Head of Trax and Operations Services, MarketAxess and Trax, and Post-trade Product Management, Trade Matching, Trax
Firms modify operational process to meet shorter settlement cycles
With the advent of T+2 settlement in October 2014, teams across trading, risk and operations have been forced to think about how they will address some of the key aspects of CSDR Article 5. For many this has meant an increase in operational cost. To ensure this hasn’t resulted in a long term increase in operational risk, it has been necessary that the infrastructure to support the post trade workflow is automated and scalable and that the workflow is carefully reviewed both intra firm as well as across the industry to maximise efficiency.
Scope of CSDR T+2 and how to handle it...
Defining instruments migrating to T+2 has been a tough one, at least for fixed income where some industry participants had questioned the scope of instruments included in the move to T+2 vs those which remained on T+3.
Trading venues converged towards keeping US ISIN prefixed bonds on T+3 but with some of these instruments settling in the European (I)CSDs some firms have considered some of these instruments part of the European market and hence have a preference to settle them on T+2. Additionally, questions were raised regarding treatment of 144A and Reg-S bonds, which under an ISIN prefixed based implementation have a combination of T+2 and T+3 default settlement. Some also questioned the rationale for different settlement dates of different tranches of the same issue.
Implementation of defined scope…
Once firms decided what securities are in and out of scope for migration, there were internal operational issues that had to be considered, and it is at this point inconsistencies could prevail. Different systems may take different data feeds from different providers who may not necessarily all have the same interpretation of the scope. An example could be a difference between pricing engines and settlement engines. If a firm identified this as a potential operational issue, they needed to address how to deal with the reconciliation of these different data feeds. If these processes were not managed appropriately, increase in the volume of operational exceptions were realised. These exceptions will need to be resolved quickly to mitigate risk and P&L implications.
Different settlement preference across the market…
Anecdotal evidence suggests dealers have embraced T+2 settlement, on the other hand some investment firms managing global funds were challenged in fully migrating to T+2. This could has led to a smoother migration in the interdealer market than the institutional market. Dealers had to give thought to whom their clients are and to what extent they need to support non-standard settlement dates.
Further consideration was given to the funding implication to the market where one party is buying on a T+2 basis and the counterparty of the trade is selling on T+3. The repo market helped cover the additional funding requirements for the one day lag, but the cost of operating under this kind of structure has been quite significant- who will be responsible for bearing this cost? Although the answer to that question remains to be seen, it’s clear that repos have the potential to become even more important in the market to ensure that cash positions are properly funded & stock lending / borrowing is likely to increase as firms search for assets to meet disconnected delivery timeframes.
A solution to help reduce operational risk…
With the effect of other new regulations affecting the industry in the coming years (such as Basel III and MiFID II) operational processes have had to be modified to accommodate the new reality of shorter settlement cycles, whilst ensuring operational risks are managed effectively. Trade date affirmation is key to stop dependent activities being impacted at a significant cost to firms both from a labour driver perspective but also as a direct impact to P&L. In fact the industry shouldn’t stop at “Same Day Affirmation” but should strive to adopt a sub 15-minute trade match of transaction details following execution, including Place of Settlement.
Email the authors: CSmith@traxmarkets.com and CMckelvey@traxmarkets.com