Settling down

In February 2023 the Securities and Exchange Commission adopted rule changes to shorten the standard settlement cycle for most broker-dealer transactions in securities from two business days after the trade date (T+2) to one (T+1).

The final rule is designed to benefit investors and reduce the credit, market, and liquidity risks in securities transactions faced by market participants.

“I support this rulemaking because it will reduce latency, lower risk, and promote efficiency as well as greater liquidity in the markets,” said SEC chair Gary Gensler.

“Today’s adoption addresses one of the four areas the staff recommended the SEC address in response to the meme stock events of 2021. Taken together, these amendments will make our market plumbing more resilient, timely, orderly, and efficient.”

In addition to shortening the standard settlement cycle, the final rules will improve the processing of institutional trades. Specifically, the final rules will require a broker-dealer to either enter into written agreements or establish, maintain, and enforce written policies and procedures reasonably designed to ensure the completion of allocations, confirmations, and affirmations as soon as technologically practicable and no later than the end of trade date.

The final rules also require registered investment advisers to make and keep records of the allocations, confirmations, and affirmations for certain securities transactions.

Further, the final rules add a new requirement to facilitate straight-through processing, which applies to certain types of clearing agencies that provide central matching services.

New policies

They will require central matching service providers to establish, implement, maintain, and enforce new policies and procedures reasonably designed to facilitate straightthrough processing and require them to submit an annual report to the SEC that describes and quantifies progress with respect to straight-through processing.

The amendments also halve the settlement cycle for trades relating to initial public offerings, from T+4 to T+2. Halving these settlement cycles will reduce the amount of margin that counterparties need to place with the clearing house, lowering risk in the system and freeing up liquidity elsewhere in the market.

According to Tom Veneziano, head of product, Americas at Pirum Systems, the level of preparation and readiness for T+1 is something of a mixed bag.

“In the US we have been looking at it for an extended period of time,” he says. “Some individuals are ready for the overall changes on the beneficial owner side, however the stock loan borrow side is still looking for efficiencies which is where our recalls manager comes into play, because you need that level of automation and real time processing.”

He suggests Canada and Mexico are a little bit further behind the curve. “Although we do have a year to get there, that is pretty advanced timing at this point if you are just starting to get into it. So, I think there is going to be a lot of need for automation and high demand for problem solving and gap closing for operational efficiencies, which is where vendors such as ourselves come into play, where we operate in a real time technology stack.”

Pirum is designing a recalls manager that will provide a full view and communications tool between counterparties from initiation and issue of the recall straight through to settlement and satisfaction.

Key development

“That is going to be a key development for our stock loan borrow community,” says Veneziano. “Then you look at other areas that could be affected by T+1, such as the changing of record dates and the changing of dividend dates that are going to come about in the corporate action space. In this context the idea of being able to also get some automation around events, instructions and elections is extremely valuable.” Pirum is looking to launch a voluntary corporate action module in Q3/4 this year. With any transition there will be firms who leave it till the last minute and then almost panic at the end to try and get in ahead of the deadline. However, Veneziano reckons there is a general acknowledgment that this

is a positive move.

“The industry is going to see a more marked difference between the acceleration of the settlement cycle from T+2 to T+1 than there was when we went from T+3 to T+2,” he suggests. “Although they feel it is a good thing to accelerate the settlement cycle and eventually (potentially) get to T+0 from an efficiency perspective, there is a little bit of fear because of where the compression is going to impact different services and processes. We have to acknowledge that it not going to be as seamless or as easy as it was in the previous settlement cycle.”

In terms of the implementation process, clearly there are a lot of moving parts. From the perspective of a vendor in the stock loan borrow space, Bob Zekraus, COO and head of Americas at Pirum Systems observes that the biggest challenge is recalls.

“There is a large amount of risk when there is settlement failure in the form of punitive damages from a buy-in perspective or from a failed claims cost,” he explains. “In our space, firms used to have 24 or 48 hours to satisfy that recall, whereas we are now looking at potentially having a valid recall all the way up to midnight on the trade date.”

Shortened cycle

This shortened settlement cycle impacts not just regular recalls for sales scenarios but also regulatory constraints, which leads to an even more specific buy in execution on the types of sales firms are dealing with.

