Insight
SEC Adopts T+1 Settlement Effective May 2024 - Will you be ready for T+1 a year from now?
Vaibhav Garg
June 2023
Imagine Wall Street in the 1990s, where traders relied on mountains of paperwork, fax machines and landline phones to conduct business. The trading floors were buzzing with the clamor of countless manual processes, while analysts sifted through stacks of printed research reports and financial statements.
Financial operations were less efficient than they are today, and the T+5 settlement cycle was standard in the U.S. market. In part as a response to major market disruptions such as the 1987 market crash and the 1990 bankruptcy of Drexel Burnham Lambert Group, the Securities and Exchange Commission (SEC) adopted Rule 15c6-1, which shortened the settlement time frame for most broker-dealer securities transactions from T+5 to T+3, with the aim of reducing the risk of systemic market disruptions.
As markets and technology continued to advance, the SEC recognized the need for further improvements. In 2017, settlement cycles were further shortened to T+2.
Today, we’ve replaced many relics of manual processes such as printed tickets with sleek digital solutions that are revolutionizing the financial world. On February 23, 2023, the SEC announced an upcoming move to reduce the standard settlement cycle further, from T+2 to T+1. For most securities transactions, this shortened settlement cycle will come into effect on May 28, 2024. The SEC said its decision to adopt T+1 settlement was influenced by recent market events, such as the surge in trading in “meme stocks,” particularly amongst retail investors, which highlighted the need to reduce risk and improve efficiency of securities settlement processes.
Rationale Behind Shortened Settlement Cycle
The T+1 settlement cycle means that securities transactions will settle one business day after the trade date, instead of the current two (T+2). This change will apply to most securities transactions, including stocks, bonds, exchange-traded funds (ETFs) and other instruments.
The move to T+1 settlement is expected to reduce liquidity risks and operational costs for market participants, such as broker-dealers and clearing agencies. It will also provide market participants with more timely access to their funds and securities, enabling them to reinvest or use the proceeds of their transactions more quickly. Additionally, the T+1 settlement cycle aligns with the global trajectory of shortening settlement time, fostering greater synchronization amongst international markets that have already moved to T+1, like China and India, or are considering it, such as the EU.
There are of course downsides for market players, with the significant initial investment required to ensure T+1 compliance top of the list for many. In the securities lending markets, collateral exchange and returns/recall process will see a dual impact in both how securities lending trades are settled free of payment (FOP) and delivery versus payment (DVP), for example, which settle on different schedules, in addition to collateral restrictions in the grade of accepted collateral. This, in addition to the proposed tiers of fines for failed settlement, adds significant financial risk and complications that firms must mitigate.
Transition to T+1 Settlement Cycle: Implications and Adjustments
The finance industry is adapting to new default rules for most securities transactions, including the transition to the T+1 settlement cycle. This change affects various aspects of securities transactions, with some of the notable examples being firm commitment offerings, prospectus delivery and institutional trades processing.
A. Firm Commitment Offerings Settlement Cycle
The T+1 settlement change has implications for firm commitment offerings. The largest issue recognized by T+1 is the current T+4 settlement cycle for firm commitment underwritings priced after 4:30 p.m. EST. The final amended rule shortens the settlement cycle for such offerings from four to two days (T+2), unless parties agree to a later date during the transaction. Prices agreed earlier than 4:30 p.m. EST are still subject to the T+1 rules.
B. "Access Equals Delivery" Model for Prospectus Delivery
The SEC acknowledges the importance of efficient delivery of key transaction documents within the shortened T+1 settlement cycle. Consequently, the “access equals delivery” model remains in place, allowing the prospectus delivery obligation to be satisfied by filing a final prospectus with the SEC, rather than physically delivering it to purchasers.
C. Policies and Procedures for Institutional Trades and Straight-Through Processing
The T+1 settlement change introduces new requirements for broker-dealers, investment advisers and central matching service providers (CMSPs) to improve institutional trades and straight-through processing. Broker-dealers must establish and maintain policies and procedures designed to ensure allocations, confirmations and affirmations are completed by 7 p.m. and 9 p.m. of the trade date respectively.
The new T+1 settlement cycle rules will further impact other areas of the financial markets. For example, the change will affect the timing of margin calls for transactions requiring a margin, as well as the timing of corporate actions such as dividends and stock splits. These actions will need to be processed and settled within the shorter T+1 settlement cycle.
Capitalizing on T+1 Settlement Advantages While Tackling Inherent Challenges
The transition to the T+1 settlement cycle brings both opportunities and challenges for securities finance firms. According to ValueExchange data, 61% of surveyed buy-side investment managers had not, as of April 2023, started any T+1 preparations, and 54% doubted they would be ready for T+1 in a year, just one month before the deadline. The report further cautioned that 66% of the market said it was struggling to resource T+1 projects.
