Ross Fox, Managing Director, Head of UK & Europe

With global capital markets already beginning to move from T+2 to T+1, it’s clear that the future of financial settlements lies in faster cycles. As a result, the funds industry is now reflecting on what a shift to T+1 settlement for securities means for them. After all, they have been here before. Back in 2014, securities settlements in the UK and EU transitioned from T+3 to T+2, with the US market joining them shortly after. The funds industry quickly followed suit, reducing their own settlement times to T+3 from T+4.

Ross Fox, Managing Director, Head of UK & Europe, spoke with Calastone’s Product Development Director Sharn Rai and Alex Chow, Investment Operations Lead at the Investment Association (IA), to understand what this latest move in the capital markets could mean for the funds industry.

Will funds follow in the footsteps of securities?

Equities have been slowly progressing toward shorter settlement timeframes, transitioning from T+3 to T+2 in 2014 for the UK and EU, and in 2017 for the US. T+2 remains the default settlement period worldwide.

The capital markets have more recently been working towards an even faster settlement cycle, with some countries having implemented, or considering implementation of T+1. This improvement in settlement timeframes aims to further reduce counterparty risk, improve operational efficiency and increase liquidity in the market. India has already completed the move, while in the United States, the SEC has adopted a rule change to shorten the standard settlement cycle from T+2 to T+1. Becoming effective on 28 May 2024, it represents a ‘big bang’ approach that contrasts with the more gradual move undertaken by India. The smaller market is one reason India could act as a first mover, said Sharn Rai, Product Development Director, Calastone. “They haven’t got the legacy drag of all of the technology and don’t have to get such an enormous market to change direction.” The EU and UK have also begun exploring faster settlements too with taskforces looking into the detail.

This change aims to further reduce counterparty risk, improve operational efficiency and increase liquidity in the market, and a number of major securities markets have either moved to or are considering moving to T+1 settlements.

With equity settlements speeding up, it’s only a matter of time before the asset management industry follows suit, just as it did in 2017 when many funds moved from T+4 to T+3. It could help remove confusion for many UK investors as today the UK has funds settling on across the spectrum of settlement periods, from T+0 to T+4.

Does this help the funds industry?

One of the main driving forces behind a move to T+1 in the capital markets is how it could improve liquidity in the financial markets. With a shorter settlement cycle, investors can access their funds more quickly following the sale of a security. This increased speed allows them to reinvest or utilise the funds sooner, contributing to overall market liquidity. This is one of the drivers for shorter settlement cycles mentioned by the SEC in their paper ‘Shortening the Securities Transaction Settlement Cycle’. A similar move within the funds industry could further aid this mission.

Reducing funding costs is another likely benefit, comments Alex Chow, Investment Operations Lead at Investment Association (IA). “To settle trades within a CCP, there is a hefty collateral requirement for clearing members to protect the buyer against default over the lifecycle of the trade. DTCC suggest that this may reduce by up to 41% (https://www.dtcc.com/ust1/faqs) which frees up capital in the market and which hopefully leads to lower fees for funds.” There is also some potential to modernise the markets – something long overdue in the fund industry. “I think T+1 may encourage firms to modernise and stop sending faxes, stop sending cheques,” says Alex. “Maybe we start to further explore DLT (distributed ledger technology) and blockchain, if it’s done in a safe way, or potentially a rework of the current system looking at operational models that cause bottle-necks in settlement such as batch-driven processes.”(Read more about the latest proofs-of-concept for tokenised funds here.)

T+1 problems for global businesses

Irrespective of sector, the move to T+1 is going to be complex. A recurring concern among many investors, noted Alex, is that the move to T+1 will create a mismatch with the funding lifecycle, particularly with respect to FX. FX issues are created by the increasingly global nature of funds’ assets and their customers. Under T+1 settlement, the time available for an FX trade to be instructed and settled is constricted.

“I think if you speak to any asset managers, the example many will give is an Australian or APAC client with a European or UK asset manager purchasing a US security. If they instruct that near close of business on T in the US, they then have to try and get the monies across in the right currency to settle the next day on T+1, so there’s a very short window between the start of next day with FX and the close of business for the US equity market.”

Where moving to T+2 was mainly about doing the same things more quickly, moving to T+1 requires new processes due to mismatches in the fund operation cycle. This will be a challenge for funds too if they attempt to speed up settlement times with a move to T+2. “If you look at the payments that need to be made on the back of these transactions, many funds still rely on systems like BACS in the UK, which is T + 3 settlement. This poses some major limitations in a T+2 environment,” notes Sharn. “Payments are going to be the main issue. For T+4 to T+3, it didn’t really matter; you could still get payments out and on time, but the shift to T+2 for funds could lead to a change in the way payments work.”

The move is also being driven by an increased demand for intraday liquidity, which will put pressure on funds to have sufficient cash reserves. Alex noted that, “in theory, you can still run a fund lifecycle on T+3 and have settlements on T+1. But it does leave an awkward funding gap where maybe you may have to consider prefunding – which could be the way the future is going anyway as we move towards atomic settlement (or T+0) – or you have to accommodate the two-day funding gap where potentially you leave the account in overdraft.”

The march towards real-time settlements

The capital markets’ ongoing transition from T+2 to T+1 settlement sets the stage for further acceleration in the funds industry – the potential long-term goal being the introduction of T+0. “Note that the UK taskforce on this isn’t called a T+1 settlement task force; it’s called an accelerated settlement taskforce,” said Alex. “They certainly have an eye on how and whether T+0 might work eventually.” However, that’s likely still a long way off. The move to T+2 alone is going to require significant operational adjustments. Atomic or real-time settlement would require even more significant changes to the existing market infrastructure and regulatory frameworks. Fund managers and administrators will have to adapt their systems and processes to comply with the new settlement cycle, which may require investments in new technology and personnel training.

The jump to T+0, noted Alex, still requires “a lot of the industry to opine” to come to a decision on whether atomic settlements are possible on the current infrastructure or “whether it would leverage new technologies such as blockchain.”

The latter seems more likely, with tokenisation, the process of representing assets on a blockchain, playing a huge part. By tokenising assets, trades could be executed, cleared, and settled instantaneously, dramatically reducing counterparty risk, improving liquidity, and enhancing operational efficiency. As Sharn put it, “tokenisation potentially takes the whole thing to a different level.”

Preparing to succeed

For now, however, the focus for fund managers, transfer agents and distributors (from platforms to wealth managers) is on making sure they’re prepared for the increasingly likely shift to T+1 securities and T+2 fund settlements. In fact, in May this year an ISITC Industry Preparedness for Accelerated Settlement survey identified how operations staff at wealth and fund managers are less prepared for accelerated settlement than the custodians and regulators.

“We’re still working with our members in forums to understand all of the implications of a move to T+1 settlements in the capital markets”,” said Alex, who is “encouraging policy makers to ‘proceed with caution’.”

The chance of an accelerated settlement timeframe in the funds industry is a likely scenario and appropriate forward thinking should be in place. Firms should seek out settlement solutions that can support any business relationship, settlement timeframe and model to make sure they cover all their requirements and any future changes. Moreover, such solutions should not be prohibitive in terms of cost or limit you to specific banking relationships.

Find out more about how Calastone’s net settlements capability is giving fund firms the ability to optimise their liquidity and achieve full, end-to-end control over the settlements process, from the choice on how to settle, when to settle (inc. T+0) and the ability to use any bank and currency when instructing a payment.

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