According to as number of buy-side firms the biggest lesson learned from the US move to T+1 was the importance of automation.
There has been a realisation that firms cannot continue to throw bodies at the problem or be invested in low-cost locations forever. Instead, participants have to start looking at their workflow, especially in Europe where there is significant fragmentation. Everyone does the same thing slightly differently and that has always made cross-border settlement problematic. The challenge is only going to be amplified by T+1 unless the industry starts to invest more in automation.
Coming from a banking background, DTCC’s Johnson is used to back-office processes like settlement playing being less of a priority than front office processes when it comes to budgets. But when a big industry change like T+1 is backed by a clear regulatory mandate, it gives the operations teams the perfect platform to secure the funding and the technology resources they need.
According to Pinnington-Mannan, the US move to T+1 has not yet been a catalyst for a widespread wave of automation. “There have been some a lot of firms in the US who have invested heavily in compensatory processes and are hiring people to support it. But I don’t think you can get away with that in Europe because of the fragmentation and the complexity of the process. So that that has to be addressed. We need to consider that not all market participants implemented T1 in a uniform way.
But, T+1 has not been implemented in a uniform way and was uneven in its approach to automating those core processes.”
For Healy-Waters, there was no one big change that had to be made for T+1, rather there were hundreds of small changes that had to be made, to either batch timings, manual touch points and processes that had to be removed from the trade flow.”
For Pinnington-Mannan, it is about looking beyond T+1 and what will be needed in the future and not seeing T+1 as the end point and supplementing it with people.
Companies also need to take into account any vendor dependencies, said Pinnington-Mannan. “From an infrastructure perspective, you may have everything nailed down and aligned. But a large bank or hedge fund might have dependency on an OMS platform or a third-party vendor. And if they can’t work in lockstep with your speed of moving to market, then that brings its own challenges too.”
T+1 has not necessarily changed the technology infrastructure behind the post-trade process but it has changed the sense of behaviour and process efficiency said Mohindra. “If we had not moved to T+1, we would not be having this conversation about securities lending recalls or FX.
“Those are lessons we can eventually take into the T+0 world because T+1 is about exercising the system, making it fitter and healthier so that it can be even faster at some point. We might eventually rip up the technology to go to T+0 but we will take forward the lessons learned from T+1 because removing the only remaining business day between trading and settlement, is a big deal,.” said Mohindra.
There is also a dependency on the central securities depositaries ( CSDs) and International CSDs as well, said Healy-Waters. “We can automate as much as we want internally and we have in our middle-office, but we’re tied by what the market does when it sends us updates or when they implement partial release. We are all dependent on that trade information coming back and it is still too slow.”
As Ware said: if T+1 will align behaviour, then T+0 will align technology. “If we do move to a new world of technology, everyone’s going to need to be on the same version of that for it to work. You can’t have one blockchain here, one blockchain there. It needs to be a seamless process. T+1 is the right direction and the right thing to do and hopefully we will more global alignment around behaviour and the way we process securities in the meantime.”
The automation argument was always there, said Johnson. “Back when T+2 was happening across Europe, the concern was that firms would be able to gain the system because some were stuck on T+3 and that created a one-day funding gap. But the market came together really well and worked out what needed to be done, said Johnson. .”
Technology costs and system upgrade requirements:
While there may be some benefits to a shortened settlement cycle, what will be the costs involved in terms of system upgrades, new technology requirements and other operational expenses? And who will ultimately bear these costs? Will participants absorb these costs themselves, potentially leading to a more consolidated post-trade market? Or will they get passed down the transaction chain, ending ultimately with the investor?
According to Ware, the cost will vary depending on the operating models used by different companies and where they sit within the transaction chain. But for those firms that see T+1 as an opportunity to be more efficient and reduce their operational risk, there are countless choices in terms of third-party vendors, proprietary platforms and different applications. “Now is the time to build on the foundations we set with the US T+1 efforts and to understand and evaluate what else is required for the EU and UK where there is potentially more complexity, and then implement any changes,.” said Ware.
For some firms, there are still some regulatory rules that need to be finalised before a T+1 budget can be established. “Our T+1 program officially kicks off in Q1 2025,” said Healy-Waters. “For now, we’ve been participating and understanding but our budget is aligned to start next year. There is work we were doing already in the US in terms of manual touch points, digital transformation and operational efficiencies but we need to see what recommendations come out and what new requirements are mandated.”
There are numerous moving parts that could throw a spanner in the works and create extra cost for firms. There is also the need to maintain connectivity with prime brokers, custodians and other service providers in order to have more timely status upgrades and future services like inventory management tools, said Johnson. “That is where you need to do analysis on the various manual touch points that create friction and whether it makes sense to automate.”
There are some mandatory changes that will need to be made around batch timings and reference data, said Mohindra. “But there is also an opportunity to rethink the way we do some things. We are seeing some solutions in Europe that remove the need for multiple touch points and improve the quality of the data so that when we move to T+1, it will be a lot more seamless.
“We have three years so that is a conversation we are having with clients such that they can start planning their post-trade strategy and budget and thus they can walk casually into T+1 rather than struggling to get to that point,” said Mohindra.
It does give everyone the time to reimagine how we do things, said Johnson. “If you were to rip everything out and start from scratch, the process would look different to how it looks today. We’ve been working with clients to identify their post-trade friction points. In the US, the depository and the affirmation process are housed within the same entity infrastructure, DTCC.In the US we have the ability to do that because we own the infrastructure – the CSD, the CCP, the matching platform – it’s all one vertical.
“So that makes it easier to incorporate. But ultimately it comes down to the appetite to change behaviour, the appetite to automate more and to reduce risk. The custodians may be a sticking point because they have a fiduciary duty to run an inventory check before the trade goes down to the CSD. But is there an automated way to do this?” asked Johnson.
