25 May 2023
T+1: Total Recall…
While you are no doubt thinking of Arnie rather than settlement cycles, there is a link to the 1990’s classic and the impending change to the U.S. and CAD markets in May 2024 (although Total Recall was set in 2084).
With all impending challenges driven by regulatory change, just like Douglas Quaid in the movie, there will be companies selling you ‘fake memories of ideal vacations.’ Your job, as always, is to decide if you are Douglas Quaid or Harry.
Let us examine the changes and look at how securities finance participants can navigate these challenges.
What is changing?
On February 15, 2023, the Securities and Exchange Commission (the "Commission") adopted SEC Exchange Act Rule 15c6-1 amendment to accelerate the standard settlement cycle for securities trades from two business days after the trade date to one business day after the trade date (or from "T+2" to "T+1" in common parlance). The final rules will become effective 60 days following the date of publication of the adopting release in the Federal Register, but the compliance date for the rule change will be May 28, 2024.
The amendment is one way in which the Commission is seeking to create a more efficient and resilient market while hopefully addressing episodes of market volatility which include the "meme stock" events of 2021 and the COVID-19 pandemic. Furthermore, compressing settlements by one day will improve investor protection and reduce credit, market and liquidity risks arising from unsettled securities trades. This shortened period will enable investors to access the proceeds from securities transactions sooner than they are able in the current T+2 environment and the compression should reduce the number of failed transactions overall, the period of exposure to those trades that do not settle, and potential price movements on the underlying securities. But if settlement efficiency is not achieved and failures increase instead, unintended consequences may arise, and it would not be inconceivable for the regulators to implement a recall fail regime and/or penalties akin to TPMG claims or CSDR penalties.
In addition, the shorter settlement cycle is aimed at improving the efficiency of capital for market participants. Like in both purchase and sale transactions, market participants will be able to wrap up the transaction a day earlier. If a trader has financing to buy the shares, they will be able to save one day’s interest which in a rising interest rate environment becomes less costly. Over the years, stock market transactions have been streamlined due to the emergence of technology. Unlike a decade ago, more than 99% of the existing shares have been converted into dematerialized form. Additionally, banking payment and settlement systems have evolved significantly with fewer errors. Given that the market infrastructure can now support shorter settlement cycles, it is the right time to change. The changes are no doubt a path to T+0 or instantaneous settlement in the future.
For securities finance participants this change makes daily life a little more of a challenge. As many of our clients will attest to, decision making is often the easy bit. It is having the tools to allow those decisions to be processed quickly and efficiently that is critical to achieving a good outcome.
Once T+1 is implemented, there is the potential for supply shocks, borrow volatility, and increased costs, passed on to borrowers, if fails increase and best practices are not followed. Furthermore, the borrowers of securities may need to collateralize with a lender (ex: non-cash) the same day the transaction is executed for instructions to be released on time with the change compressing the time to check SSI’s, collateral etc.
If you are the lender, your focus might totally be recall related. SIFMA best practice recommendation for cut off is 11:59 P.M. EST making the lenders, the protagonist of the movie (Vilos Cohaagen) and the borrowers the citizens of Venusville. If you will forgive the extension of the metaphor, the sharing of the turbinium ore is the only way to resolve this disconnect. In real-world parlance, technology is critical to achieving best practice, and this is where Pirum offers a securities lending solution.
Pirum’s real-time processing abilities and our (total) Recalls Manager product (the second chapter of our Front Office Services offering) supports recalls being processed in real-time reducing time to market, manual effort, and overall risk of failure. Let us not forget that the T+1 change will affect the protect period on corporate actions as well, which Pirum will cater for in the Voluntary Corporate Actions (VCA) product launching later this year. Some people reading this article will already be part of our Design Partner Groups (DPG) for both Recalls and VCA (if you want to hear more, please reach out to us).
In 2017, when the U.S. last shortened settlements (T+3 to T+2), the impact from a securities finance perspective was more nuanced and in many ways a non-event, whereas the move to T+1 is much more impactful and has resulted in much more time analyzing operational processes with focus on recalls, affirmation, and emphasis on real time automated connectivity between lenders and borrowers compared to the current outdated model of batch processing.
Considerations for clients to look at the holistic events on the lifecycle of transactions has become of greater importance as businesses look to better manage and mitigate risks and exposures. Lastly, from a recall perspective, the action for the lender to notify and the ability for the borrower to receive, consume and process recalls automatically becomes paramount given the shortened settlement cycle and eroding timeline to action, source/cover and collateralize obligations.
In closing, do not be Douglas Quaid and look for a Melina at the last resort, start planning and making your decisions now. Ideal vacations do exist and Pirum has an itinerary.
Douglas Quaid could not remember a ‘Rekall,’ and it changed his life forever!
EMEA Head of Origination
Product Director, Head of NAM Product