T+1 – A radical change to your global operating model

This article is the third in our series of deep dives on the challenges of T+1. The first articles focused on:

• The urgency of completing a T+1 impact assessment now to be ready for May 2024
• The importance and opportunity that counterparty performance offers

For this third installment, we want to focus on operating models, and look at the global impact that the North American shift to T+1 may have on the financial market institutions.

North America’s T+1 – A global disruption to your operating model:

The impact on the operational team to accelerate their activities and meet the end-of-day affirmations and allocations deadlines could see an increase in operational risks. We believe that the impact on the front office, cash management, and inventory team could also be significant.

From the industry working groups, surveys, and our direct client interactions, we have identified four areas of impact on the global operating model:

Cost of failure. With the acceleration of the settlement cycle, the risk of failing trades increases due to the compressed timeline to manage exceptions (e.g., RAD, RTTM, allocations, new accounts, and incorrect SSI). This will drive higher impact on P&L, especially as the current overnight interest rates used to calculate interest claims are at their highest level in a decade.

International realignment (e.g., US corps). A few North American assets in scope under the T+1 change can settle at different depositories (e.g., US corporate bonds settle on T+2 in Euroclear). Often, trading and booking systems do not contain or capture depos or intended settlement date inventory information; these calculations are left to the inventory management or SBL systems. This could lead to systemic shorts, where a trader sources a US asset on a T+2 depo but sells it on a T+1 basis in the domestic US market. This could cause settlement fails due to short inventory and result in interest claims.

Funding and FX. International investors, buy side firms, and even smaller brokers and dealers could see challenges with their daily funding requirements and cash management. Firms that are funding their purchase on the FX/MM market on a T+2 basis will need to adjust their timeline to meet requirements by T+1, or risk failing purchase transactions or face overdraft charges from their custodians or agent.

Stock borrowing and lending. Borrowing and lending functions, whether for stocks or corporates bonds, could also cause settlement fails. There is a risk that the current borrowing and recall timelines cannot meet a T+1 cycle, which may drive inventory management challenges and result in fails and interest claims.

An impact beyond the operations team: will your front office / investors grab the opportunity?

These four global operating model challenges could also be seen by firms as an opportunity to perform better than their peers, to embrace the “spirit” of the regulation, and strive for a more efficient, more liquid, and less capital-intensive North Americas settlement cycle.

At Capgemini, with our track record of large technological transformation, we believe this type of market change creates opportunities for challengers to become leaders, and ultimately create a better financial market for retail investors.

Inaction is not an option

Firms need to take swift and decisive action in at least three areas:

Optimise your pre-funding and FX management. Firms need to fully understand how they currently fund their US and Canadian trading activities when they place their FX trades, and when they settle currently. These changes could bring additional costs.

“Just-in-time” borrowing/recalling/realigning. Inventory management, and communication between the settlement team, SBL team, and front office, will need to be optimised to reduce the risk of shorts. Organisational changes, SLAs, and operating methods will need to evolve through technological and workflow enhancements or operating model optimisation.

Design and source inventory and funding information in near real time. Sell-side front offices need to be equipped with the near real-time MI and information from their middle office and operations teams to rectify trade errors as soon as they are identified to avoid costly fails. Buy-side firms should continue to increase their dialogue with their service providers (e.g., prime brokers, custodians, and middle and back office outsourcers) to fully assess the impact of the accelerated timeline and agree on a sustainable economic model.