As T+1 looms, non-US firms consider out-of-hours trading

Asset managers outside the US are looking to automate foreign exchange trades to help meet tighter cutoff times for settling the transactions.

The impending transition from T+2 to T+1 settlement in the US in May presents a logistical hurdle for non-US buy-side firms. When buying or selling US securities, the firms typically arrange the FX leg the day after trade execution. This FX transaction is then fed through to global settlement service CLS the following day, T+2.

The compressed timeline now requires firms to either execute same-day FX transactions to meet the deadline to get trades into CLS—which would be outside of normal trading hours in many non-US time zones—or pre-fund custodian or broker accounts with preemptive dollar allocation, which brings opportunity costs and operational risks.

Failure to hit the new deadline would force firms to bilaterally settle the FX trades, which would increase FX settlement risk and prevent the counterparties from enjoying the cost efficiencies of using CLS.

While some foreign firms have looked at setting up new offices in the US just to handle the FX execution, for many that’s too expensive. And so banks say buy-side firms are exploring automated services, which would allow them to pre-set their FX trading to occur outside of working hours but still make the CLS cutoff.

“I think this T+1 transition is an example where clients need both automation, and flexibility on how this automation works,” says Vincent Bonamy, head of global intermediary services for FX and commodities at HSBC.

HSBC, State Street and BNY Mellon are among the firms developing automated services.

In the current T+2 structure, securities trades are matched and confirmed in the US at 11:30 Eastern Time on the day after the trade. However, under T+1, securities trades will need to be confirmed by 21:00 ET on the trade date, to be settled the following day. This leaves a limited window on the trade date to execute the FX leg and for the trade to be booked into CLS.

The cutoff time for CLS to accept a trade for settlement is midnight Central European Time. A counterparty that executes a trade near to market close in New York at 16:00 ET would have only two hours to execute the FX leg and submit it to CLS in time for the equivalent local cutoff time of 18:00 ET.

CLS is considering extending its cutoff times to give market participants more leeway to meet the new shortened settlement cycle, but banks complain the necessary changes to infrastructure would be costly and onerous. It is unclear whether CLS would be able to implement any changes to its cutoff times before the May start date for the new T+1 rules.

Foreign investors hold around 20% of US securities, according to official figures from June 2022. In a BNY Mellon report published in January, the bank found that roughly a third of trades settled by the Depository Trust & Clearing Corporation will face problems in preparation for T+1. The report, based on analysis of BNY Mellon’s US custody base, shows that 25% of client transactions would need to adjust workflows to meet new settlement cutoffs and another 9% would need significant operating model changes.

To help meet the new timetable, HSBC is offering automated trading outside of normal hours for clients using the bank as a custodian, based on pre-agreed terms set ahead of time by the client.

“We have developed an automated FX solution with dedicated protocols. It notably addresses specific liquidity concerns linked to this new trade lifecycle for US equities. It is especially geared towards our Asian clients, due to the time zone challenge they face,” says Bonamy.

State Street launched a service in October, which links together the Depository Trust & Clearing Corporation’s trade matching platform with the bank’s FX trading service, StreetFX. This allows users to automatically execute the FX trade needed to fund the purchase or sale of a securities transaction shortly after it is affirmed and staged at the DTCC. It is also custodian agnostic, working across all the major providers.

Tara Taylor, head of North America StreetFX pricing services, says global asset managers and those in Asia in particular, will have to look at more automated ways of trading given the time zone challenges.

“If it’s manual, firms are going to need to look at other ways to do that, because it’s just not going to be sustainable,” says Taylor.

BNY Mellon in October also launched Universal FX, a new FX platform building on its existing OneFX services, which allows for rules-based FX execution across different custodians and prime brokers.

Adam Watson, head of commercial product for custody at BNY Mellon, says, “If clients want to come to us as close to the point of execution and bifurcate the trade process, and execute FX, we can do direct integration with our FX desk via direct dealing. If certain clients want to keep the FX and the trade process connected we can support that through custody FX. And if clients want to execute same-day FX, we can support that too.”

Order management system providers also offer tools to tackle the T+1 problem. Ion, for example, offers a feature through its Barracuda OMS called Order Hub, which allows orders to be sent to a partner bank to manage overnight.

“[T+1] is calling for real time automation. You have to take all manual settlement tasks and operational tasks out of the settlement process, and you have to work on automating it all so you can process quickly and efficiently with a new timeframe. And the only way to do that is to have it done automatically,” says Eugene Markman, chief operating officer of Ion.