One mitigant, especially for non-US entities e.g. in Asia or Europe that need to meet these compressed FX settlement timelines, is to consider implementing greater automation within their FX portfolio.
In this article we consider the upcoming changes, and what the buy-side can do to help lessen the operational impact. And although current changes are limited to the US (& Canadian) securities market, both the UK and EU are considering whether similar changes might be applied in their jurisdictions as well.
The impact on FX
- US securities settlement will move from T+2 to T+1 effective 28 May 2024.
- Shortening US security settlement window raises the risk that transaction funding dependent upon FX settlement may not occur in time.
- Cross-border US security transactions with a linked FX trade will mean expediting execution of both trades to enable settlement to be completed within the shortened T+1 window.
- FX settlement involves trade matching, confirmation and payment all being completed within local currency cut-off time.
- Cut-off time for CLS-settled FX trades (in 18 eligible currencies) is midnight CET on T0 if they are to be in time for T+1 securities settlement the following day.
- FX trades that miss CLS cut-off, or are not eligible for CLS, can still be settled bi-laterally (with netting of trades between counterparties if enabled), although this adds credit and operational risk.
- Consideration should be given to the potential impact on transaction costs, either as a result of pre-funding securities transactions where there are time zone challenges, or as a result of late payment fees and interest charges.
There are varying levels of concern across the market about the severity of the impact of T+1, ranging from rolling on as usual to geographic shifts of operational teams to ensure trades are processed correctly. The most consistent theme is the level of confidence of funds being available in time for settlement, together with concern about additional costs and settlement risk, especially across non-USD based funds.
Further details on FX considerations for T+1 US Securities Settlement can be found in the GFXD [2] paper from May 2023.
The broader context
With the US & Canada moving to T+1 in May, focus will inevitably switch to the plans in the UK and EU. The latest news from the UK was a letter from the chair of the UK Accelerated Settlement Taskforce in December 2023 noting the "broad consensus that the question is how and when the UK moves to T+1 and not whether it should do so". In the EU, ESMA [3] has published a call for evidence on shortening the standard settlement cycle.
As set out in a recent paper by GFXD, within the wholesale FX market there is greater scrutiny on how to execute and when to settle FX transactions, driven by technology, a desire for increased operational efficiencies and reduced settlement risk, and of course by changing regulation.
Add to that the continued obligations for best execution and a need for greater transparency and better data, and the pressure is on to find innovative solutions.
Primary and secondary impacts
We’ve focused here mainly on second order impacts of the upcoming changes from the perspective of a UK bank with clients outside the US operating in the US securities market, and the implications for FX settlement. However, of course the primary impact will be with the US securities market itself. The general consensus seems to be that the SEC's decision will reduce counterparty risk across the ecosystem and may act as a driver for further automation and standardisation.
That said, there are potential implications... How might the move impact DCM [4] re-issuance, does the reduced timeline stress the issuance process? If there is an increase in non-standard settlement, will funding markets bridge the gap and will that have cost implications?
How can automation help?
A requirement for shorter execution and settlement windows can be facilitated by a move towards greater automation. Automation can operate around the clock irrespective of where teams are located and can be leveraged as a replacement to operational teams processing settlement trades or as a last minute safety mechanism should funds not be available. For more information on NatWest’s automation tools please see our website.
Are you ready?
All eyes are on the end of May and how the industry will respond to the settlement changes in the US - depending upon the success of these measures in the US and globally, expect to see more change in this space as other jurisdictions fall in line, and execution & settlement timelines tighten.
Glossary
[1] Continuous Linked Settlement
[2] Global Foreign Exchange Division
[3] European Securities and Markets Authority
[4] Debt Capital Markets
This article has been prepared for information purposes only, does not constitute an analysis of all potentially material issues and is subject to change at any time without prior notice. NatWest Markets does not undertake to update you of such changes. It is indicative only and is not binding. Other than as indicated, this article has been prepared on the basis of publicly available information believed to be reliable but no representation, warranty, undertaking or assurance of any kind, express or implied, is made as to the adequacy, accuracy, completeness or reasonableness of the information contained in this article, nor does NatWest Markets accept any obligation to any recipient to update or correct any information contained herein. Views expressed herein are not intended to be and should not be viewed as advice or as a personal recommendation. The views expressed herein may not be objective or independent of the interests of the authors or other NatWest Markets trading desks, who may be active participants in the markets, investments or strategies referred to in this article. NatWest Markets will not act and has not acted as your legal, tax, regulatory, accounting or investment adviser; nor does NatWest Markets owe any fiduciary duties to you in connection with this, and/or any related transaction and no reliance may be placed on NatWest Markets for investment advice or recommendations of any sort. You should make your own independent evaluation of the relevance and adequacy of the information contained in this article and any issues that are of concern to you.
This article does not constitute an offer to buy or sell, or a solicitation of an offer to buy or sell any investment, nor does it constitute an offer to provide any products or services that are capable of acceptance to form a contract. NatWest Markets and each of its respective affiliates accepts no liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this material or reliance on the information contained herein. However this shall not restrict, exclude or limit any duty or liability to any person under any applicable laws or regulations of any jurisdiction which may not be lawfully disclaimed.
NatWest Markets Plc. Incorporated and registered in Scotland No. 90312 with limited liability. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and Prudential Regulation Authority. NatWest Markets N.V. is incorporated with limited liability in The Netherlands, authorised and supervised by De Nederlandsche Bank, the European Central Bank and the Autoriteit Financiële Markten. It has its seat at Amsterdam, The Netherlands, and is registered in the Commercial Register under number 33002587. Registered Office: Claude Debussylaan 94, Amsterdam, The Netherlands. NatWest Markets Plc is, in certain jurisdictions, an authorised agent of NatWest Markets N.V. and NatWest Markets N.V. is, in certain jurisdictions, an authorised agent of NatWest Markets Plc. NatWest Markets Securities Japan Limited [Kanto Financial Bureau (Kin-sho) No. 202] is authorised and regulated by the Japan Financial Services Agency. Securities business in the United States is conducted through NatWest Markets Securities Inc., a FINRA registered broker-dealer (http://www.finra.org), a SIPC member (www.sipc.org) and a wholly owned indirect subsidiary of NatWest Markets Plc.
Copyright © NatWest Markets Plc. All rights reserved.
