The global move to shorter settlement periods

It might be hard to imagine now, but back in the ancient history of securities trading (ie the 1970s and 1980s), UK equities trades used to settle on a 2 week cycle. The advent of fax machines and telex machines helped bring that down to T+10, then T+5, then T+3, and then eventually T+2. The US markets have been on their own journey, moving from T+5 to T+3 in 1995, and then to T+2 in 2017.

Earlier this year in May, the US took the leap down to T+1.

What will Europe do?

Not to be outdone, the UK and European market authorities are taking notice. The UK already announced earlier this year its intention to move to T+1 no later than the end of 2027, regardless of what the EU does. This week, the ECB, ESMA, and the European Commission announced their plans to work towards T+1 settlement in the EU, with the aim of trying to align with international markets.

While the authorities on this side of the Atlantic have been talking about faster settlement for a long time, it was the move by the US SEC that brought this topic to the top of the pile. As some have noted, if the US didn’t move first, it’s unlikely that the Europeans would have focused on this. But the misalignment of settlement cycles across developed markets is an issue for market participants. In the 2010s there was a real mix between T+3 and T+2 across various European markets and the US, but by 2017 everyone had settled on T+2. (Most of Asia is on T+2 now as well). Now with the US taking the next step forward towards T+1, they are essentially forcing the rest of the world to follow in order to preserve alignment.

What’s in scope

It’s important to clarify what’s in scope here: we’re talking about secondary market transactions for regularly traded securities (stocks, bonds, ETFs, government bonds, Munis, ABS), as well as derivatives linked to those securities. For now, primary market transactions still primarily maintain longer settlement periods (eg T+5 in our familiar world of bonds).

Costs and Benefits

The costs involved in this transition are fairly obvious. Moving from T+3 to T+2 was largely a change involving tightening up existing processes (many of which were, and still are, manual). But moving from T+2 to T+1 cannot happen by simply “tightening up” workflows even further. With only one overnight cycle between trade date and settlement, manual steps become unresolvable bottlenecks, and the only way to break through them is to invest in automation and digitisation. That investment obviously comes with an upfront cost, and firms of different sizes will have different capacities to whether those costs.

That being said, the benefits are significant. Since the US moved to T+1 in May, it has found that the amount of capital deposited at its clearing fund has dropped by $3.7 billion (29%) from the previous quarter average, and trade failure rates are actually lower than before. If the EU were to follow suit, harmonizing the settlement cycle across global markets, billions of dollars of capital could be released from margin and collateral requirements, improving profitability and ultimately productivity. The move would also spur the digitisation and automation necessary to remove back-office costs, improve efficiency, and reduce errors.

How does this affect the primary bond markets?

The migration from T+2 to T+1 in secondary trading serves as a great blueprint for what is possible in the primary markets. Primary market transactions are larger in size and can involve many more participants, especially in large syndicated deals with global order books. However, the benefits are even more significant, especially for the issuers who are relying on the cash raised for their activities over in the “real economy.” Faster settlement means that cash starts being put to work faster. And given the large sizes involved in these transactions, the capital allocated by underwriters during the settlement period is significant. Faster settlement releases that capital, improving dealers capital ratios, and ultimately, profitability.

So if the benefits are so obvious, why haven’t we moved yet? In response to previous pilot “digital bonds transactions” that have been executed on T+0 basis, many issuers and investors we’ve spoken to have said that T+0 is too short. The main reason is that for these larger size orders, investors need to execute some secondary market transactions in order to free up cash to fulfill their order. A move from T+2 to T+1 in the secondary market will help bring primary market settlement times down, but you can expect primary transactions to always have a longer settlement period than secondary trades.

Document automation is the key

The other reason is that the technology required to reduce settlement times hasn’t been fully deployed…yet. In the various digital bond trades that we’ve seen over the past few years, the T+0 achievement was in truth, a sleight of hand. These were obviously highly choreographed pilot transactions, and thus, much of the normal administrative work that takes place between T+0 and T+5 was completed ahead of time…before the trade date. This was the work of preparing the legal documentation, liaising with market infrastructure and post-trade counterparts, lawyers, etc etc. In these choreographed deals, essentially all of the administrative work was done ahead of time, so that on trade date, the dealers and issuers just had to “press a button” to “execute” a same day cash and security swap - demonstrating T+0.

But in the real world, the bottleneck for shorter settlements isn’t about whether the securities exist on a chain or in a “legacy” centralized database. No, it’s all that administrative stuff that I talked about earlier: legal docs, liaising with IPAs, CSDs, exchanges, etc. The market has settled on 5 days as the appropriate amount of time necessary to get all those steps finished before the securities are created and the cash moves.

However, we believe that no longer needs to be the case. 5 days is necessary if the workflow involves lots of people in lots of institutions emailing lots of documents around to each other. But, advances in document automation technology have significantly reduced the time required for transaction documents such as Final Terms and other docs to be prepared, reviewed, and signed. Post-trade market infrastructure institutions and data companies are developing APIs, so communicating new issue information is no longer via emails to ops teams - information can be sent instantaneously with the click of a button from a platform.

At Origin, we’re at the forefront of this work with our Documentation product. We have completed over 170 primary bond transactions so far this year, and in many cases, all the “admin” work is finished by T+1 - participants are then just waiting another 4 days to settle the trades out of habit. As our more seasoned clients have gotten comfortable with the new way of issuing, we expect to see shorter settlement periods very soon.

But market-wide coordination is key. We would call upon regulators to not stop at the secondary markets, but turn their attention to the primary markets as well, nudging the market to digitize, automate, and operate on a faster settlement cycle here too. As we’ve seen from the secondary markets, it’s difficult for any individual institution to effect change on their own, but when the market acts together, the benefits to all are significant.

And when the market does take that step - we’ll be here to help.