To successfully navigate this significant shift, the industry needs to strike a balance between leveraging the potential benefits and addressing the complexities that arise from the change.
A. Managing Risk and Capital Allocation While Adapting to New Operational Processes
The T+1 settlement cycle presents an opportunity for securities finance firms to refine their risk management and capital allocation strategies by minimizing unsettled trades and reducing exposure duration. However, navigating this change necessitates adjustments in behavioral processes and operational workflows. Firms must adapt to accelerated trade affirmation, which now needs to occur on the trade date and ensure efficient coordination across front-, middle- and back-office operations.
B. Harnessing Technology and Automation for the T+1 Transition
The T+1 transition highlights the benefits of leveraging advanced technology and automation to navigate the shortened settlement cycle. By adopting these innovations, firms can achieve greater efficiency and adaptability in a constantly evolving market. Adapting to the T+1 settlement cycle demands robust technological infrastructure and scalability. Firms must invest in relevant technology to ensure their systems can support increased transactional volume and reduced settlement times while maintaining the integrity and security of their existing operations.
C. Navigating the T+1 Settlement Cycle and Cross-Border Complexities
The adoption of the T+1 settlement cycle in the U.S. not only impacts domestic markets but also has significant implications for overseas investors. Global ETF baskets, which include U.S. components, are affected by this change, as two-thirds of the MSCI World Index consists of U.S. stocks. Furthermore, approximately 40% of investments in U.S. markets come from foreign investors. ValueExchange reports also show that European and Asia-Pacific custodians perceive T+1 to have a significantly higher impact (4.7/5) on their businesses compared to their American counterparts (3.3/5), meaning that time zone differences could lead to trade failures if errors are not resolved on the same day.
The impact of this will vary by firm size but will have an impact across the board. Larger buy-side firms may be able to adopt automated processes via tech vendors. However, smaller asset managers may consider utilizing technology if budgets allow, strengthening their U.S. operational teams or outsourcing settlement functions, each of which will present unique challenges. Leveraging technological advancements like EquiLend’s 1Source, securities finance market participants can strategically manage settlement timeframe disparities and mitigate risks, bringing about efficient and risk-controlled operations.
Adopting the T+1 settlement cycle prepares firms for shorter settlement cycles globally, fostering harmonization and expanding cross-border transaction opportunities.
Leveraging EquiLend for a Seamless T+1 Transition
A smooth transition to T+1 will be most effectively facilitated by technology which removes blockers downstream from the earliest opportunity. EquiLend’s suite of solutions offers T+1 readiness inbuilt, which benefits firms at all pressure points in the trade lifecycle for a smooth transition to T+1 settlement thanks to interconnectivity across many of our solutions and to many other market providers.
Pre-matching and automation rulesets within NGT ensure point-of-trade errors can be reduced to as low as 0.3%, further supported by a real-time data view at point-of-trade with our new hard-to-borrow platform, Competitive Bid.
Significant efficiencies can additionally be achieved in post-trade in a T+1 environment. Manage collateral agreements, triparty collateral management and collateral mobilization with EquiLend Exposure. Settlement Monitor is a bloodhound for settlement breaks, identifying and supporting their resolution on the real-time platform. Central management of Returns and Recalls on their respective platforms enable parties to initiate and agree on returns and recalls in real-time eliminating exceptions and settlement delays as well as monitor workflows within the UI. The Auto Recalls solution is agnostic to market cut-offs so it can support the 23.59(GMT) deadline. Mark-to-Market Comparison can run at any time of the day to ensure prices are kept in line and facilitating accurate intra-day DVP returns settlement.
EquiLend 1Source additionally facilitates T+1 settlement by automating and expediting all aspects of the trade lifecycle. 1Source, a distributed ledger technology (DLT) based single source of truth for securities finance transaction information, keeps both counterparties in sync throughout the entire trade lifecycle. This in turn eliminates reconciliations and trade breaks that stand in the way of timely settlement.
The key to success for firms in a T+1 environment is improvements to existing processes, supported by relevant technological advancements. The future of securities finance is sure to include further disruption in the pursuit of ever-more-efficient markets. Efforts now offer a greater opportunity to meet future change head-on.
Who We Are
EquiLend is a global financial technology firm offering Trading, Post-Trade, Data & Analytics, RegTech and Platform Solutions for the securities finance industry. EquiLend has offices in North America, EMEA and Asia-Pacific and is regulated in jurisdictions around the globe.
