Laura Matthews and Caroline Mandl
NEW YORK (Reuters) – U.S. trading moved to a shorter settlement cycle for securities trades on Tuesday, leaving investors and regulators wary of increased trading glitches and other disruptions in the world’s largest financial market in the coming days.
Investors in U.S. stocks, corporate and municipal bonds and other securities must now settle their transactions one business day after the trade, rather than two, to comply with a rule change adopted last February by the U.S. Securities and Exchange Commission.
Regulators hope faster resolution will reduce risks and improve efficiency. They were looking for a new standard, commonly referred to as T+1, after the 2021 trading frenzy surrounding “meme stock” GameStop (NYSE:) highlighted the need to reduce counterparty risk and improve capital efficiency and liquidity in securities transactions.
“Shortening the settlement cycle … will help markets because time is money and time is risk,” SEC Chairman Gary Gensler said in a statement.
However, this comes with risks because companies have less time to save up dollars to buy shares, call back borrowed shares or correct transaction errors, which can increase the risk of settlement failures and raise transaction costs.
The big test for the market will come on Wednesday when trades entered into last Friday, when T+2 was still in effect, will be settled on Tuesday, the first day of T+1. This is expected to lead to increased volumes.
“Tomorrow and the day after tomorrow are important days,” said John Oleon, managing director of prime brokerage Clear Street. “It comes down to customer distribution and confirmations, and that’s not going to go away in the next few days.”
Settlement is the process of transferring securities or funds from one party to another after a transaction has been concluded. It occurs after clearing and is operated by the Depository Trust Company, a subsidiary of the Depository Trust and Clearing Corporation.
Trades fail if the buyer or seller fails to meet their trading obligations by the settlement date, which can result in losses, fines and reputational damage.
The US will follow India and China, where a faster settlement already exists. Canada, Mexico, Argentina and Jamaica implemented it on Monday.
“Hopefully we’ll start to see the expected benefit, which is reduced risk, reduced margin or collateral, and we hope that happens without a major impact on settlement rates,” R.J. said. Rondini. Director of Securities Operations at the Investment Company Institute.
TRADING FAILURES
Market participants such as banks, depositories, asset managers and regulators worked over the weekend to ensure a smooth transition.
“To date, all T+1 implementation activities have been completed as planned,” said Jeff Naylor, director of industry operations for ICI.
An increase in trading failures is initially expected, although the DTCC and market participants have been conducting a series of tests for several months.
“It’s completely normal that we’ll see some small changes in settlement rates… but we expect settlement rates to quickly return to normal,” Rondini said.
Further failures could result in “tens of millions of dollars in fines every day,” BNY Mellon (NYSE:) said.
According to research firm ValueExchange, on average market participants expect the failure rate to increase from 2.9% currently to 4.1% following the implementation of T+1.
Sifma expects the increase in denials to be minimal, and the SEC has said a short-term increase is possible.
Ted O’Connor, senior vice president and head of Treasury sales at financial technology company Arcesium, said some market participants are keeping increased cash on hand to deal with problems that could arise from the change.
“We will be keeping a close eye on mid-market and small business managers as they tend to rely more on manual processes,” he said.
Brian Steele, president of clearing and securities services at DTCC, said more than 90% of the industry has participated in the process since testing began in August 2023. The industry’s transition to T still retains “deep muscle memory.” +2 in 2017, he said.
RISK/REWARD
Traders say the shift will reduce systemic risk as it reduces counterparty risks, improves liquidity and reduces margin and collateral requirements.
However, some market participants are concerned that the change could shift risks to other parts of the capital markets, such as trading-related foreign exchanges for transaction financing and securities lending.
Foreign investors holding about $27 trillion in U.S. stocks and bonds must buy dollars to trade those assets. Previously, they had a whole day to search for currency.
Natsumi Matsuba, head of foreign exchange trading and portfolio management at Russell Investments, said the firm used small trades in the weeks before implementation to test market liquidity after hours, at a time when it is notoriously rare to see how many banks counterparties extend trading hours on weekends. .
Market participants may have to rely on overnight funding markets to bridge liquidity shortfalls caused by different asset settlement times, which could prove costly given that short-term funding rates exceed 5%.
The move also requires exchange-traded funds (ETFs) to juggle multiple jurisdictional and capital requirements.
Gerard Walsh, presenter Northern Trust Global Capital Markets Client Solutions (NASDAQ:) said managers need to be aware of the potential range of solutions available.
“I don’t think any of that will show up in Week 1,” Walsh said.