T+2 becomes T+1 upcoming changes in the US stock market may cause headaches for international funds

The Zhitong Finance App learned that the upcoming shortening of the US securities settlement cycle is causing headaches for international fund management companies. As they prepare to comply with regulations, they face staffing problems, the prospect of holding more cash, and rising foreign exchange risks.

To reduce the risk of unsettled transactions after a volatile period, the upcoming changes will allow securities transactions to be settled one business day (i.e. T+1) after the transaction, rather than two business days.

The move was launched after the collapse of GameStop (GME.US) in 2021 and will be implemented in the US on May 28.

However, this makes the country different from many other countries in the world, where the typical cycle is T+2. As a result, market participants have been rethinking their processes to avoid failed deals and higher transaction fees, according to custodians, traders, and consulting firms.

“(Transformation) will not be without costs,” said Ben Springett, head of European electronics and program trading at Jefferies. “You would expect more cash balances in the fund to cover any potential gaps and cash mismatches.” “As a result, this will hurt the Fund's performance.”

The American Depository Trust Clearing Company (DTCC), which provides securities clearing and settlement services in the US financial market, has been preparing with industry bodies such as the American Association of Investment Companies (ICI).

Tom Price, managing director and head of technology, operations and business continuity at the American Securities and Financial Markets Association, said that although T+1 was a “complex and complex initiative,” it “reduced risk and brought operational benefits” to the industry.

RJ Rondini, head of business at ICI Securities, said that for the US securities market, “the overall reduction in capital far exceeds the actual absolute value of the increase in risk in all of these areas.”

DTCC declined to comment. Market participants must speed up preparations, according to a paper published by the agency on February 28.

Trading hours

Shorter cycles may present operational challenges, such as potential chaos in forex trading. Foreign investors are required to buy dollars to fund trading in US securities.

Nathan Vurgest, head of trading at Record Financial Group, said he is studying whether foreign exchange costs will rise if liquidity decreases in early London trading and US late trading increases.

The European Funds and Asset Management Association (EFAMA) said earlier this month that the faster settlement speed in the US poses a “systemic risk” to Europe, and pointed out that the financing window for non-US financial institutions is very limited. Market participants will have to enter CLS, the world's largest multi-currency settlement system for foreign exchange transactions.

According to EFAMA, asset managers trading before the US stock market closes have only two hours to confirm these transactions and submit them to CLS. EFAMA members surveyed said they expect $50-70 billion of foreign exchange transactions to be settled outside of CLS every day, which led to calls for an extension of the CLS deadline.

Jefferies's Springett said some non-US investors. Participants are considering emergency measures, including setting up an outpost in the US or working time in the US.

Shortening the cycle may have other ripple effects, such as increased demand for short-term financing. Normally, some investors have to wait until they get cash from one market to buy securities in another, but those who sell international securities to buy US securities may find themselves short of cash one day.

Adam Watson, head of commercial products for escrow services at Bank of New York Mellon, said this could increase the use of overnight repurchase agreements, but shift credit risk — the risk that counterparties are unable to pay their debts in full and on time — to banks in the sector.

“This will force portfolio managers to start thinking 'Am I going to the overnight buyback market or... can my custodian give me the letter of credit overnight? '” Watson added.

Custodians, custodians of clients' assets, usually provide short-term credit to clients in the form of intraday liquidity and provide overnight funding under special circumstances to help with settlement across different systems and time zones.

However, this type of loan is usually limited to processing clients' securities or payment transactions, so there is no guarantee of extension of credit, Watson said.

chain reaction

There may be other consequences. Fund managers said that global index funds, such as ETFs with large asset portfolios and mismatched settlements, may also face collapse.

Steve Fenty, head of foreign exchange management at State Street Global, said that when a fund's settlement cycle is not in harmony with its underlying assets, fund managers may consider splitting the settlement cycle to separate funds with a higher share of underlying assets from more diversified global funds.

Josh Galper, head of management at capital markets consulting firm Finadium, said that this change may also reduce the liquidity of the stock market because the shortened US period may shorten the time to recover securities loaned to short sellers.

“People often overlook the liquidity that short selling and securities lending bring to the stock market,” Galper said. “It's something you only know when it's gone.”