Stocked up on "ammo" in case of accidents! The T+1 settlement era of U.S. stocks will open next week, and Wall Street is worried that something will happen

Finance Associated Press

2024-05-25 09:57Published on the official account of Cailianpress, a subsidiary of Shanghai Poster Industry Group

Finance Associated Press, May 25 (Editor Xiaoxiang) After the end of the memorial weekend holiday, the "T+1 settlement era" of U.S. stocks will officially start next Tuesday. However, before the arrival of this epoch-making reform of the settlement mechanism, many Wall Street institutions were quite "restless......

Jefferies Financial Group tendered off about $3 billion of debt last month, in part to prepare for problems that might arise under the new settlement cycle rules that take effect next week, according to people familiar with the matter.

The borrowing will help the investment bank build a buffer against any surprises that arise during the rollout of the stock fast settlement, which begins next Tuesday, the people said.

However, Jefferies officials have only said to the outside world that the bond sale is only for general corporate purposes. Jefferies representatives declined to comment.

Previously, the U.S. Securities and Exchange Commission (SEC) announced in March this year that from May 28, 2024, the standard settlement cycle for U.S. stocks will be shortened from T+2 to T+1, that is, "investors who sell stocks on the same day will receive the settlement cash one business day after the transaction".

This has prompted banks, brokers, and investors to conduct internal scrutinies to assess their ability to respond to change and ensure they are prepared.

Pros and cons of T+1 settlement

At present, the U.S. stock market is trading on T+0, but the settlement cycle is T+2. That is, an investor buys a stock on the same day and can sell it on the same day, but it will take two days for the money to arrive.

As technology plays an increasing role in the market, the SEC has been reducing the time required for the settlement process – from about five days in the '90s to today's T+2 settlement system.

In a typical trading process, a broker deposits collateral with a stock exchange clearing house, the Depository Trust and Clearing Corporation (DTCC). This way, if one party defaults, the other party to the transaction is also protected. But if the customer fails to complete the transaction, the bank's funds are tied up.

For the benefits of further adjustments to T+1 settlement, the SEC said that a shorter settlement window means lower margin requirements for brokers, and there will also be less risk that high volumes or volatility will force brokers to restrict trading.

For retail investors, the new settlement system can prompt investors to keep abreast of their positions and have a clearer understanding of their funds, and can quickly use the funds from selling stocks for new investments, improving transaction speed and capital utilization efficiency.

Previously, both U.S. Treasury bonds and U.S. stock options have achieved T+1 settlement.

But equally, the T+1 settlement mechanism may also bring some operational risks. Most obviously, this will set the U.S. apart from many other countries around the world, where the typical settlement cycle is still T+2. This change will require market participants to adjust their operational strategies and capital allocation in a timely manner to meet the challenges of halving the settlement time.

Investors outside the U.S., in particular, need to adapt to this change as quickly as possible, as the usual financing methods for subsequent U.S. transactions take longer than they actually execute the trade. The unknown parts of the trading process, such as the confirmation process, error correction, and the withdrawal of lent securities, must be done at least twice as fast. Many overseas institutions trying to buy U.S. assets need to get U.S. dollars in advance to ensure they have U.S. dollars in time to complete the transaction. Failure to do so may result in some purchases failing altogether.

(Foreign investors' holdings of U.S. securities have been increasing in recent years)

In fact, some traders in the FX market are already worried about the impact that this reform could have on global currency markets, especially during the usually dull dawn of the Asian session. As the cut-off time for submitting transactions to the Continuous Contact Clearing System (CLS), a large foreign exchange settlement platform, has not changed, and remains at midnight CET (6 a.m. Beijing time), settlement risks for foreign exchange market transactions may also increase.

Wall Street did not dare to be careless

Settlement failures are usually rare in modern markets and often stem from technical issues or human error. They can lead to regulatory penalties, loss of trading capital, and even in rare cases, the collapse of all parties to a transaction when the transaction size is large enough.

Many institutions are now clearly concerned that the T+1 system may increase the chances of settlement failure, as the compressed time frame has the potential to make mistakes more likely to occur and reduce the chances of correcting them. Most critically, it makes it more difficult for buyers and sellers to ensure that their funds and securities are ready.

Michele Pitts, Global Head of Custody Data at Citigroup's Securities Services, said, "All of us are going to be all in. In the first few weeks of the new rules, settlement risk is likely to rise significantly."

Société Générale, Citibank, HSBC, UBS Asset Management, Baillie Gifford and others have said they are moving staff, restructuring shifts or setting up new systems – in some cases all three – in preparation for the T+1 settlement transition.

Amy Hong, head of market structure and strategic partnerships at Goldman Sachs' Global Banking & Markets Group, also noted at an event this month that "there's a lot of anxiety even around technology and how the actual settlement is done." There will be some mismatches in terms of funds, and we need to address some FX-related issues. ”

JPMorgan's internal model shows that about a quarter of the currency transactions it processes for its clients are expected to be affected. Brown Brothers Harriman is running a "T+1 simulation" of customers to identify those with potential problems.

In a survey conducted by research firm CoalitionGreenwich in April and May, only 9% of sell-side firms said they expected the T+1 settlement transition to go smoothly, 38% warned that buy-side managers were not prepared, 28% felt that the trading platform was not fully ready, and nearly a fifth expected a large number of or serious problems, causing huge chaos.

It is worth mentioning that just three days after the T+1 settlement of US stocks took effect, the quarterly adjustment of MSCI's major stock indices around the world will also officially take effect, and one of the most influential trading days of the year may bring more pressure to the market that is still adapting to the new mechanism.

(Finance Associated Press Xiaoxiang)

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