volatility," he added.

The settlement cycle in the U.S. was shortened to T+2 from T+3 in 2017, a process sources said went smoothly and benefited all market participants.

But getting to T+1 will be far from easy, Mr. Price said. "It's exponentially more challenging to go from 2 to 1 than it was from 3 to 2," he said. "Everything now gets put on a shorter cycle and there's no room for error."

Because the process is complex, the industry report recommends migration to T+1 in early 2024 in order to give market participants enough time to assess firm-level required changes and allocate resources and budgets accordingly, including the creation of an early 2023 comprehensive testing plan.

When the industry was shifting to T+2 in 2017, one of the main concerns was an increase in failed trades, but that didn't happen, according to Mr. Burns. Since the T+2 transition went so smoothly, the industry report recommends a similar timeline — about 30 months — to shift to T+1 and a heavy reliance on testing.

"It's so critical to ensure you're able to test in as many scenarios as you can possibly think of and to be sure that the changes that you make in one area of the operation don't somehow affect another area that wasn't anticipated," Mr. Burns said. "You want to find those in a test environment and obviously not in a production environment where it can mean trades fail or money gets lost."

Mr. Price said it's important to work out any kinks before a T+1 environment is live. "This is complicated, it's complex and it's important, so we don't want to rush things," he said. "This tighter time frame, taking an entire 24 hours out of the system here, we have to make sure that trades get executed right, settlement instructions get implemented right, that the funds are allocated to pay for the trades at the right time."

In order to ensure T+1 will be a success, Mr. Price said the industry needs to "automate, automate, automate." He added: "In this new compressed timeline, we're going to really have to leverage technology and depend upon automation in order to really be able to achieve the goals of high settlement rates for securities in a T+1 environment."

But before firms can get to work making plans and allocating resources in preparation for the T+1 shift, the SEC needs to update its rules greenlighting the process.

"Firms don't want to spend the money, make the investment until they know for sure that the regulatory community is going to change the rules appropriately," Mr. Price said. "In order to do the budgets, in order to assign personnel, in order to make sure that you get the organization as a whole engaged in this discussion, I think regulatory certainty and support is critical."

To that end, the SEC's Mr. Gensler has directed SEC staff to put together a draft proposal for the commission's review on shortening the settlement cycle.

At a virtual conference hosted by the Healthy Markets Association on Dec. 9, Mr. Gensler was bullish about moving to T+1 and eventually to T+0, or same-day, settlement.

"The technology exists today in 2021 to do same-day settlement," Mr. Gensler said. "The business models are not arranged to do it that way, but there are things like affirmation confirmation and allocations that could be … as soon as technologically practicable on same day."

The industry report did not recommend shifting to T+0. "When you try to move things too far in advance, it takes away the ability to fix things," Mr. Burns said, indicating that the number of failed trades could increase in a T+0 environment.

Added Mr. Price: "We have the deepest, most liquid markets in the world, we have a uniquely advanced clearing and settlement system here in the U.S., it's efficient, it works … so I think before we embark upon a journey to even consider (T+0), we have to understand what the consequences are, we have to go into that with eyes wide open."

Mr. Gensler said he's also asked staff to review T+0.

"I do think that there will be a future when we'll have settlement on the same day," Mr. Gensler said at the Healthy Markets Association conference. "How do we set the groundwork in the early 2020s so that we can get to that later?"