By John Oleon, Managing Director of Clearing and Settlement Operations, Clear Street

A reduced settlement timeline aims to provide numerous benefits to the market, including lower risk, improved efficiencies, increased liquidity, and reduced volatility. For hedge

funds and asset managers, the shorter timeframe between execution and settlement can also reduce the margin needed to offset settlement risk.

Paradoxically, the impending May 2024 transition to T+1 has introduced significant short-term risks to the market. Industry participants must ensure their technology and internal operations – and those of their clients and counterparties – can accommodate the change. After the move to T+1, dealing with issues retrospectively will be far more costly and disruptive. 

The shift to T+1 settlement will impact a wide variety of aspects of the financial ecosystem, from equities and ETFs to prime brokerage and securities lending. Market participants will need to address key areas such as allocations, affirmations, prime brokerage, and securities lending, understanding the implications of the shortened settlement cycle in each area.

Preparing for the transition presents a significant challenge, particularly for participants who still rely on manual processes. While the primary financial burden is expected to fall on broker-dealers, clearing firms, and prime brokers, many buy-side firms are unaware of the full extent of the implications of T+1 on their businesses. An informal poll by SS&C conducted in February 2024 found that only 28% of investment firms have a detailed plan for T+1. 

Therefore, it is crucial for buy-side firms to collaborate closely with their sell-side counterparties ahead of the transition, ensuring seamless alignment of processes and both parties are well-prepared for the change. A lack of preparedness could result in increased operational inefficiencies and financial costs. For example, the shortened execution-to-settlement window may reduce the margin needed to offset settlement risk.

Firms must address four critical vulnerabilities: legacy technology, counterparty risk, time zone synchronization, and higher costs due to delays. Addressing these vulnerabilities requires a combination of people-based and technology-based solutions.

Both the buy-side and sell-side should address counterparty risk, ensuring that their clients and partners employ sufficient staff to manage the transition and seek to upgrade and automate their technology. Market participants must communicate readiness plans to their clients now to ensure clarity regarding each party’s responsibilities and that there are no remaining vulnerabilities in the settlement process. As the Depository Trust and Clearing Corporation (DTCC) has said: “Firms are only as strong as their weakest counterparty.”

Short-term solutions will lean heavily on people, with additional staff needed for 24-hour support and to assess and manage the risks in case of increased errors and inefficiencies. These issues could be exacerbated when trading across time zones or where batch processing is still in place.

Long-term solutions will involve upgrading legacy technology, removing manual processes wherever possible, and implementing automation. A shorter settlement period inherently means less time to correct mistakes, and systems that successfully address this change must prioritize automation and resilience. If adopted correctly, these attributes can effectively reduce failure and error risks while supporting increased processing demands.

Cloud-native clearing, settlement, and custody solutions offer a promising avenue for addressing these challenges. Modern infrastructure and real-time processing capabilities can optimize settlement cycles, drive value creation, lower costs, and minimize risks. Companies should seek to leverage resilient service orchestration and scalable data warehousing to provide seamless communication and eliminate manual reconciliation processes.

In conclusion, while the transition to T+1 settlement is a welcome development intended to reduce systemic and operational risk, it introduces short-term challenges requiring proactive preparation and technology investment. Market participants must prioritize readiness and collaboration to navigate this transition successfully.

With urgency comes opportunity. As firms employ modern infrastructure to replace legacy technology, automate processes, and de-silo fragmented data, there will be opportunities to further optimize settlement cycles, drive value creation, lower costs, and minimize risks. By embracing technology, firms can ensure a resilient financial ecosystem for the future.