For all the talk of “real-time settlement”, it wasn’t until 2014 that Europe moved from a settlement cycle of three business days after the trade date (T+3) to two business days (T+2). And the United States only followed suit in 2017.

“We like to think we’re in a fast-paced environment. But actually, significant structural changes take time to materialize, because we work in an industry where we can’t just hit the pause button and rewrite everything,” says Sachin Mohindra, executive director of global markets and market solutions at Goldman Sachs. Mohindra has held a range of post-trade roles during his 18 years at the bank. “It’s like we’re on a moving train and we’re trying to service that moving train at the same time,” he says.

Now, five years later, the US markets regulator is pushing for a T+1 settlement cycle. In February, the US Securities and Exchange Commission published a proposal that would make amendments to existing rules for broker-dealers, investment advisers, and certain clearing agencies, with a view to shortening the standard settlement cycle for most broker-dealer transactions from T+2 to T+1. The comment period for these changes closed on April 11. If adopted as a concrete set of rules, T+1 settlement would come into effect in the US on March 31, 2024.

The commission’s proposal considers a report published in late 2021 by the Depository Trust & Clearing Corporation, the Investment Company Institute, and the Securities Industry and Financial Markets Association that made recommendations to implement a T+1 settlement cycle in the US.

In the proposal, the regulator quotes the adage that “time equals risk”—less time between a transaction and its completion reduces risk. Moving to a shorter settlement window would reduce risk in the clearing and settlement process, and increase operational efficiency across the trade lifecycle. The commission says that moving to T+1 was especially attractive considering two recent episodes of extreme market volatility—during the “meme stock” frenzy and the Covid-19 pandemic—which “highlighted the significance of the settlement cycle to the calculation of financial exposures and exposed potential risks to the stability of the US securities markets.”

Some securities industry participants, however, say that for T+1 to work, all jurisdictions should make the move at the same time. If one market moves to T+1 before others, a disjointed settlement framework emerges.

These critics are concerned that the move to T+1 could have knock-on effects on other markets, especially considering new regulations in Europe that require investment firms to pay cash penalties for settlement failures. Most notable is the Settlement Discipline Regime, a central piece of the European Commission’s review of the Central Securities Depositories Regulation (CSDR), which came into force on February 1, 2022. European investment firms trading US securities will have a shorter timeframe—especially factoring in time zone differences—to allocate and fund securities, fix settlement issues, and comply with CSDR’s new penalty rules.

“This is an area that still needs a lot more thought within the US, and it’s a question we’ve posed to Sifma, various trading groups, and the DTCC. [We’ve said], ‘Great, you have figured it all out in terms of which batches you need to change at the DTCC, what reports need to be updated for your local brokers’ et cetera, but we haven’t really thought enough about the international community.’ So, a bit more work still needs to be done there,” Mohindra tells WatersTechnology.

Mohindra says some participants might look at the move to T+1 in the US as simply losing a full business day to trade and settle a transaction. But the situation is more complex than that.

In Europe, the settlement time could go from a 12-hour window down to two hours.

“If you go from 12 hours down to two hours, that equates to something like an 83% reduction in that post-trade processing time,” Mohindra says. “I think a lot of people don’t appreciate that because everyone thinks going from T+2 to T+1 is a 50% reduction in time, but actually it’s an 83% reduction ahead of the settlement date.”

Non-US firms also face technical challenges if the SEC’s proposed rule amendments are passed. Many investment firms are still dependent on legacy technologies and manual practices for managing their post-trade operations, an area that still struggles to attract much investment from businesses.

“There is still that rump of transactions that require some level of manual processing. For example, your client might be a bit more technically illiterate and is still sending their trade allocations via email, which requires manual translation into your central securities depository system,” says an industry source with knowledge of the US’s T+1 discussions.

Adding to the possible confusion is that while the US is home to three central securities depositories and one legal structure under the SEC, the EU manages 30 CSDs (31 if you include the UK’s Euroclear) and has 27 different legal and tax frameworks for each EU member state.

T+1 in the US would also affect markets in Asia, says the industry source. “In Europe, we have some level of overlap with both the US and Asia, but it’s a challenge for those in Asia who wake up and the settlement window is already closed, and you have no opportunity to fix any issues,” they say.

A possible solution is for counterparties on either side of a trade to agree to pre-match trades before settlement. This would require that matching instructions on either side are ready, ensuring both counterparties have their cash and securities secured and systems prepped before the trade is settled. But this setup might not work for the buy side, Mohindra says.

“It’s not always the most effective process for an asset manager. You can’t have everything pre-allocated and pre-agreed upfront, because sometimes an asset manager reacts to their order being filled throughout the day and then figures out what’s the most optimal way to allocate it. So, sometimes these things must happen in post-trade and can’t always happen in pre-trade,” he says.

Déjà vu

John Abel, executive director of clearance and settlement product management at the DTCC, says that in trying to accommodate a T+1 cycle, the industry can learn from the past decade’s initiatives to shorten the settlement cycle, as well as the markets that already operate on a T+1 basis, such as US government securities.

If the US adopts the proposals, Abel says, non-US investors will be able to choose from a variety of vendor tools to help them meet the new deadlines for trade allocations, confirmations, and affirmations.

“Most of the non-US members also employ custodians, which are very active in the US markets, and they offer their own tools and processes to help non-US investors,” he adds.

One head of product at a broker-dealer says that historically, when one jurisdiction moves, it speeds up the process for other markets to follow suit. If the US does move, it provide impetus for EU firms to align their own systems and practices.

“This has happened before, when Europe moved and then the US moved, and it helped to lay the groundwork for all the other system and operational changes,” says the executive.

But Mohindra says industry participants across the European market need to consider why settlement problems happen in the first place before T+1 can become a reality in the region. For example, why does the sell side suffer from inventory problems that lead to failures? Data from the International Capital Markets Association show that a large majority of settlement fails are due to the seller not being able to deliver the sold securities on time, accounting for over 70% of all fails.

Goldman Sachs, alongside other investment firms, has asked the SEC for a two-year implementation window from when the rule is finalized to when it must be implemented.

In one scenario, Mohindra says, European and Asian asset managers might have to give power of attorney to local brokers or pass on some outsourced function to a third party locally in the US time zone to effect settlement processes on their behalf and prevent failures. Alternatively, if there is enough volume to warrant it, European buy-side firms might decide to set up branches in the US to be responsible for settlement decisions. But much of this is yet to be worked out.

“We’re asking for those two years [from when the rule is published] to allow for all these creases to be ironed out in the process,” he adds.

A European Commission official tells WatersTechnology that following its “extensive consultation process” on CSDR, the EC had received no comments or concerns relating to the shortening of the bloc’s settlement cycle from T+2 to T+1. However, the EU legislator says it is still monitoring regulatory changes occurring in other jurisdictions, including the US, to see how any changes play out.

“We are following international discussions on this issue closely,” the official says. “It should be noted, however, that CSDR currently mandates a maximum of T+2 and as such, does not prevent industry to use shorter settlement cycles.”