More and more global financial systems are embracing the switch from T+2 to T+1 settlements, but why should financial institutions and services take note of this seismic shift?
Writing for Payment Expert, Alan Verschoyle-King – Chief Commercial Officer at RTGS.global – details why T+1 is a pivotal landmark for payment and asset settlements, who has already made the switch, and what its impact may lead to.
With the Securities and Exchange Commission’s (SEC) T+1 settlement update happening yesterday (28 May), the global financial landscape braces for impact.
From corporate treasurers to global banks, everyone will need to adapt cash management, funding, and foreign exchange strategies to this shorter settlement cycle. Smaller firms and emerging markets, with limited resources and less advanced infrastructure, may face bigger challenges adapting.
Canada and Mexico’s alignment with the US timeline highlights the need for swift preparation in these regions. The pressure to adopt T+1 could extend to Europe and Asia, currently on a T+2 cycle, if they want to stay competitive and attract global investors.
Collaboration is key to maximising the benefits of this shift. By working together, market participants can enhance efficiency, minimise risks, and boost cross-border investment flows.
Who is best prepared?
The current state of readiness among corporate treasurers and banks varies significantly. Some have proactively begun assessing their systems, processes and resources to identify gaps and areas for improvement, while others have been taking a wait-and-see approach, delaying preparations until closer to the implementation date.
This varying level of awareness and understanding of the implications of T+1 settlement leads to the widening gap we can see between those who are well-prepared and those who are not (yet).
Corporate treasurers and their banks face numerous challenges in adapting to the new settlement cycle. Updating legacy systems and integrating new technologies to support faster trade processing and reconciliation is a complex and time-consuming process. Additionally, aligning agreements with counterparties and service providers to meet T+1 requirements is a challenging and resource-intensive process.
Organisations that are not adequately prepared risk failed trades, potential regulatory penalties and fines for non-compliance. Moreover, they may find themselves at a competitive disadvantage relative to peers who have successfully adapted to the new settlement cycle.
As a result of heightened risk perceptions, these companies and banks may also face reduced access to liquidity and higher borrowing costs, further compounding the challenges they face in the new T+1 settlement environment.
The biggest barriers to global alignment
The potential misalignment of securities and cash settlement in the upcoming move to T+1 presents a significant challenge for market participants, particularly in relation to cross-border trades, where technology limitations and geographical time differences can exacerbate the difficulties in conducting the necessary FX transactions to support T+1 securities settlement.
For instance, Asian markets may find it especially challenging to align their FX transactions with the compressed settlement timeline. If an Asian investor needs to execute an FX transaction to facilitate a T+1 securities trade in the US market, they may find that their FX window with their bank has already closed due to time zone differences, leading to increased operational risk and potential settlement failures.
The impact of this issue extends beyond individual trades, affecting cross-border liquidity management as a whole. Companies and banks may find themselves in a position where they need to borrow foreign currency at short notice and at non-competitive prices to meet their settlement obligations. This not only increases the cost of doing business but increases the exposure to additional liquidity risk.
To address these challenges, the adoption of instant settlement technology can play a crucial role in supporting T+1 requirements. Market participants can, using this technology, streamline their FX processes and reduce the risks associated with any settlement misalignment. However, widespread adoption of this technology will require planned investment and collaboration among market participants and regulators alike.
What happens next?
The transition to T+1 settlement is just the beginning.
As emerging technologies continue to evolve, their potential to revolutionise cross-border payments and settlement processes becomes increasingly evident. The move towards T+0, or real-time, settlement, seems inevitable, driven by growing customer demands for faster, more efficient transactions and mounting regulatory pressure for greater transparency and risk reduction.
To keep pace with these developments, financial institutions will need to make significant investments in upgrading their technology infrastructure. Legacy systems and manual processes will need to be replaced, and investments in new technology will be critical in enabling those financial institutions to handle the increased volume and speed of transactions in an eventual T+0 settlement environment.
So, the path to real-time settlement is not without its challenges. The current correspondent banking model, which has long been the backbone of cross-border transaction settlement, will need to be re-evaluated to accommodate instant settlement and to manage the associated risks effectively. Financial institutions will need to find a delicate balance between business as usual and needing to ensure that robust risk management practices have been put in place.
To navigate these challenges successfully, global collaboration and standardisation will be key. Regulators, financial institutions and industry bodies must work together to establish common frameworks, protocols and best practices that will facilitate seamless cross-border transaction settlement whilst mitigating risks effectively.
