(Bloomberg) — Everything will likely look normal when U.S. markets reopen next Tuesday after the long holiday weekend. The cracks are expected to appear after the close of trading and the day after.
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As the trading process for U.S. securities accelerates, cutting the time allowed to complete all trades in half to one day, a sharp rise in the number of failed trades, operational glitches and additional costs have become a concern for the industry. ing.
Spurred by the original meme stock frenzy, the Securities and Exchange Commission is pushing this transition to reduce the chance of anything going wrong between the time a trade is executed and it's cleared. . But switching to what is known as T+1 comes with its own risks.
International investors, who hold about $27 trillion in U.S. markets, face a system in which the usual way of funding U.S. trades takes longer than actually executing the trades. The unheralded parts of the trading process, such as affirmations (confirming details), correcting errors, and retrieving securities on loan, should run at least twice as fast. Global funds face a mismatch in which money flows in and out at a different rate than the assets they have to buy and sell.
And all face an immediate stress test, with several of the world's major indexes rebalancing or revealing planned reconfigurations by the end of this month.
“It's going to be a collective effort from everyone,” said Michelle Pitts, global head of custody data for Citigroup's securities services division, pointing to the possibility of an increase in failed trades across the industry. “Settlement risk will increase significantly in the first few weeks.”
“A lot of anxiety”
Under current rules, buyers of U.S. stocks have two days between hitting the “buy” button and actually handing over the proceeds of the transaction, giving sellers time to do the same. This long settlement period in such a large and sophisticated market is a holdover from the days when trades were done manually and took investors up to a week to complete.
This has been shortened over the years, but new SEC rules will shorten the May 28 settlement deadline to one day again. On and off Wall Street, major banks, asset managers, and various professional services firms are bracing for this impact.
Internal modeling at JPMorgan Chase estimates that about a quarter of the currency transactions it processes for clients will be affected. Brown Brothers Harriman & Co. has its customers run a “T+1 simulator” to identify customers with potential problems.
Financial institutions such as Société Générale SA, Citi, HSBC Holdings, UBS Asset Management and Baillie Gifford are preparing for the switch by either moving staff, reorganizing shifts or building new systems, or in some cases all three. He says he is doing all of the above.
“There's a lot of uncertainty around the technology and even the way payments actually happen,” Amy Hong, head of market structure and strategic partnerships for global banks and markets at Goldman Sachs Group, told Bloomberg. told Sellside Leaders. This month's forum. “There will be some disagreements regarding funding and there will be some exchange-related issues that will need to be resolved.”
The world of finance and investing is notoriously averse to change, and prophets always emerge whenever new rules are proposed. But for T+1, the concern is not just about Cassandra in one or two markets.
A poll conducted by the Greenwich Union in April and May found that only 9% of sell-side firms expected a smooth T+1 transition, and 38% said buy-side executives were not ready. 28% said they believed trading platforms were not sufficiently prepared. Ready. Almost one-fifth expect major disruption due to “many or significant problems.”
The consensus view is that failed transactions, where sellers fail to deliver securities or buyers fail to make payments, are on the rise. The question is how large and sustained that rise will be.
Payment failures are generally a minor feature of modern markets and are usually caused by technical issues or human error. These can lead to regulatory penalties, loss of capital associated with the transaction, and, in very rare cases, if the transaction is large enough, the collapse of the parties to the transaction.
The T+1 method increases the probability of failure as the time frame decreases, increasing the chance of errors and decreasing the opportunity to correct them. Most importantly, it becomes difficult for buyers and sellers to ensure that their funds and securities are ready.
The $7.5 trillion daily foreign exchange market is the flashpoint for this change, as foreign exchange transactions are typically settled on a T+2 basis. Foreign investors buying U.S. stocks will soon need to either come up with dollars or find them within a day in an arena that takes two days.
friday fear
Baillie Gifford, the £225 billion ($285 billion) investment firm, has hired two people from its headquarters in Edinburgh, more than 3,200 miles from Wall Street, to ensure the firm continues to operate after the U.S. stock market closes at 4 p.m. It moved its traders to New York and strengthened its payments desk.
Important for asset managers seeking dollars to raise capital as T+1 Shift and CLS Group, a market-centric platform that settles more than $6 trillion in currency trades daily, have a 6 p.m. deadline It will be a great time. US trading. However, this period also marks the beginning of what is known in the forex industry as the “witching hour” due to the famous lack of liquidity.
“If you look at the bid spreads, they're generally tight throughout the day, but from about 5pm to 8pm Eastern time, the spreads just widen,” said Brendan Burke, managing director at BBH. “It's as simple as having less liquidity in the market because banks are understaffed.”
Baillie Gifford has urged U.S. regulators to force banks to extend foreign exchange trading hours and continue providing liquidity until at least 6pm five days a week in New York. Adam Conn, head of trading, said the firm has been trading as if T+1 was already in effect to ensure everything goes smoothly since the staff change in January.
“It's about trying to reduce the additional operational risk that falls on asset managers,” Kone said, adding that the time frame for the issue to be resolved after U.S. markets close is “very short.”
