Many of us are old enough to remember the epic anti-climax of the Millennium Bug: the glitch that would launch nuclear warheads into the sky, capsize entire navies, bring transportation networks to a standstill, create energy blackouts and turn back the clock on the considerable technological advances of the 1990s. The chaos that didn’t happen was an enormous relief, but the run-up to New Year’s Day 2000 provided many consultancies with hay to make as they issued dire warnings about the doom that awaited those who ignored their pitch.
Granted, it was hardly ill-advised to ensure internal capabilities existed to process dates past 31 December 1999. But presuming that such fragility is innate in the technology that we rely upon every day highlighted significant doubts about how far we had come, and whether the gurus of the early internet age were anywhere near as focused on solving actual problems as they were on creating attention-grabbing websites or impressing spendthrift venture capitalists.
Though hardly of the same magnitude as Y2K, the transition in North American markets to T+1 settlement next May shares some characteristics with it, mainly its “ready-or-not” inevitability. Unlike internally-driven projects that can be delayed or postponed, investment firms will not be able to deprioritise T+1, and potential errors resulting in overdrafts could have material—even if not existential—consequences for those that did not manage the transition successfully.
The degree of impact implied by T+1 does not represent a sea-change in operations or market conventions—only that the settlement cycle will become slightly more condensed in the US and Canada, requiring funding for trades to be available at midnight on the day following execution. Regardless, global participants in North American markets may encounter unwelcome complexity and consequences. Asian managers that trade North American securities will find that T+1 can be little more than a few hours following execution. In Europe, enforcers of CSDR (Central Securities Depositories Regulation), the system under which penalties are charged for late settlement, may become much busier if firms have failed to adjust to the new convention.
Fortunately, the same safeguards that exist now to prevent overdrafts or misalignment in settlements will still work, but this means that solving for T+1 is not an isolated endeavour, and that the inability to deal with this change is likely rooted in issues that may have been neglected up to now. A few items require validation to help ensure a seamless transition to T+1:
Cash Visibility.There is no substitute for having full visibility on all cash-relevant transactions within both the ABOR and IBOR. Attributes include:
A high-quality, reconciled, dynamic IBOR that maintains its own cash and positions intraday, and persists to the next business day without overnight refresh
Contractual settlement assumed by IBOR; contractual vs actual settlement tracked by ABOR
Input/import of any non-trade transaction (client in/outflows, income and maturities, margin/collateral, etc.) on trade date in real- or near-real-time
Cash services provided by third parties may also hinder visibility on available balances. Activity based on standing instructions on FX, along with sweeps to base currencies and money market instruments by custodians, should be notified to managers and their order management platforms intraday to provide a complete picture of current account in- and outflows.
Process Reliability. Investment firms should be fully aware of the volumes and transaction types that do not follow the “typical” STP for listed instruments and, more importantly, why this is the case. If the permutations of non-STP transactions go beyond private transactions and selected alternative instruments, further analysis regarding defaults or the rules used to assign settlement conventions is likely required.
Operational Backstops.The inability to rely on contractual settlement may make the impact of T+1 considerably more acute. These items may help to shore up cash visibility in the case that managers cannot count on contractual settlement, regardless of why:
Custodian funding facility to support contractual settlement for income, bond interest and maturities
Manager/TA funding facility for extended settlement cycles for funds (mainly an APAC issue)
Cleared funds policy for client inflows
Technology. Platforms will distinguish themselves by how easy or difficult it is to adapt to T+1. Ideally, there is a “master” setting for market settlement conventions and an “as of” date for the change, but it is possible that system providers have hardcoded themselves into a major development issue. Investment managers should verify their providers’ readiness for T+1 and validate their action plan, including any presumptions of user testing built in.
The temptation to make T+1 into something bigger is easily countered by addressing the issues above and challenging any claims made regarding the uncertainty presented by T+1. Cash visibility, process standardisation, steps to mitigate exceptions and operational readiness can all be assessed well in advance of the May 2024 deadline. However, investment managers should wait no longer to assign ownership of these tasks and communicate their prioritisation of T+1 as a critical item for delivery next year.