T+1 The P&L of change
“T+1 means a reduction in counterparty risk in return for higher operational risks and greater liquidity risk. Overall the risks will be higher.”
At its heart, the transition to T+1 will deliver funding and margining improvements to everyone who trades North American securities. In return, it will require all investors to process and settle their trades twice as fast as they do today – meaning an almost unavoidable increase in operational risk as processes are accelerated. In addition, with funding flows shifting and the likelihood of failing trades increasing, liquidity risk also looks set to increase.
For many back offices, this means a net increase in the risks inherent in trading North American securities. For some, it also creates new opportunities – especially for custodians and broker-dealers.
So how will T+1 impact the Asian back office?
Our industry roundtable leaders cited these key concerns in their own preparations for T+1
1.
What is affirmation?
Asian investors have historically had little involvement in (or awareness of) the US trade affirmation process, with affirmation rates being very low from Asia into the US. However, with the Securities and Exchange Commission (SEC) mandating a 100% affirmation rate for all US trades by 21:00 ET after the move to T+1, the US brokers who service Asian investors will be pushing hard to drive a change in these established behaviours. For those in Asia, this means either relying on global custodians (many of whom provide an auto-affirmation service for their clients) or on their connecting to the DTCC’s CTM platform before May 2024.
2.
The end of bespoke instructions
Faced with such short timeframes for trade processing, Asian brokers and investors will have no choice but to ensure that their communications can all be handled on a straight-through-processing basis. Inevitably this means that they will have to dispense with all manual and non-standard forms of trade communication (e.g., allocations or trade confirmations by email) and ensure that all messaging is coherent with global standards (such as FIX or SWIFT messaging formats).
3.
Funding – from pre-funding to credit?
For many Asian wealth and retail investors, the question of trade funding looks set to become an issue. Under a T+1 environment, Asian investors will have to ensure that their brokers have received all trade funding on the same day as their trade order (i.e. T+0). This may not appear to be a significant shift for many (as most retail and wealth trading today works on a pre-funding basis), but this shift effectively removes all contingency for any potential errors in cash transfers. With an increased likelihood of trade failures due to a lack of client funds, Asian brokers will have to decide whether to pass on failing trades to clients – or to fund the trades and increase their credit exposures.
4.
Who will manage FX at 4-6am HKT?
Even when funding is received from investors, a pressing question is how these funds will be converted into US or Canadian dollars in time for the relevant market deadlines. With little likelihood of having anyone working in Hong Kong or Singapore at 4am to manage FX trades, Asian brokers will be compelled either to pre-fund their trades in USD or to receive only USD funding from their clients.
5.
Securities lending recalls: do we have time?
For securities out on loan, Asian back offices will have to work extremely efficiently in order to instruct, process and reconcile recalls when they are required to facilitate a settlement. Given time differences, Asian back offices will have only one working day to complete an entire recall process and ensure that stocks are ready for settlement – creating a huge pressure on numerous processes. In the short term, this looks set to reduce willingness to lend by Asian counterparties and hence may impact the overall liquidity of (hard to borrow) North American stocks between Asian investors.
6.
Cash and securities ledger postings: Overnight
Assuming all goes smoothly (the US dollar funding is received and securities recalls completed successfully) the question of cash and securities posting into Asian brokers’ accounts is then the next challenge. With many brokerage back office systems in Hong Kong, Singapore and Japan working on batch processing (and overnight downtime periods), many organisations will be effectively blind to whether cash funding is available, whether a security has been successfully recalled and whether a trade is ready to settle. Inevitably, these brokers will need to find alternative platforms to provide real-time visibility on cash and securities balances.
7.
Custodian cut off times
Unfortunately, few Asian investors have the luxury of contending only with market deadlines for settlement. Trading and settling through global custodians in many cases, the majority of Asian investors and brokers will see the time available to manage their T+1 settlements further limited by the cut offs required by global custodians. What was a 21:00 ET market deadline may become a 19:00 ET custodian cutoff, or even earlier if investors rely on multi-tier custody structures (where more than one custodian is involved). With each hour taken away by custodians, the pressure on Asian back offices will grow – driving many to consider transferring their settlement activity to custodians with direct, onshore presence in North America.
8.
Saturday is the new Friday: Working on HK holidays and weekends
Who will safely manage trade settlement for any contentious trades on the North American Friday afternoon? The smooth processing of trade exceptions at the end of the trading week looks set to inevitably require Asian back offices to be active well into their Saturday mornings – or on Asian holidays when the North American markets remain open. Whilst remote working means that physical office presence may be optional in these cases, there is little doubt that the removal of one day to handle errors under T+1 will have a deep impact on back office resourcing in Asia.
