Shortening the Settlement Cycle in Equities Trading - Securities Services (2024)

Shortening the Settlement Cycle in Equities Trading

Alan Cameron, Head of Financial Intermediaries and Corporates Client Line Advisory, Securities Services, BNP Paribas, andAman Mehta, APAC Sales Director and APAC Digital Assets Lead, Securities Services, BNP Paribas, discusscompressing the settlement cycle in securities trading with Terry Flanagan, Global Trading’s editor.

Terry Flanagan: Hello and welcome to theGlobalTradingpodcast. I’mTerry Flanagan,EditorofGlobalTrading.GlobalTradingis a Markets Media Group publication.Today we’re talking about compressing the settlement cycle in securities trading.

On 15^th February, the U.S. Securities and Exchange Commission adopted rule changes to shorten the standard settlement cycle for most broker-dealer transactions in securities from two business days after the trade date, T+2, or, to one business day, T+1. The compliance date is 28 May, 2024.

The SEC’s move is the latest in a long road in accelerating the settlement cycle worldwide. By way of background, in the U.S., settlement moved from T+5 to T+3 in 1993 and then to T+2 in 2017. In the European Union, the settlement cycle has been T+2 since 2014.Most markets in Asia are on T+2, though India recently moved to T+1 and Chinese equity markets are T+1 or even T+0.

Broadly speaking, the aim of accelerating settlement is to reduce the credit, market, and liquidity risks in securities transactions faced by market participants.

Here to make sense of it all, today I’m pleased to be joined by two experts in the space from Securities Services at BNP Paribas.

Aman Mehtais APAC Sales Director and APAC Digital Assets Lead for Securities Services at BNP Paribas. Aman is based in Hong Kong.

And we haveAlan Cameron, who is Head of Financial Intermediaries and Corporates Client Line Advisory for Securities Services at BNP Paribas. Alan is based in London.

Why shorten settlement cycles?What’s the real rationale behind this?

Alan Cameron:Iwould saythere are three main reasons for shorteningsettlement cycles. The first and the most important one is to reduce risk, and here we are talking about pre-settlement risk.Pre-settlement risk is a risk that your counter-party does not deliver onsettlement date.Pre-settlement risk increases with the time between trade date and settlement date, soreducing thattimesimply reduces risk. And if that risk has beenmargined aswith transactions being cleared at CCPs,then reducing the riskreduces the margins, andthisall for reducesthe capital required. Secondly, I think it’s fair to say that we live in a world where expectations are changing all the time, and people expect things change much more immediately.Nobody wants to wait for anything.So the idea that we should settle days afteratradeismadehas really become old hat, and it’s notin line with whatpeople are expecting, either in their business or personalfinancial situations. Finally,there is a need forglobal standards. As more and more markets move to T+1, the pressure on the remaining markets increases; it’s helpful to everyone if all marketshavethe same settlement period, especially for international investors.

Why not shorten securities settlement times?

Aman Mehta: I guess the other sideof the coin of efficiency is that wehave a reduced timeframeto complete more tasks; this includes part of the matching process, and the allocation process. As we start looking into the trading patterns of the world,which is essentiallyclientsare trying to access more markets globally,youthen have to take into accountmore thingsto doin less time, coupled with different time zones. For example, clients in Asia Pacific are trying to access to the US market.The danger this brings is an increase in operational risk. What we effectively do is we reduce pre-settlement risk, and introduce operational risk. This operational riskcan havedirect and indirect cost, but alsocanincreasecapital, when taking into account things like theRisk Weighted Assets (RWA). The other thing to consider is the situation where not all markets are harmonized in terms of settlement cycles; some are T+1, some are T+2, and some are T+3. For example, if an investor is waiting for cash from one market to pay for securities in another. If they have different settlement cycles, this then creates an overnight funding requirement based on different settlement timings. This of course has to be funded by the investors themselves, or the custodian can come in and provide that type of overnight funding. Lastly, there is a knock-on effect in other areas, such as stock lending and borrowing, where you mighthaveless time for loan recalls based on the settlement cycle.

Settlement cycles across geographic regions

Americas

Alan Cameron: From my impression, confidence is quite high in America, thatthis can all be done.Butthere is a lot to be done. There are three initial stages that firms have to go through when looking at this.Theyhave to conduct an impact assessment, then buildand mobiliseaprogramme with appropriate governance.Thirdly, they have to develop a roadmap and kick-off the project. I think most firms have done the first stage and are moving into the next step. So, they have done the impact assessment, and they are beginning to mobilise theirprogrammes. There is a lot tobe happened, sotheyreally have to get on with this. Whentheyare looking at the programmes, I think it is a good opportunity to consider automating anything that is still manual.The other thing I would say is, I would ask all my American colleagues toremembertheirinternational offices and international clientsin doing all this. Since the impact of reducing the settlement cycle isactuallymost severe the earlier in the day that you are living, it’s most severe for the Asians, followed by the Europeans, and then the Americans. There is a lot to be done. When all this is happening, the key thing is to reach out to the international clients base and the international offices; they are the areas that are really going to take the heat.