As far as Healy-Waters is concerned, the industry must find the appetite to do so. If not, the efficiencies required in a T+1 environment will not be achieved.
There also needs to be some collaboration, added Ware. “You cannot fix it on your own, so you have to work with your different stakeholders, brokers, custodians and other counterparties.”
The custodians play an intrinsic part in the process but in the US T+1 move, they kept their head below the parapet, said Johnson, because the SEC focused on the sell-side.
According to Healy-Waters, the sell-side had a lot of changes to make in the US but custodians typically use different systems in different regions because their systems are not the same.
So what was the reason that the US pursued T+1 in the first place? Partly, it was the role of the SEC chairman Gary Gensler who had been vocal about the need to move to T+1 and simply wanted tonot get it done, said Healy-Waters. But in Europe it is different, there isn’t a single CSD so ESMA has a bigger job on its hands than both the US and the UK which has a vertical structure in terms of an exchange, a CSD and a CCP that are all linked.
“But as soon as you open the floodgates to the EU, then you’ve got that whole raft of different participants all doing the same thing, but in their own nuanced way,” says Pinnington-Mannan. “So the EU piece is going to take a lot of thought around alignment with custodians.”
Tokenisation:
One of the criticisms levelled at the move to T+1 is that it is diverting resources away from other projects like tokenisation, which begs the question – should we instead be focusing on more radical long-term changes like tokenisation instead of spending millions to shorten the settlement cycle. Or will the move to T+1 necessitate more automation and STP, which will ultimately help drive the development of tokenisation.
For Johnson, it is the latter. “We all have very similar technology stacks and architecture and the industry conversation is how we qetget a trade from A to B as quickly as possible. At the end of the day, it doesn’t matter what asset class it is, it is just money in, money out. So how do you make that as simple as possible without having to go around and around.”
Arguably, it is possible to do this day, said Johnson. However, it is requires alignment across all infrastructure and from all participants. “What the move to T+1 will do is shine a spotlight on where the friction is in the current structure and amplify the conversation on why we are not doing this. We have the perfect opportunity to modernise now, so why would we not? There is no benefit to not doing it.”
Atomic settlement, via tokenisation, and shortening the current settlement cycle are two different things, said Ware. “You can meet T+1 through tactical movers and doing the ‘bare mimimum’. But when it comes to radical market change and putting things on the blockchain, that’s not possible by just tweaking the existing models. They have to be completely redesigned.”
Right now, it is possible to book and settle a trade at T+1, said Healy-Waters. The problem is that it is not possible to settle that trade all the way through on the same timescale. “We still can’t the matching right and other fundamentals. they have to be fixed to enable things like tokenisation.”
It is also a question of scale, said Ware. “You can settle at T+0 today but if you wanted to do it at scale, all those complexities just aggregate into something that is unmanageable.”
Mohindra called the move like moving the speed limit from 70mph to 140 mph overnight. “While the cars are capable of it, the driver behaviour isn’t there, the education isn’t there and we haven’t fixed all the potholes in the road. So while you could achieve it technically, I would not recommend it because there will be too many accidents.”
Instead, there needs to be more pilot projects, said Mohindra. Continuing the automobile analogies, he referred to the Formula 1 races in urban centres like Las Vegas, Singapore or Monaco where they turn the streets into a racing track for a weekend and it becomes possible to do 140 mph on a bend. “It is a closed circuit, restricted to highly trained F1 drivers. But we are not ready to have the same thing at mass-market level. It’s going to take time,” said Mohindra.
“You don’t just suddenly put someone on the moon,” noted Ware. “And you don’t suddenly have someone driving an F1 car at ridiculous speeds. You have to do the work to get there.”
There is also a hype around tokenisation that has to be taken into account, said Pinnington-Mannan. “There are different fintechs pitching to us every month about using distributed ledgers but many of them overpromise and underdeliver and we waste a lot of time and energy engaging with them. It sounds great theoretically but it will only work if you have mass participation. Right now, we will have to go along on the journey but see how it evolves.”
In addition, as Ware said, there will still be the need for interaction between traditional and atomic settlement, even if you do have fully functioning tokenisation.
But it will at least be possible to lay the foundations for tokenisation through the work done on T+1, said Mohindra. He used the example of the unique transaction identifier in the world of derivatives. “We don’t use it yet at a wholesale level in the securities market but it is a great way to introduce more transparency and standardisation and to lay the foundation for machine-to-machine communication and exception resolution. And it is those types of solutions that will allows us to develop things like tokenisation and DLT settlement,” said Mohindra.
There also needs to be some realism when it comes to tokenisation, said Johnson. “For example, the UTR is just a data field that goes on a transaction message, so it’s realistic. We then have to look at different operating models around the world.”
For example, the US clearing model allows for the buy-side to access clearing workflows,allows for the buyside, which don’t exist in the Europe securities markets today. And according to Johnson, it is possible to unlock more opportunities from a risk perspective. “You still have CSDs doing a pre-match when a matching platform has already done that. So you have a duplication of effort. There are a number of realistic things that can be done and there needs to be a conversation to understand what should be done first rather than jumping into a brand- new technology like tokenisation that hasn’t been tried and tested.”
Participants:
Jaime Healy-Waters, Citigroup, T+1 project sponsor in the US
Sachin Mohindra, executive director, client and market solutions, Goldman Sachs
Andrew Pinnington-Mannan, head of client strategy, DTCC
Martin Ware, European head of counterparty operations at Vanguard
Matt Johnson, director, ITP Industry Relations, DTCC
Moderated by Mark Latham, deputy editor, Funds Europe
