John Oreon, Managing Director, Clearing and Settlement Operations, clear street
Shorter settlement timelines are intended to bring a number of benefits to the market, including reduced risk, increased efficiency, increased liquidity and reduced volatility.for hedges
For funds and asset management companies, the shorter period between execution and settlement may also reduce the amount of margin required to offset settlement risk.
Paradoxically, the impending transition to T+1 in May 2024 has posed significant short-term risks to the market. Industry players need to ensure that their technology and internal operations, as well as those of their clients and trading partners, are ready for change. Addressing issues retroactively after the transition to T+1 is much more costly and disruptive.
The transition to T+1 payments will impact a wide range of aspects of the financial ecosystem, from stocks and ETFs to prime brokerage and securities lending. Market participants need to understand the impact of shorter payment cycles in each sector and address key areas such as allocation, affirmations, prime brokerage, and securities lending.
Preparing for migration poses significant challenges, especially for participants who still rely on manual processes. While the primary financial burden is expected to fall on broker-dealers, clearing companies and prime brokers, many buy-side firms are unaware of the full extent of the impact T+1 will have on their businesses. According to an informal poll conducted by SS&C in February 2024, only 28% of investment firms had a detailed plan for T+1.
Therefore, it is important for buy-side firms to work closely with their sell-side trading partners ahead of the transition to seamlessly align the process and ensure both parties are well prepared for the change. Being unprepared can increase operational inefficiencies and financial costs. For example, if the period between execution and settlement is shortened, the margin required to offset settlement risk may decrease.
Businesses must address four critical vulnerabilities: legacy technology, counterparty risk, time zone synchronization, and increased costs of delays. Addressing these vulnerabilities requires a combination of people-based and technology-based solutions.
Both the buy-side and sell-side must address counterparty risk and ensure that clients and partners hire sufficient staff to manage the transition, upgrade and automate technology. Market participants must communicate their preparedness plans to their customers now to clarify the responsibilities of each party and ensure that no vulnerabilities remain in the payment process. As the Depository Trust and Clearing Corporation (DTCC) states, “A company is only as strong as its weakest counterparties.”
Short-term solutions rely heavily on human resources, requiring additional staff for 24-hour support and risk assessment and management in case of increased errors and inefficiencies. These issues can be exacerbated when trading across time zones or when batch processing is still occurring.
Long-term solutions include upgrading legacy technology, removing manual processes where possible, and implementing automation. Shorter settlement windows inherently mean less time to correct mistakes, and systems that successfully deal with this change must prioritize automation and resilience. Adopting these attributes correctly can effectively reduce the risk of failures and errors while meeting increasing processing demands.
Cloud-native clearing, settlement, and custody solutions offer a promising avenue to address these challenges. Modern infrastructure and real-time processing capabilities allow us to optimize payment cycles, accelerate value creation, reduce costs, and minimize risk. Enterprises should strive to leverage resilient service orchestration and scalable data warehousing to provide seamless communication and eliminate manual reconciliation processes.
In conclusion, the transition to T+1 payments is a welcome development aimed at mitigating systemic and operational risks, but it poses near-term challenges that require advance preparation and technology investment. Market participants must prioritize preparation and cooperation to successfully navigate this transition.
With urgency comes opportunity. Companies can adopt modern infrastructure to replace legacy technology, automate processes, and unsilo fragmented data to further optimize payment cycles, drive value creation, and reduce costs. , creating an opportunity to minimize risk. By embracing technology, businesses can ensure a resilient financial ecosystem for the future.
