Executive Director of Industry Relations
In a market increasingly under pressure from regulatory change, globalisation and cost-pressures, one impending development in financial markets is going relatively unremarked – the global trend towards shorter settlement cycles. Yet this change will have a significant impact on Australasia.
The disparity in global settlement cycles extends across asset classes, exchanges and geographical locations. Settlement cycles can range from five days after trade execution (T+5) to zero (T+0). This lack of harmonisation has resulted in an extremely complex matrix of market requirements.
Surprisingly, some of the world’s most mature markets have relatively long settlement mandates. The US equity market moved in the mid-nineties from T+5 to T+3 and there it has remained, despite all of the advances in technology that have occurred since. Many European markets still settle on T+3, as do Japan, Singapore and Australia. Why does this matter? Well, to begin with, this inefficiency exists in stark contrast to front office trends. When a trade can be executed in a millisecond, why should it then take a three day cycle to settle? Furthermore, the longer a trade remains in flight, poised between execution and settlement, the longer the exposure to operational risk. A three day settlement period can create substantial systemic risk in times of extreme volatility and uncertainty.
The European Union has been working for some years towards a harmonised, accelerated settlement landscape. All 28 member states will be mandated to adopt a T+2 settlement cycle by January 1st 2015, ahead of the June 2015 adoption of Target2 Securities (T2S) – a pan-European clearing and settlement system. Three European markets (France, Belgium, Netherlands) have also announced a earlier move to T+2 on Oct 6th 2014 and some Nordic markets are expected to opt for T+2 in the near future. US industry bodies have also begun to focus on the potential impact and benefits of shortening settlement cycles across a number of asset classes. Though there is no current talk of mandating the process as there is in Europe, momentum is building and the initiative has many supporters. Asia Pacific remains disparate, boasting some of the world’s shortest settlement cycles as well as some very lengthy ones.
Many operations departments are not as yet prepared for a move to T+2, leaving their firms vulnerable to compliance and operational risk. As the earliest markets to start the global trading day, the impact of shorter settlement cycles in Australia and New Zealand will be particularly acute. A T+2 cycle in the US and Europe would place a great deal of pressure on local investment managers and banks. In order to comply with the proposed changes in settlement cycles firms only have couple of options – add significant resources to operations departments and have staff working long hours or introduce automation to post-trade processes across asset classes and markets.
Of these two scenarios, by far the most beneficial is adopting automation. In the post-trade arena, the ne plus ultra of efficiency is a streamlined environment in which trades can flow from execution through to matching, confirmation and settlement with the lightest of touches. Automating a trade not only reduces the time to settlement; it also alleviates the risk of human error associated with having staff “eyeball” trades after execution. Critical to achieving this best-practice is the implementation of a robust post-trade infrastructure based on technology that represents the latest developments in automation and encourages best practice, specifically:
- Central Matching: Central matching refers to a trade confirmation process between Investment Manager and Broker/Dealer where trade information is exchanged non-sequentially and subsequently matched, typically using a central matching system that is centrally hosted. Central matching positions firms to successfully operate in markets on T+2 or shorter settlement cycles.
- Same Day Affirmation (SDA): Where economic details of trades are affirmed by both counterparties on the same day that the trade is executed. (Studies have shown that high rates of SDA is essential in reducing settlement cycles.)
Central matching is the optimal electronic trade-matching model and delivers exemplary rates of SDA. With increased automation, most trades will then match and settle without the need for manual intervention. Staff will then have ample time to focus on any discrepancies, thereby ensuring compliance with the strictest of settlement deadlines.
Australasian firms need to consider their plans for T+2. The deadline for Europe may seem quite a while away, but a year and a half is not especially long. At Omgeo, we have been working with our community and other global industry bodies to assist with the changing settlement landscape.
This article first appeared in Investor Strategy News on 4 November, 2013