The industry has been quick to hail the transition to T+1 settlement for US equities a success, voicing a sentiment that can certainly be considered accurate for the ‘flip the switch’ moment in the opening days of the cycle shortening.
The lack of major issues and positive data signals on affirmation and fail rates will come as a huge sigh of relief to the industry, which is benefitting from an over-preparedness strategy and its highly alert, round-the-clock ‘war room’ and ‘command centres’.
“It was very smooth and someone in our office likened it to Y2K, which I took umbrage with because I think the reason it was smooth was because the industry got its act together and made sure that everybody knew what they had to do and when they had to do it. I think that really folded into a very smooth transition,” said one operations executive from an asset manager, speaking on the T+1 War Rooms initiative launched by The TRADE’s sister publication, Global Custodian.
“We don’t often get the chance to pat ourselves on the back, so you might as well take this opportunity.”
Another buy-side source said: “I think as much as we can make a joke that it was kind of a non-event, that shouldn’t take away from the planning, preparation, full scale project teams that went on for a year or so beforehand.”
For such a far-reaching market structure change however, the true measure of success will be measured in weeks and months – not just for affirmation and fail rates, but across geographies, client types and adjacent functions such as ETFs, FX and securities lending. Further tests will also arise through upcoming public holidays and market participants exiting this phase of ‘hyper focus’ on the matter.
“It’s more the longer-term items of extending settlement stress testing, your custodian’s ability to afford you an overdraft, seeing what the claims do in this quarter compared to last quarter,” said another asset manager on the discussion being held under Chatham House rules. “It’s not the day-to-day so much now, but more those rainy-day scenarios and seeing how the market reacts to that along with your custodian and your counterparts.”
What the data says so far
The first three days saw incrementally increasing affirmation rates – 92.76%, 94.55% and 94.66%, respectively – while fail rates stayed consistent with those seen in a T+2 environment over day one and two. However, affirmations then dipped to 91.26% on day four, while fails saw an uptick over days three and four.
What is important to remember though, is that within the opening week there was both a double settlement day – whereby T+2 and T+1 transactions were settling together – along with the MSCI rebalancing, an event which many believed would be a stumbling block for the new operational setup for US equities.
What the data for Monday 3 June has shown us is that the affirmation rates jumped back up to 93.65%, while fail rates were the lowest since the transition. Despite this, Reuters, Bloomberg and Financial News quickly jumped on the spike in fail rates through alarmist headlines on 31 May. One day of fail rates is not indicative however, especially when that day coincided with a major market event – in this case the MSCI rebalancing on 31 May. Many market experts look at monthly, or three-monthly averages, for an indication.
Outside of the quantitative data, the feedback both on the record and behind closed doors from the securities industry has been overwhelmingly positive.
One source at a leading custodian said that the double settlement date didn’t cause issues despite an increase in trades requiring repair and a notional increase. Meanwhile, they noted the MSCI rebalance saw a 50% increase in volumes, but – again – no concerns and it “all went smoothly”.
In addition, SEC chair Gary Gensler, along with the DTCC and SIFMA, were quick to herald the transition a success.
What else we’re hearing
The data right now is so positive that fail rates on certain days are eclipsing those seen in a T+2 environment, however it’s almost inevitable that this purple patch will have days – and weeks, even – where it comes crashing down.
A survey by The ValueExchange in January saw market participants predict the fails rate would eventually rise to 4.1%, so could we be seeing a temporary quiet before the storm?
“Most have put in place contingency support to deal with the switchover but that isn’t a long-term solution – and the more markets that move to T+1, the more pressure there will be to move away from manual and batch-based processing,” said Virginie O’Shea, founder and CEO of Firebrand Research. “The costs are higher than anticipated too due to the service providers charging for lending and overdraft facilities for funding support.”
Two tests have been passed thus far, but what would a spate of market volatility mean for participants? We have already seen spikes in fails during turbulent markets, and with so many elections on the near horizon – along with upcoming public holidays – it’s not out of the question to foresee some tough market conditions – which could serve as a true measure of industry readiness around T+1.
In addition, we should begin to hear reports of how parallel functions are faring. CLS has said it will monitor the impact of the shift to T+1 and make assessments in both June and September through “temperature checks”.
“It’s difficult to ascertain exactly what might be related to T+1, because we don’t have that level of detail, but we can look around certain parameters. If we found that actually volumes and values stay exactly the same, then we can safely assume that the impact has been negligible. Obviously, if impacted volumes are much higher than expected we’ll reassess it sooner,” Lisa Danino-Lewis, chief growth officer at CLS told The TRADE and Global Custodian earlier this year.
In addition, the impacts on securities lending will be one to watch – along with how the ETF markets have adjusted. There may also be some impacts on corporate actions which soon come to light.
“The real test is the test of time,” said one custodian, speaking under the condition of anonymity. “We will continue to monitor affirmation rates, settlement rates, non-STP trades and funding changes to ensure the initial behavioural partners maintain into BAU processing.”