“When you get into those scenarios and look at items where you have a hard to borrow stock, you are going to have a much shorter compression time in order to cover those and get that recall satisfied before you get a regulatory buy in,” adds Veneziano.

From the beneficial owner side or buy side where they are doing proprietary transactions, the main concern is going to be in the lack of time to reconcile trade affirmations and net settlements. Where beneficial owners used to have 24 or even 48 hours to resubmit trades and still be able to net down in the settlements and have those affirmation processes completed, they are now going to have to have those trades done, reconciled and prepared for affirmation and submission on the trade date.

“That is going to be difficult, especially when you think about cross-border scenarios where you might potentially have APAC clients or European clients that are lending or borrowing or buying or purchasing within the US marketplace, because now there is a timing differential as well as a compression to the settlement cycle,” says Veneziano.

The obvious question to ask once the move to T+1 has been completed is when T+0 might happen. However, Pirum’s COO and head of Americas acknowledges that there is plenty of work to do on T+1 before the industry can fully focus on real time settlement.

Industry disconnect

“When you look at all the industry group meetings we have been on and the panels we have spoken at, there are a lot of different situations where borrowers and lenders have a bit of a disconnect in terms of understanding what best practices are going to be,” says Zekraus

“The regulators and industry will naturally let T+1 settle down before it starts with T+0 just to make sure all kinks have been ironed. But any firm that is looking at its processes now should be considering whether they are scalable for T+0 so when that change happens they are not trying to do another secondary lift or change all of their processes.”

Larry Albaugh, global head of operations and middle office at eSecLending also acknowledges that T+1 readiness various from entity to entity.

“There is a high level of engagement in industry discussions and focus groups from the major industry participants,” he says. “We are in very good shape a year out, and our observation is that all major participants will be ready in advance of the implementation date.”

Benefits acknowledged

He also believes that most market participants acknowledge the benefits of faster settlement as the move toward shortened settlement cycles continues across the globe and that most are taking this opportunity to evaluate, refine, and improve settlement processes holistically.

“The major challenge lenders and borrowers face in moving from T+2 is consuming sell notifications in a timely and efficient manner to achieve what essentially will be same day recalls,” says Albaugh. “Depending on the model (custodian, third party, etc.), firms have different levels of challenges to overcome. For example, a custodial programme likely has a larger lift as the process is embedded within core processing. As a third party provider, our process circumvents our lenders custodian process and therefore will require optimisation and not a major change in technology.”

According to EquiLend clients, conversations are taking place both internally and with external vendors observes head of post trade EMEA, Gabi Mantle.

“Looking at this through a purely securities finance lens, the settlement cycle is not changing as we operate on a T+0 basis,” she says. “However, securities finance’s reaction to sales needs to be slicker and right first time as there is far less margin for error once sale settlement cycles are squeezed.”

“The business certainly appreciates the notion that market volatility risks will reduce. Additionally, the adoption of technology solutions will improve operational efficiency and reduce manual touch points. But operational teams may not share such a positive view as they are faced with significantly less time to action lifecycle events and/or correct errors.”

Faster processes

One of the consequences of the change is that lenders are faced with recalling shares out on loan from borrowers in time to satisfy their client’s sale. With one day less to re-deliver the shares, their notification and operational processes need to be swift, streamlined and correct first time.

Borrowers need to take significantly faster action all the way through the trade lifecycle - shorts need to be covered faster, collateral needs to move earlier, and exceptions need to be managed more effectively (and even eliminated). Borrowers also need to be positioned to act on recalls in a shortened cycle and in some instances up until 23.59pm EST.

Collateral constraints will also play a part, adds Mantle. “All activity needs to be funded whether the collateral is on the way in or out. How will both borrowers and lenders manage funding processes in a shortened timeframe? Will borrowers be able to position the collateral fast enough to pre-pay their borrows? All of this leads to the need for transparency, visibility and automation.”

As for whether there is general acceptance that the timeframe for this change is realistic, Mantle says she is not hearing any noise on this subject. “My observation is that all the clients we are speaking to are working towards the deadline, rather than challenging it.”