On February 15, 2023, the Securities and Exchange Commission (SEC) adopted a rule amendment to shorten the standard settlement cycle for most routine securities trades from two business days after the trade date to one business day after the trade date, also known as T+1 (i). The proposed May 2024 deadline has lit a fire under market participants, who must move quickly to prepare for the change.
This amendment is expected to lower risk, and promote efficiency, as well as increase liquidity in the markets. It’s one way in which the SEC is seeking to address recent episodes of market volatility, including the “meme stock” events of 2021 and the COVID-19 pandemic.
Impact on hedge funds and asset managers
The move to T+1 settlement will have a great impact on hedge funds and asset managers. One of the most significant benefits is that it will align the settlement date for options and equity traders, helping everything from treasury financing to margin funding. This has the potential to lower margin requirements and benefit the buy side by shortening the time frame between execution and settlement. It will certainly reduce the level of margin market participants must post to offset the settlement risk, particularly during periods of heightened market volatility.
Preparing for a shift on the sell side
The bulk of the cost introduced by the move to T+1 will be borne by broker-dealers, clearing firms, and prime brokers. However, some firms may not be aware of the breadth of implications of T+1 internally and on their buy-side clients.
Clearing and settlement are the areas that will be most affected, where clearing and executions need to match on both the trade side and the street side for affirmation at line speed. The throughput and integration demands for modern clearing platforms are not easily changed in larger firms with legacy technology. The risk is further amplified when replacing legacy solutions while continuing to operate normally, or making changes “in-flight.”
The move will be impactful for three reasons:
- Changes to operational workflows. Firms will have to dedicate valuable time that could be spent on client services or front-end products to managing the move to T+1. Firms with the most relationships that clear the most shares will likely be the participants most at risk. Firms that robustly automate clearing processes will be best positioned to emerge successful from the T+1 transition.
- Cost. Typically, firms favor investments in front-end technology and are slower to invest in the back-end. Those who have not made the necessary investments over time on their back-end technology will feel the impact of those decisions as they find and test every parameter or setting that must change before the move to T+1.
- Regulatory considerations. In addition to the technology challenges that T+1 introduces, resolving settlement fails and stock loan breaks will become more challenging on a tightened timeline.
Many firms that are encumbered with legacy technology and manual processes already have problems with T+2. Shortening the settlement cycle will only increase the amount of noise and breaks that they see shortening the cycle by a day.
A modern clearing, settlement, and custody platform for T+1
The throughput and integration demands for modern clearing platforms are not easily navigated in large organizations, especially when replacing a legacy solution in-flight. Newer firms like my firm, Clear Street, have built their infrastructure on modern technology and already operate with more robust data sets and in real time. At Clear Street, we don’t have a batch process, and we don’t have to worry about waiting until tomorrow to see stock record updates, matching of trades, or or allocations. That all already happens real time, making us well prepared for a move to a shorter settlement cycle.
We’re building the platform that reimagines the legacy workflows and silos that are essential to increasing access in the financial markets, all while transparently decreasing risks and costs. Our cloud native clearing, settlement, and custody stack can work in a shortened settlement regime. In just a few years, we’re already processing around 2.5% of U.S. equities volume daily through our platform.
Our goal is to give all market participants, from emerging managers to large institutions, the tools and services they need to compete in today’s fast-paced markets. It’s never been more apparent that the forces of volatility, regulatory change, and speed are demanding tools that allow firms to make sense of the markets in real time.
A version of this article originally appeared in TabbForum.
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