Industry experts tackle T+1 settlement challenges in FX

Rick Steves

FinanceFeeds spoke with Alex Knight, Head of EMEA, Baton Systems; Craig Stirling, Head of Securities Product at AccessFintech; Tomo Tokuyama, EVP Managing Director of FX at Trading Technologies; and James Maxfield, Chief Product Officer at Duco; to ascertain their perspectives on the challenges ahead.

Experts address challenges of T+1 settlement in FX

The transition to T+1 settlement in the foreign exchange (FX) market, while promising improved efficiency and reduced risks, brings with it a set of significant challenges.

This new settlement cycle demands rapid adjustments in operational processes, risk management strategies, and technology infrastructures.

We spoke with FX industry experts to uncover what challenges in FX will arise from the implementation of the T+1 settlement cycle and how to address them.

An overview of the FX challenges ahead

The compliance date for the rule amendments is May 28, 2024, at which point the standard settlement cycle will be T+1, which means that all applicable securities transactions from U.S., Canadian, and Mexican financial institutions will settle within one business day of their transaction date.

The “T+1” settlement cycle will apply to stocks, bonds, municipal securities, exchange-traded funds, certain mutual funds, and limited partnerships that trade on an exchange.

This shift will have a profound impact on global securities markets, given the dominance of the US market and its interconnectedness with other economies. We will look at the impact from an FX perspective.

Operational Overhauls: A major challenge in moving to T+1 settlement is the need for comprehensive operational changes. Financial institutions must update or replace existing systems to handle the increased speed of settlements. This involves integrating advanced technology that can support faster and more reliable data processing. The use of distributed ledger technology could be pivotal in managing the complexities of quicker settlements, offering transparency and reducing errors in record-keeping.

Managing Risk in a Shortened Window: The reduced timeframe for settling trades amplifies several risk management challenges. There is less time to resolve discrepancies and address counterparty risk, which increases the pressure on risk management systems to perform flawlessly under tighter deadlines. As highlighted by DTCC, institutions must enhance their risk assessment tools to quickly identify and mitigate potential risks arising from faster transaction cycles.

Technology and Infrastructure Costs: Upgrading technology and infrastructure to support T+1 settlement involves substantial investment. Financial institutions must consider the cost implications of adopting new technologies, such as high-speed computing systems and secure, real-time data processing solutions. The initial outlay for technological upgrades can be significant, posing a financial challenge, particularly for smaller market participants.

Regulatory and Compliance Issues: With the implementation of T+1, regulatory compliance becomes more complex. Institutions must ensure that their new systems and processes comply with both local and international regulatory standards, which may differ significantly. The need for compliance can introduce delays and additional costs, complicating the transition process.

Training and Adaptation: The move to T+1 necessitates extensive training for personnel to adapt to new systems and processes. Ensuring that all staff—from traders to back-office personnel—are well-versed in the intricacies of a T+1 environment is essential. This training must be thorough and ongoing, adding to the operational costs and complexity of the transition.

Addressing ‘FX Dead Zones’: As detailed in MarketsMedia, another specific challenge in the FX market is managing the ‘FX dead zones,’ which refer to periods when trading volumes are low due to time zone differences and the cut-off times of settlement systems like CLS. These periods pose a risk to liquidity and can complicate the settlement of trades under a T+1 system.

What experts say about T+1 settlement in FX

FinanceFeeds spoke with Alex Knight, Head of EMEA, Baton Systems; Craig Stirling, Head of Securities Product at AccessFintech; Tomo Tokuyama, EVP Managing Director of FX at Trading Technologies; and James Maxfield, Chief Product Officer at Duco; to ascertain their perspectives on the challenges ahead.

Alex Knight from Baton Systems points out the operational difficulties, emphasizing the compression of post-trade processes. He notes, “Under T+1, firms manually conducting their post-trade payment processes would be rushing the required steps for trade settlement, in both CLS-eligible and bilateral trades, increasing the chance of incorrect payment terms.” The automation of trade confirmations and netting becomes crucial to minimize payment risks and manage workflow more effectively.

Craig Stirling, Head of Securities at AccessFintech, highlighted the broader implications of the T+1 transition, such as the potential rise in settlement failures and challenges in managing short positions. He explained that “the T+1 move underscores several issues, such as reduced time between trade execution and the start of the settlement cycle, a potential rise in settlement failures”, which necessitates a reassessment of risk management strategies to ensure timely and accurate trade and settlement processing.

Tomo Tokuyama, EVP Managing Director of FX at Trading Technologies, addresses the technological challenges, particularly for liquidity providers and the integration required to shift from T+2 to T+1. He states, “For the liquidity providers themselves, there is probably some integration work in order to configure spot as T+1 instead of T+2.”

James Maxfield, Chief Product Officer at Duco, emphasized the broader implications of such transitions: “Transitioning to T+1 may mitigate risks in the trade settlement process; however, it also introduces additional complexity and potentially increased costs elsewhere.” He pointed to the need for a thorough overhaul of systems not only to accommodate new timelines but also to manage the increased complexity and potential misalignments in settlement cycles.

AccessFintech’s Stirling also discussed the impact of T+1 on regulatory compliance, particularly how it affects international transactions. “The US T+1 regulation will affect numerous international transactions, because the FX portion of these transactions needs to be settled to facilitate funding the T+1 security settlement cycle,” he noted, warning it will require firms to navigate a complex landscape of global regulations that may differ significantly from one region to another.

