SmartStream
Future-proofing: Beyond reconciliations
The impact of a T+1 settlement schedule goes far beyond banks’ reconciliations processes to affect many lines of business. Consequently, it is forcing a rethink of large parts of systems infrastructure. Future Banking talks again to Roland Brandli of SmartStream about how banks can best manage the many changes that will result.
mplementing an automated, AI-enabled, lightning- fast suite of reconciliations and exceptions management solutions will go a long way in helping banks to soften the impact of T+1, and prepare them for the advent of real-time settlement when it arrives, but it won’t solve all of their problems. T+1 will cut across vast swathes of bank operations. Some of the ripples of next-day settlement come from a lack of synchrony with other aspects of trading, and banks that appreciate the full impact of a shorter settlement cycle are focusing on building partnerships with technology providers that understand the entirety of their journey.
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When T+1 comes into effect in May 2024, forcing firms to pay for and deliver securities faster, the result will be a distinct market disconnect. Many markets will still be using a T+2 settlement model. This means that cross-border transactions will now be taking place under two different settlement cycles, which could increase operational risk.
As the move to T+1 will affect all banks trading securities covered by the SEC ruling, not just those operating in the US, there are implications for both direct currency funding and cross-currency funding. There is also potential for the industry to start changing how it settles cash flow, too. It could, for example, move to real-time gross settlement. The fact that the foreign exchange (FX) market traditionally settles on a T+2 basis could mean that the cogs in the securities trading machine do not perfectly align, and the gears will grind.
International counterparties wanting to buy US securities will need to prefund their transactions with US dollars, or arrange for a short-dated T+1 FX settlement. Prefunding could have an effect on other investments, perhaps forcing sales a day earlier to have the dollars available, in which case an investment manager would be out of the market for a day. T+1 will also radically increase the demand for intraday liquidity. The result will be much greater competition for funding sources, and a heightened
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need for short-term funding. Furthermore, there will be less time to spot and correct any mistakes in the post-trade process, which could be expensive if a late funding request results.
A closer look at liquidity
The implications for liquidity management are huge. Banks must be able to provide the increased intraday liquidity and satisfy growing demand for faster payments. They will need to be able to access more cash and more liquid assets in the short term, which will come at the cost of investment in new technology to facilitate faster settlement.
Once set up, these reconciliations systems would certainly reduce the cost of exceptions management, as finding out about a problem when it has just happened will allow them to address it sooner and more efficiently. T+1 removes that latency between problem identification and solution. Nevertheless, there are more changes to systems infrastructure and process design that will need to happen. For example, banks will have to overcome the time constraint on securities lending, which arises because the lender will either need to get the original securities back from loan or perhaps substitute the lender with another party. That will give rise to challenges where the security has been sold late in the day on T+0 in order to effect settlement the next day. To manage the heightened demand for liquidity, treasuries may need to use more short-term funding, such as repos and money-market funds. One potential problem is that these instruments are prone to volatility. If short-term rates rise, or compressed settlement times create greater competition for the same funding sources, banks may face increased costs. Many of the obstacles that arise with cash and liquidity management can be addressed by putting in place the right controls, so a combination of technology investment and process optimisation will be required. For this to happen, banks will need to make this a prime focus if they are to manage liquidity and
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