After the weekend of Memorial Day, the “T+1 settlement era” for US stocks will officially begin next Tuesday. However, before this epoch-making change in the settlement mechanism, many Wall Street institutions were quite “uneasy”...

According to people familiar with the matter, Jefferies Financial Group (Jefferies Financial Group) sold a debt of about 3 billion US dollars last month, partly to prepare in advance for possible issues with the new settlement cycle rules that will come into effect next week.

According to the above sources, this portion of the loan will help the investment bank establish a buffer to deal with any unforeseen circumstances during the launch of rapid stock settlement starting next Tuesday.

However, Jefferies has now only stated to the outside world that this bond sale is for general corporate purposes only. Jefferies representatives declined to comment.

Earlier, the US Securities and Exchange Commission (SEC) announced in March of this year that from May 28, 2024, the standard settlement period for US stocks will be shortened from T+2 to T+1, that is, “investors can receive cash for settlement one working day after trading for stocks sold on the same day.”

This has prompted banks, brokers, and investors to conduct internal reviews to assess their ability to respond to changes and ensure they are prepared.

Advantages and Disadvantages of T+1 Settlement

Currently, US stocks are traded at T+0, but the settlement cycle is T+2. In other words, if investors buy stocks on the same day, they can sell them on the same day, but it will take two days to get the money.

As technology plays an increasing role in the market, the SEC has been shortening the time required for the settlement process — from about five days in the 1990s to the current T+2 settlement system.

In a typical transaction process, a broker deposits collateral into a stock exchange clearing house — a depository trust and clearing company (DTCC). In this way, if one party breaches the contract, the other party to the transaction is also protected. However, if the customer fails to complete the transaction, the bank's funds will be taken over.

Regarding the benefits of a further adjustment to T+1 settlement, the SEC said that a shorter settlement window means lower margin requirements for brokers, and the risk of high trading volume or volatility forcing brokers to restrict trading will also decrease.

For retail investors, the new settlement system can enable investors to keep abreast of their holdings and more clearly understand the capital situation, and can quickly use the funds from selling stocks for new investments, improving the speed of transactions and the efficiency of capital utilization.

Previously, US Treasury bonds and US stock options had already achieved T+1 settlement.

But similarly, the T+1 settlement mechanism may also present some operational risks. The most obvious point is that this will make the US different from many other countries in the world. The typical settlement cycle for most countries around the world is still T+2. This change will require market participants to adjust their operating strategies and funding allocations in a timely manner to meet the challenges posed by halving settlement times.

Investors outside the US in particular need to adapt to this change as soon as possible — because the usual financing method for next US transactions will take longer than they actually execute the transaction. The unknown parts of the transaction process, such as confirmation, correction of errors, and withdrawal of loaned securities, must be carried out at least twice as fast. Many overseas institutions trying to buy US assets need to get dollars in advance to ensure they have dollars in time to complete the transaction. Failure to do so may result in some purchases being completely unsuccessful.

(The amount of US securities held by foreign investors has been rising steadily in recent years)

In fact, some traders in the foreign exchange market are already worried that this reform of the mechanism may have an impact on global foreign exchange markets, especially when the dawn of the Asian session is usually quiet. Since the deadline for submitting transactions to the major foreign exchange settlement platform Continuous Contact Settlement System (CLS) has not changed, and it is still midnight Central European Time (6 a.m. Beijing time), the settlement risk of foreign exchange transactions may also increase.

Wall Street doesn't dare to be careless

Settlement failures are generally rare in modern markets, and are often due to technical issues or human error. They can lead to regulatory penalties, loss of trading capital, and even in rare cases, when the deal is large enough, to the collapse of all parties to the transaction.

Many institutions are now clearly worried that the T+1 system may increase the chance of settlement failure, because the compressed time frame may make errors more likely to occur, while also reducing the chances of correcting them. Most importantly, it makes it harder for buyers and sellers to ensure that their funds and securities are ready.

Michele Pitts, global head of escrow data at Citigroup Securities Services, said, “Everyone will do their best. Settlement risk is likely to rise significantly in the first few weeks of implementation of the new regulations”.

According to reports, institutions such as Société Générale, Citibank, HSBC, UBS Asset Management, and Baillie Gifford have now indicated that they are mobilizing employees, restructuring shifts, or establishing new systems — in some cases, all three to prepare for the T+1 settlement transition.

Amy Hong, head of market structure and strategic cooperation at Goldman Sachs Group's Global Banking and Marketing Division, also pointed out at an event held this month, “There are many concerns even around technology and actual settlement methods. There will be some mismatches in terms of funding, and we need to resolve some issues related to foreign exchange.”

According to J.P. Morgan's internal model, it is expected that about a quarter of the currency transactions it processes for customers will be affected. Brown Brothers Harriman is conducting a “T+1 simulation” on customers to identify those with potential issues.

In a survey conducted by research firm CoalitionGreenwich in April and May, only 9% of seller companies said they expected the T+1 settlement conversion to proceed smoothly, 38% of seller companies warned that the buyer manager was unprepared, 28% of companies believed that the trading platform was not fully prepared, and nearly one-fifth of companies expected numerous or serious problems, causing great chaos.

It is worth mentioning that just three days after the T+1 settlement for US stocks comes into effect, the quarterly adjustments of MSCI's major global stock indices will also officially take effect. One of the most affected trading days this year may put more pressure on markets that are still adapting to the new mechanism.

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