Baton Systems‘ Knight also touched upon the need for increased control over post-trade payment workflows to adapt to T+1. The requirement for automation and prioritization in trade processing to release funds efficiently under tighter deadlines illustrates the need for comprehensive training and system familiarity.

Trading Technologies‘ Tokuyama also addressed the specific challenges related to FX dead zones, where different currencies have varying settlement cut-off times. “Moving cut-off times or settlement times would be a massive overhaul and require a lot of work,” he explains. Managing these dead zones is critical to ensuring liquidity and timely settlements in the T+1 environment.

Duco‘s Maxfield further added: “Whilst some of the FX market does settle on a T+1 basis, market convention is still typically for a T+2 cycle, whether settling bilaterally or through CLS. This will require firms to apply the same rigour around understanding how to accelerate their FX settlement to avoid over/under funding, as they have had to around their security settlement process.”

Below, we present the complete, unaltered quotes provided by each expert, offering direct insights into their perspectives on the matter at hand.

Alex Knight, Head of EMEA, Baton Systems

“Under T+1 we will see a compression of the time to conduct post-trade processes across asset classes, including for the FX leg of a cross-border equity or bond trade. In the context of T+1, much has been spoken about the FX settlement challenges over the lack of CLS cut-off window extension. But even if a small extension had been granted, those firms manually conducting their post-trade payment processes would be rushing the required steps for trade settlement, in both CLS-eligible and bi-lateral trades, increasing the chance of incorrect payment terms. By automating trade confirmations and netting and more effectively identifying and resolving breaks in trades, firms can minimise payments risk. This is the case in a T+2 environment, let alone T+1. Beyond reducing payments risk, increased automation over the orchestration of payments will also provide much more control over post-trade payment workflow allowing firms to prioritise certain trades, including specific FX trades to release the dollars needed to buy US equities and bonds ahead of market cut-off times.”

Craig Stirling, Head of Securities Product at AccessFintech

“The transition to T+1 settlement in North America is prompting other regions to consider re-synchronizing their securities settlement cycles with North America. However, it’s crucial to address potential difficulties. As AFME notes, the T+1 move underscores several issues, such as reduced time between trade execution and the start of the settlement cycle, a potential rise in settlement failures, challenges in tracking and managing short positions in the securities lending sector, and the need to reassess critical dates and practices for affected corporate actions. Moreover, the FX market is likely to encounter additional post-trade challenges due to this shift.

Discussions around T+1 settlement have been lively among market participants, policymakers, and industry groups in the UK and the EU, where greater standardization and automation could improve settlement efficiency. In FX, given that 20% of US securities and 16% of US equities are owned by foreign investors, the US T+1 regulation will affect numerous international transactions, because the FX portion of these transactions needs to be settled to facilitate funding the T+1 security settlement cycle. Many of the trades will be executed after-hours for international investors creating the conundrum of how much and when to execute the FX needed to fund the transaction whilst still achieving optimal FX prices.”

Tomo Tokuyama, EVP Managing Director of FX at Trading Technologies

“The impact of T+1 settlement in FX for Trading Technologies is not that significant given that we are simply providing direct access to OTC FX liquidity via our platform. Therefore, we will display the spot price details the way the liquidity providers send it to us.

“Also, for the liquidity providers themselves, there is probably some integration work in order to configure spot as T+1 instead of T+2, but it’s not an entirely new concept in OTC FX as spot USDCAD, USDTRY, USDRUB, and USDPHP have all been trading T+1.

“I believe the biggest impact is going to be on the post-trade and funding side. Custodians, agent banks, FX Prime Brokers and CLS will probably go through some teething challenges, as reconciling trade breaks could increase significantly, which will cause a lot of work on the post-trade side. I also believe there is a technology and infrastructure challenge within the OTC FX ecosystem, as settlement cut-off times are different for different currencies, and CLS has a schedule that all of its members have been mapped to for years. Therefore, moving cut-off times or settlement times would be a massive overhaul and require a lot of work.

“There could be challenges on the funding side as well. Clients that trade globally will have to be cognizant that this phase only impacts North American securities markets. Therefore, Europe and Asia will still be on the T+2 schedule. So they would have to manage that difference internally for the different regions. Automating everything for T+1 might still be too early.

“Ultimately, the market has been looking at decreasing the time to settlement for a while with the goal of T+0 in mind. With the emergence of blockchain technology, it could become a reality; however I believe it will still take some time, as accepting a market standard technology, and then deploying that globally throughout the entire financial market ecosystem, is no easy task.”

James Maxfield, Chief Product Officer at Duco

“Transitioning to T+1 may mitigate risks in the trade settlement process; however, it also introduces additional complexity and potentially increased costs elsewhere. One of the key areas of concern is the misalignment of settlement cycles that this shift creates between the actual trade settlement and FX transactions that support out of currency settlement. Whilst some of the FX market does settle on a T+1 basis, market convention is still typically for a T+2 cycle, whether settling bilaterally or through CLS. This will require firms to apply the same rigour around understanding how to accelerate their FX settlement to avoid over/under funding, as they have had to around their security settlement process. Although firms might have an inclination to rely on technology automation to address these challenges, automating processes with inaccurate data will still result in exceptions that require immediate management on T+0 to meet the new timelines. Firms need to employ a data-centric approach if they are to avoid difficulties in meeting deadlines and fulfilling data requirements. Those that grasp both the challenge and opportunity presented by T+1 will navigate the transition more easily, enjoy its advantages and secure a means to gain a competitive edge – especially with the deadline just weeks away.”

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