A major shift looms over the horizon of the US stock market, stirring concern among international fund managers. The impending adjustment to the settlement cycle for US securities is triggering a wave of challenges, ranging from operational logistics to heightened financial risks.
Scheduled to kick in on May 28, the new settlement cycle shortens the period between securities transactions and their settlement to just one business day after the trade (T+1), a move aimed at mitigating the risks associated with unsettled trades during volatile market periods.
While this change aligns the US with a faster settlement standard, it diverges significantly from the prevailing T+2 cycle adopted by much of the rest of the world. Consequently, market players are scrambling to overhaul their processes to avert transaction failures and escalating trading costs, as noted by industry experts.
Ben Springett, from Jefferies, forewarns of potential cash shortages within funds and subsequent detriments to fund performance. The adaptation demands a reevaluation of liquidity management strategies to bridge any resulting gaps and mitigate cash mismatches.
The Depository Trust & Clearing Corporation (DTCC), in collaboration with industry bodies like the Investment Company Institute (ICI), is spearheading preparations for the transition. While acknowledging the complexities involved, industry insiders see benefits in terms of risk reduction and operational efficiency.
However, the shortened settlement cycle introduces a slew of operational hurdles, particularly concerning foreign exchange (FX) trades. Nathan Vurgest from Record Financial Group anticipates FX costs to spike, especially during the late US trading hours, potentially causing disruptions in liquidity dynamics.
European stakeholders, represented by EFAMA, have raised concerns about the systemic risks posed to Europe by the accelerated US settlement timeline. The constrained window for non-US market participants to access CLS, a pivotal FX settlement system, adds to the apprehension.
Contemplating contingencies, some non-US entities are pondering establishing footholds in the US or adopting US trading hours. Additionally, the shift could trigger a surge in demand for short-term financing, thereby redistributing credit risks across financial institutions.
The ripple effects extend beyond operational logistics to impact global index funds, potentially necessitating adjustments to settlement cycles and asset compositions. Steve Fenty of State Street Global Markets suggests a potential fragmentation of settlement cycles to navigate the disparities in asset settlement timelines.
Josh Galper, of Finadium, highlights the potential reduction in equity market liquidity, underscoring the role of short selling and securities lending in bolstering market dynamics. The impending shift underscores the intricate interplay between market regulations, operational logistics, and financial stability, setting the stage for a transformative period in global finance.