A looming shift in the way US equity trades are settled is sending unintended shock waves through the $7.5 trillion-a-day global market for foreign exchange.
(Bloomberg) — A looming shift in the way US equity trades are settled is sending unintended shock waves through the $7.5 trillion-a-day global market for foreign exchange.
At major financial institutions including banks, brokers and investment houses, currency desks are preparing for the world’s biggest stock market to halve the time it takes to settle equity transactions to just one day.
That switch — due in May next year — will put US stocks out of step with the world of foreign exchange, where trades typically take two days to complete. It means many overseas institutions trying to buy American assets will need to secure dollars in advance to ensure they can make settlement — or face a desperate scramble to find the cash in time.
Failure to do so would mean purchases falling through entirely.
The change sets up a potential pivotal moment for global currency markets that could reorder the established trading day. Longer hours for foreign-exchange desks in New York, rising volumes in Asia’s notoriously volatile mornings, and the relocation of staff out of Europe are among potential side effects when the new regime comes into force.
“The question is how to book, fund and settle any required foreign exchange trades within the required one-day time-frame when most FX markets settle on T+2 today,” a Citigroup Inc. team led by Okan Pekin wrote in a recent report. “Timezones matter in the move towards accelerated settlements and foreign investors are always the hardest hit.”
Moving Jobs
Baillie Gifford is reshuffling headcount in a bid to forestall any issues.
The Edinburgh-based money manager said in a letter to the Securities and Exchange Commission in November that investment advisers based outside the US “will either have to set up an FX trading and settlement presence in North America (or Asia) or add staff abroad to create, execute, and settle FX transactions” to meet the shorter timescale.
“The real squeeze for us is going to be getting the FX trade executed, matched and away to custodians in time,” said Catriona Lawlor, a trader at the $293 billion firm. She’s one of three Baillie Gifford employees moving to the US to help ensure the asset manager’s currency needs can be fulfilled in the accelerated timetable.
The complexity of the landscape makes it impossible to gauge the volume of currency trades that might be affected or how many jobs might move, but since the biggest firms likely already have a presence on Wall Street, the impact is set to be felt most among mid-sized institutions.
More than half of European firms with fewer than 10,000 staff are planning to either move people to North America or hire overnight staff in Europe or Asia, according to a survey sponsored by the Depository Trust and Clearing Corporation.
The upheaval stems from SEC regulations that will expedite the settlement time-cycle for US securities — that is, the time between when the trade occurs and when payment is received and ownership of the asset is transferred. The shift will move the market to what’s known as T+1, after it transitioned to T+2 back in 2017.
The idea is that the smaller window reduces the chances of default on either side of the transaction. That lower risk in turn helps cut the collateral demands faced by brokers for unsettled trades, which got so high during the “meme stock” frenzy in January 2021 that some platforms like Robinhood Financial Inc. restricted trading.
The downside is it creates new operational risks for an industry used to T+2, and a potential time crunch for players outside of the US.
“For international participants wanting to buy US securities, pre-funding the transaction with US dollars or arranging for a short-dated T+1 FX settlement will be required,” said Joe Urban, managing director of electronic trading at Clear Street. “Any pre-funding requirement could potentially push asset managers out of the market for one day, driven by the need to raise US dollars a day prior for today’s transaction.”
Witching Hours
The halving of the settlement time will have a curiously magnified effect in the foreign-exchange market because of the structure of the trading day. The cash market for US stocks closes at 4pm in New York, which for most of the year is 9pm in London — leaving little time for European investors to begin a new currency trade that day.
The Association for Financial Markets in Europe estimates settlements teams will only have two core business hours between the end of the trading window and the start of the settlement window, compared to 12 hours currently.
“The new cut-offs are very challenging for international clients,” said Emmanuelle Riess, a global custody product manager at BNP Paribas. “The international client may want to review their operational model. They may think about moving their back-office or mid-office teams.”
Urban said he has “heard discussions” from both buy- and sellside firms about ensuring sufficient staff are available to trade the US close. He expects to see the buyside in particular turn to outsourcing relationships to ensure its funding coverage.
Another solution may be rushing transactions through in the day following a trade. This could mean fresh activity during the notoriously illiquid Asian session — colloquially known as the “witching hours” because the thin volumes contribute to occasionally outsized moves. Some US firms are already moving their post-trade operations to the West coast of the US in anticipation of such a shift, according to Nellie Dagdag, DTCC Managing Director for Marketing and Communications APAC.
“London will still be one of the major players,” said Thomas Friesleben, managing director of currency platform StoneX Pro EMEA, referring to the UK capital’s status as a foreign-exchange hub. “But in two to three years trading could be more tilted toward the US and Singapore.”
Longer Days
For many in the industry, the acceleration of US stock-trade execution is a clarion call for the currency market itself to move faster. They argue that technological advances mean that two-day settlement for foreign exchange should also be relegated to history.
Alex Knight, head of EMEA at post-trade processing company Baton Systems, reckons moving staff to the US is little more than “throwing headcount” at the problem. He’s advocating for distributed-ledger technology to speed up so-called payment-versus-payment transactions, a settlement mechanism that coordinates transfers to ensure no one is left holding a claim.
“The far more elegant approach is to use automation and technology rather than needing to shift people physically or from a timezone perspective into New York,” he said.
A Citi poll of 483 financial professionals ranked accelerated settlements to T+1 as the most significant post-trade issue impacting their businesses. With eight months to the switch, the potential challenges are rising up the foreign-exchange industry’s agenda — not least because they also raise the specter of longer working days.
In its letter to the SEC, Baillie Gifford said US FX desks typically close early on Friday evenings, which might mean trades need to be made in Asian hours on a T+0 basis. It suggested US regulators encourage banks to extend their trading activities to at least 6 p.m., five days a week.
“Who is going to be there at the end of the day at 5pm on a Friday to give us a price?” Baillie Gifford’s Lawlor said.
–With assistance from Naomi Tajitsu and Alice Atkins.
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