Friday afternoons have emerged as a particular cause for concern, as foreign exchange markets are closed for the weekend. This usually means liquidity is at its lowest right before the US joins Europe and Asia in closing. “Both the buy-side and the sell-side don't really know what's going to happen” in the post-changeover period, said Brijen Puri, JPMorgan's head of global exchange services.
“Once we have more data about what's happening in that time zone, at that point banks and asset managers may decide to offer more coverage,” Puri said. Ta. “Just as there is a night desk, there may be a Friday night desk.”
The Association of Foreign Exchange Professionals expects this problem to become more acute around month-end, quarter-end and public holidays, posing the risk of “significantly higher volatility and wider spreads.” Foreign investors who purchase US securities before the local holiday will effectively face a T+0 settlement.
“There are 25 to 30 days a year where there are potentially specific challenges,” said Vincent Bonamy, head of global intermediation services at HSBC. He organized staffing around “select holidays globally” to help provide liquidity to customers.
The European Fund Asset Management Association estimates that despite all its preparations, up to $70 billion of its members' daily currency transactions may miss the next day's CLS settlement deadline. Companies without a U.S. presence can use workarounds such as buying dollars in advance or outsourcing currency trading, but both approaches come with additional costs and challenges.
“Liquidity is going to be a big issue,” said Natsumi Matsuba, head of foreign exchange trading and portfolio management at Russell Investments in Seattle. “It will be a learning experience for everyone.”
double jeopardy
The move to T+1 comes after the 2021 meme stock boom forced retail investor platforms such as Robinhood to restrict trading in certain securities at the broker-dealer level in the U.S. stock market. The aim is to reduce the risk of This was because the rapid increase in trading volume meant that the amount of collateral needed to be posted in cash to cover the transactions during the two-day settlement process could exceed the amount that could be paid.
A T+1 switch should alleviate such concerns as less collateral is required across the day's risk. Domestic liquidity may also improve as cash in the market is recycled more quickly. However, the process required to complete each transaction is taxing.
The new rules require affirmations to be completed by 9pm in New York on the trading day. The positivity rate rose to 83.5% in April from 74.95% the previous month, according to data from Depository Trust & Clearing Corp., which oversees post-trade functions for most U.S. securities transactions.
The firm said this represents “significant progress” as the rollout of T+1 approaches, but with only a few weeks to go, it falls short of DTCC's own target of a 90% same-day positivity rate.
“When you consider that the market closes at 4 p.m. and you have to sign off by 9 p.m., it doesn't really shorten it to 24 hours, it actually shortens it to five hours,” Citi's Pitts said. Ta.
In preparation for the changeover, DTCC is conducting regular tests for nine months until the end of May. This includes trading from Friday (still using T+2) and next Tuesday (T+1), allowing the industry to respond to “double settlement days” like next Wednesday when trading volumes spike. It also includes an evaluation of whether it is possible. Must be completed at the same time.
Val Wotton, Director of Institutional Transaction Processing, said DTCC has increased its staff in advance of the transition, and plans for this weekend include having members of its technical and product teams closely track trade flow. It includes “monitoring events”. “We are confident in our ability to support volume from day one,” he said.
chain twist
The US switch to T+1 means leaving other jurisdictions behind, which is a headache for many investment vehicles operating across borders. Mexican and Canadian markets will also move to one-day payments next week, while other markets, including Europe, remain in a slow cycle.
Under the new system, U.S. investors who sell an ETF will receive cash for their shares within one day, but proceeds from the sale of the fund's underlying international stocks could take at least two days to arrive. is high. And when most foreign investors buy a fund containing U.S. stocks, the new underlying assets should be paid out in one day, even if the ETF shares take more than two days to pay out.
This is the kind of mismatch that has existed before in different regions, but it is the first on this scale and risks adding friction and operational costs to many investment vehicles.
Adding to the pressure, the T+1 switch comes just days before the MSCI Inc. index rebalances with corresponding funds around the world in preparation for a reshuffle of holdings next weekend. is. It was the “biggest trading day of the year” for UBS Asset Management, said Lynn Challenger, head of trading at the $1.7 trillion management firm.
Challenger said “we expect even more funding needs” on rebalancing day. He said the problem could be further exacerbated by the fact that much of the order flow could be heading in the same direction. “We are talking to brokers to make sure we have the funds,” he said.
To prepare for T+1 more generally, Challenger said UBS Asset has trained additional US staff to generate foreign exchange orders and built new trading processes to facilitate same-day settlements. .
Many financial companies have strong transition plans of this type in place. The Coalition Greenwich survey showed that most sales respondents are not concerned about the readiness of their desks. But each institution is linked to the others through a series of trade processes, meaning any kinks in that chain can spell trouble for well-prepared institutions.
“The sell side thinks there's going to be a problem, but it's going to be somebody's fault,” said Jesse Forster, senior market structure and technology analyst at Coalition Greenwich. “We may see a lot of criticism over the next few months.”
–With assistance from Katherine Doherty, Isabel Lee, Carter Johnson and Alice Gledhill.
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