The promise of faster settlement
This May, after decades of equity trades in the US settling T+2, all trades will move to T+1.
This shift may sound minor, but its impact will have a major impact on global markets, including the bond markets. We think it could also create opportunities for what we’re building at Origin.
Ready for change
The FT has an excellent explainer discussing the implications of the move, and assessing how different firms are preparing for its arrival.
Some firms are already well set up for the shift due to their robust infrastructure. Others will have to invest in infrastructure so that they comply. Unfortunately, some smaller players, especially non-American firms, may choose to exit certain businesses as they don’t have the appropriate infrastructure to accommodate the new, faster settlement.
But the problems some face should be offset by the fact that in a market where trades are settled quicker, there is less settlement risk in the system. It’s clear that the US regulators took the view that the market wouldn’t ever change of its own accord, so they decided to force the issue with the rule change, and then allow participants to adapt in whatever way they felt best.
Opportunities for DCM
As you know, Origin’s focus is on the primary debt capital markets, but the change in equity market settlement could be exciting for us and present some interesting opportunities.
Today, the vast majority of bond issues are settled T+5, so if an issuer issues a new bond on Monday, they won’t receive the cash until the following Monday. Many of the digitisation initiatives that we’ve seen in recent years, (including tokenisation and DLT), have focused on reducing that settlement, with some even trying to achieve T+0.
The quest to reduce settlement windows has obvious benefits. Issuers want to get their hands on the cash ASAP and dealers have underwriting commitments outstanding (and balance sheet tied up) until bonds settle and the cash is delivered. Hence, any speeding up of the current settlement process seems to offer benefits to both sides of the market.
Enjoying the old
That being said, there is caution around going all the way to T+0. T+5 allows for the tying off of loose ends. For the issuer, their dealer, and maybe their lawyer, this involves making sure all documentation is correct, ensuring all the relevant registrations have been completed on listing venues and regulators, and that the bonds are set up correctly in clearing systems.
Also, investor(s) want to ensure that they have the cash ready to deliver to the issuer on settlement. If the investor has placed a big order, this isn’t a trivial thing, and they may need to sell other assets to free cash for the payment. Bond transactions in the secondary market settle T+2, which means they can participate in a new issue on Monday, and spend Tuesday/Wednesday figuring out what to sell to make space for the new bonds coming in the following week.
A problem of admin
So, a lot goes on in that 5-day window. But what’s interesting is that if you dig into these tasks, you quickly find that a lot of them are administrative.
Once a trade is done, there is no uncertainty that the parties want to actually settle the trade on settlement date, i.e. there is no “break-clause” between T and T+5. What’s clear is that during the settlement window, the issuer definitely wants cash and the investor definitely wants bonds. They are essentially dashing around triple-checking to make sure that there is no risk of failure.
And this is where technology can step in, especially Origin’s. Much of the work between trade and settlement date is related to documentation creation, signature, and communicating those docs to post-trade entities. The traditional timeline is that if a trade is completed on Monday, documents are signed on Thursday, and accepted into the exchange on the following Monday when the transaction “settles.” Our technology helps to streamline this process.
The promise of technology
In digital transactions we’ve completed with clients, we’ve seen that all the documents are, essentially, ready to go on T+1, (especially for simple transactions, such as private placements) and everyone is then typically waiting two days to sign, and then waiting another two days to receive cash.
We believe that with the technology we’ve built to automate documentation, and the extensive suite of integrations we now have, issuers are now able to comfortably issue and settle faster than T+5. T+3 is certainly possible. Investors are sensitive to raising the cash, so pushing below T+3 might be too ambitious and/or disruptive. But if Europe follows the US in mandating T+1 for secondary market transactions, going to T+3 or even shorter for primary could become a real possibility.
Change = opportunity
As the US securities market demonstrates, the biggest hurdle to market change isn’t technology – it’s changing entrenched habits. The status quo “works,” so market participants are rarely keen to deviate, even if there are clear benefits on the other side of a period of change.
However, if regulators push for change and participants are left with no choice, the market finds a way to adapt. It’s for that reason we applaud what’s happening in US equity markets as they shift to T+1. For a host of reasons, we encourage Europe and the bond markets to follow suit. When they do, we’ll be here to help clients make the most of a whole new world of opportunity.