Asia

In Asia, we are proud,becausewe have T+1 and T+0 markets. The last market that moved to T+1 wasindeedIndia, whocompleted the transaction in January this year.It has been judged as a success both in terms of the actual implementation,as well as the consequences and efficiencies created. They had a relatively short time to move;itwas announced by the Securities and Exchange Board of India (SEBI) inSeptember 2021. They did really well on working very closely with the Stock Exchanges, Clearing Corporations,Depositoriesandcustodians. They agreed on adopting the risk-based implementation approach, where they implemented 11 different phases startingwith the least risky phasesand finishingin January 2023with the mostrisky and mostliquid securities.The overall feedback was that the implementation went well without any significant issues.Collectively across the Capital market associations,market participants,custodians, and the FPIs community, the response was thatmoving toT+1 allows for afaster flow of capital and lesser exposure for FPIs.What we have learnedthisis that strong market advocacy is the key, there aremerits ofhavinga phased approach andthe benefits ofmoving to shortened settlement cycles can be achieved and materialised.

Now, let’smove on to Stock Connect. Stock Connect has gone one step further;we have the ability tohas partiallysettledon T+0 markets. This settlement cycle is in line with the onshore cycle of China, where they also have T+0, but themechanismis a little bit different. In China, it is essentially a pre-funded market where there is zero tolerance of fails. So, once aninstruction for settlementis in place, it settles. On the other hand, Stock Connect has separatedcash and securities legs,with securities settling on T+0 and cash settling on T+1. On top of that,you also have the pre-execution check. The result is an intrinsic overnight funding requirement,and the need for a seamless operating modelespeciallyif you are a brokertrying to link between clients who are expecting cash the moment they deliver their securities, who they need to have access to that funding. We have many clients on our platformviaThird Party Clearing, wherewe helpthem with both the funding and the STP operating model.For Investors, they need an STP operating model with minimal touch pointsgiventhereducedtimeframe for settlement. This is where we help with the Multi Approved Partner Broker model, which isessentiallya multi-brokerExecution-to-Custodymodelfor Stock Connect.

Lastly, I want to talk about clients in Asia Pacific, who accessmarkets globally. We really need to think about the reduced latency and increasedoperational need for this type of clients, as they often sit in time zones that are completely different to the market in which they are booking activity. This is where the keythatthey have someone they can rely on as their partners. This is where we come in. We do the heavy lifting on their behalf and help bring them with solutions such as the fullExecution-to-Custody model, so that they can access markets globally with minimal operational intervention.

Europe

Alan Cameron: In Europe, it is more a question of “how” and “when” rather than “if”. There is a broad acceptance, so this is something that will give thementhusiasm even if somewhatis muted. It really splits into the UK and the European Union. In the European Union, there has been some individual marketssoundings, but thereisnothing really substantial yet. TheAssociationOfFinancialMarketsin Europe, which is our industry body,has reached out to other industry bodies to start planningand all the work that has to be done.They have written a very good paper on this that I would recommend.But it’s not thatfar advancedfor theEuropean Unionyet. The UK is a little bit different; thereis a political angle to this. Shortening settlement cycle is actually mentioned inthe government’sEdinburgh Reformspackage, and the treasury has put together a task force to look into how this can be achieved. The political angle is that the government is keen to show that since Brexit, the UK can movefaster than European Union. So, I think that this is all going to be happened first in the UK, and then in therest of Europe.

Role of the asset servicing specialist firm in helping market participants navigate accelerated settlement cycles

Aman Mehta: Our job is to service the clients globally. This means we give clients access to markets globally,across the buy-side and sell-side. We help to build solutions on top of the market infrastructure andsettlementtimeframe to bring ease of settlement and access. Take for example theExecutionto-Custody model;client can execute in marketsglobally andthenreceivethe settled position directly intotheir custody account. This can be extended further to outsource dealingtypes of models fully,and can also apply to Stock Connect via themulti approved partnerbroker model as mentionedearlier.Clients can go one step further andoutsource a part of their operations via Third Party Clearing or full back-office outsourcing. Weput in placepeople, technology,and banking services to completely run the back office operations of our clients. What this essentiallymeansis that the problem is now transferred to us to clear and settle their trade, especially navigating the shortened settlement time frames.Lastly,our own operating model consists offollow the sunoperational dual centre,allowing us to service different markets across multiple time zones. For example, we have afulloperational team basedin Lisbonthat helps to service the US market and clients. In situations where we have to provide clients based in Europe access during non-US hours, we can help do so through our team based in Lisbon. Through the combination of strong solutions and operations, we take on the responsibilities to navigate the settlement cycles to help our clients.

This recording is followed by the disclaimer below:

Please be informed that this podcast is produced by GlobalTrading.
The information contained within this recording is believed to be reliable but BNP Paribas Securities Services does not warrant its completeness or accuracy. Opinions and estimates contained herein constitute BNP Paribas Securities Services’ judgment and are subject to change without notice. BNP Paribas Securities Services and its subsidiaries shall not be liable for any errors, omissions or opinions contained within this recording. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. For the avoidance of doubt, any information contained within this recording will not form an agreement between parties. Additional information is available on request.