The shift to a next-day settlement cycle for trading U.S. securities is set to introduce a new level of complexity for exchange-traded funds (ETFs) and market makers. With the new system, stakeholders aim to decrease risk and boost efficiency in the world’s largest financial markets. However, this transition is anticipated to temporarily increase transaction failures for investors, posing a significant challenge for the involved parties.
Recent adjustments to settlement cycles in other countries such as China, India, Canada, Mexico, and Argentina have already accelerated their processes. These changes are in line with the U.S. move to a T+1 settlement cycle. Previously, European ETF issuers have faced different settlement timelines, which may complicate the U.S. shift. The new settlement cycle in the U.S. will require ETFs and market makers to adapt their strategies to meet these varying global requirements, impacting capital management and liquidity.
Impact on ETF Issuers
U.S.-listed ETFs must now adhere to the T+1 settlement rule, while not all underlying assets follow the same schedule. European ETF issuers will have to manage a two-day wait for payments on their products, while simultaneously managing a one-day payment cycle for U.S.-traded components. This “mismatch” between settlement schedules is expected to create logistical difficulties for asset managers, particularly those with European holdings, necessitating more collateral to mitigate risks.
John Hooson from BBH indicated that these mismatches would push authorized providers to post additional collateral to maintain smooth operations. Market makers, responsible for creating and redeeming ETF baskets, will need to balance speed and cost-efficiency. If not managed effectively, this could lead to increased capital costs and a greater need for short-term liquidity.
Challenges in Liquidity Management
Time zone differences add another layer of complexity to the settlement process, leading to potential liquidity issues and wider bid-ask spreads. Todd Rosenbluth from VettaFi suggests this will be a short-term challenge, which the markets will eventually overcome. However, the initial phase will test the resilience of market participants.
Robert Humbert of BNY Mellon highlighted that currently, about 30% of trades overseen by his firm settle on a T+1 basis, a figure expected to rise to 70% with the new rule. While mismatches may present issues, he views the T+1 settlement as a more capital-efficient process, requiring market participants to hold capital for a shorter duration.
Inferences
Key points drawn from the transition include:
–
The necessity for market participants to adapt quickly to mitigate risks.
–
An increase in collateral requirements to manage mismatched settlement cycles.
–
Potential short-term liquidity issues due to time zone differences.
–
Broader acceptance of the T+1 cycle as more capital-efficient over time.
The move to a T+1 settlement cycle in the U.S. marks a significant step towards increasing market efficiency and reducing risk. While some initial challenges are expected, such as mismatched settlement schedules and liquidity issues, the overall capability of market participants to adapt will play a crucial role. With 70% of trades expected to settle on a T+1 basis soon, the market shows a promising shift towards a more streamlined process. Asset managers and authorized providers need to remain vigilant, employing robust strategies to navigate this transition effectively. As global markets continue to evolve, harmonizing settlement cycles across jurisdictions will be key to minimizing disruptions and enhancing overall market stability.
