Time for Accelerated Settlement: T+1 as Evolution of Global Financial Markets

We recently spoke to Andrew Douglas, chair of the UK Accelerated Settlement Taskforce and senior director on financial services at APCO, about the global T+1 initiative. Here is the summary of our chat.

What Does T+1 Mean?

When we talk about “shortening the settlement cycle,” we refer to the period of time between the moment when a transaction takes place (e.g., when a bond or security is purchased or sold on a recognised trading venue) and the period when settlement takes place (i.e., the actual transfer of ownership of the security and usually, the transfer of money). Nowadays, the exchange of value and ownership occurs in most markets in two days, in a so-called T+2 (short for “Trade date + 2 days”) structure. Historically it has been three days; but in some markets it was 10 days, in others two weeks, or in others it has been open-ended. 

Origins of T+1

Over the past few years, however, there has been a global tendency to reduce the settlement cycle for securities—a trend that has been embraced by various global markets. For example, the Chinese mainland market moved to a T+0 structure (trading and settlement happening on the same day, as it means “Trade date + 0 days”), while few years ago, India implemented a T+1 cycle and recently introduced an optional T+0 settlement cycle.  

These are extreme examples because they refer to an even shorter cycle than T+1. However, generally speaking, there is a growing consensus that reducing settlement cycle is a positive development, especially from a commercial perspective. The reason for this is pretty straightforward: the longer the settlement is, the greater the risk that your counterparty can go bankrupt or fail in the intervening period. The longer your cash is tied up, then the longer you can’t use and don’t have access to that money.  

 Typically, more “established” markets used to operate on a T+3 cycle, but some years ago they moved to T+2. As part of this ongoing trend towards reducing settlement cycles, in 2021, the United States decided to reduce such time to one day. As a result, on 28 May 2024, the United States, Canada and Mexico will move to implement a T+1 cycle: at that point an estimated 55% of global equity and fixed income trading will be executed against a T+1 cycle.  

Every Rose Has Its Thorn

Time is money, and a longer settlement time means greater risks for the whole system. So up to this point in the analysis, T+1 does not seem to entail excessive negative effects, at least as long as one looks at the domestic market. So far so good. 

The topic becomes more complicated when one looks at the connections between different geographies and at the inherently cross-border nature of financial markets. In fact, T+1 can leave markets remaining on T+2 (e.g., EU, UK, Switzerland, South-East Asia) in a disadvantageous position from an efficiency perspective.  

That’s because as with the previous move from T+3 to T+2, generally, it was possible for market participants to tweak their existing internal systems and processes and there was no need for a wholesale re-engineering process. Received wisdom is that to move to T+1, current systems will have to be automated to accommodate the reduction in time available to process transactions. 

There are also the time zone differences which creates added levels of complexity. To better understand this point, let’s take a practical example: imagine you are an investor in New Zealand (the start of the global business day) and you want to invest in U.S. stocks (so exactly on the other side of the globe, at the end of the business day). There is a 16-hour difference between you and New York, and you cannot complete your order until the U.S. markets open. But, by then, your business day is over, and you’ve gone to bed. You can place an order to buy stocks as soon as the U.S. stock exchange opens at 9 am, but at that point you may have to deal with currency exchange. And until the trade is struck, you won’t know the cost of US$ because of exchange rate variation. This leaves you with a number of options: run a 24-hour shop in New Zealand (with consequent reallocation of staff, new hires to cope with the night trade, etc.), open an office in the United States or outsource to a U.S. organisation. Some may even consider the drastic option and stop investing in the United States, but no one we have spoken with has heard this option being discussed.  

You Go Ahead, I’ll Catch Up

As anticipated, in May this year the United States, Canada and Mexico will start implementing this shortened settlement cycle. And in recent months, it seems to have become firmly established that the European continent will also have to follow the same path, since many in the industry—particularly parts of the fund management community with a large exposure to the United States—believe that a lengthy dislocation from the U.S. settlement cycle is not ideal.  

 However, a rather big problem remains: when? In theory, there is a clear benefit for the market to have a coordinated migration of UK, Switzerland and the EU, but the continental countries are hesitating to define a precise window. The only geography that seems to have clear ideas in this area is the UK, which has recently made the decision to move to T+1 in 2027, subject to the big caveat that much will depend on what happens in the United States in May of this year and the decision in the EU.  

My take on it was that the UK seems willing to wait, for now, for its European neighbours and partners. But should their decision take too long, or should the EU opt for a date too far down the road, it will mean that Brussels would end up chasing a hare with a three-year lead.