T+2: Coming to US Fund Managers

How much difference can it make that a US trade group representing mutual fund advisors adds its support to longstanding efforts by the Depository Trust & Clearing Corp. to move the US to a two-day settlement cycle? Enough to make it clear that the ball is now rolling, and deadlines are being considered.

The result: operations and technology specialists are going to be spending a lot more time together, as they join forces to address back-office inefficiencies that create obstacles to meeting faster settlement deadlines.

The three top priorities, according to a dozen operations directors at some of the US largest mutual funds and other institutional fund management shops who spoke with FinOps Report on condition of anonymity, are: affirming trades the day they are executed; recalling securities out on loan more quickly; and settling foreign exchange transactions faster.

“We will be setting up steering committees and subcommittees of business line operations and IT specialists to address T+2,” one senior-level operations director at an East Coast fund management shop tells FinOps. Another says that his firm has already created a T+2 steering committee with trading desk, IT, middle and back-office reconciliation, settlement, and securities lending experts.

Regardless of just which departments are represented in such groups, they are likely to be reporting to the chief operating officer. “Operations, not IT specialists, will be heading the T+2 ship but we will need to set aside any differences for a common goal,” says the operations director of a West Coast fund management shop.

In its endorsement of a two-day settlement cycle last week, the influential mutual fund lobbying group Investment Company Institute (ICI) appears to be the first trade group representing buy-side firms to publicly join the bandwagon for shorter settlement. In doing so, it has given DTCC — along with its broker-dealers and custodians — the comfort of knowing that they can make the necessary operational changes without worrying fund managers will balk.

Operations specialists at five of DTCC’s broker-dealer and custodian bank members tell FinOps Report they are eager to move to a T+2 settlement cycle, but remain concerned whether fund manager customers could make the necessary switch from a batch to a real-time post-trade process.

“DTCC has been working with industry stakeholders since 2012 and reached out to buy-side and sell-side organizations, including ICI,” says Kathy Joaquin, chief industry operations officer for ICI in Washington, D.C. “We believe the shorter settlement cycle would reduce operational risk and agreed to work with DTCC on this matter.”

Joaquin won’t specify just when the ICI, representing 250 mutual fund complexes with US$16.5 trillion in assets, wants T+2 settlement to take place or what the next stepping stones might be other than to say that progress will be staged. DTCC declined to respond to questions posed by FinOps, instead referring them to subsidiary Omgeo, the post-trade communications giant which has heavily promoted central matching of trade instructions on both sides of the Atlantic to ensure shorter settlement. Omgeo was unavailable for comment at press time.

Regardless of how US buy and sell-side firms manage to reach a T+2 settlement cycle, it’s clear they want to avoid a regulatory mandate to do so. There is no interest in a repeat of the 1995 experience, when the SEC laid down the law that the US would migrate to T+3 from T+5. Nevertheless, the SEC will have to approve of any rule changes requested by DTCC to adapt its own operations to meet the T+2 timetable.

“The initial surveys conducted by the DTCC clearly indicate broad support among fund managers, broker-dealers and custodians for a shortened settlement cycle so a formal push is likely not necessary,” says Jeff Zoller, chairman of International Securities Association for Institutional Trade Communication (ISITC), the trade group representing buy and sell-side operations specialists.

So when can T+2 happen? The US can ill-afford to fall behind Europe for too long, concede buy and sell-side operations specialists. The European Commission has already mandated that the continent unify its settlement cycle to T+2 by January 2015. About ten markets have indicated they will do so even sooner — in October 2014.

At ISITC’s annual meeting in March 2013 in Boston, DTCC floated 2016 as the year T+2 might take place in the US. However, DTCC clearly indicated that the timetable was “preliminary” and subject to change, pending industry feedback. While ISITC won’t publicly back a specific date, Zoller suggests 2016 won’t be feasible.

“While we do not believe the required market infrastructure changes are significant in a T+2 scenario, we cannot underestimate the potential process and technology changes that mid and smaller-tier investment management firms may have to make,” says Zoller, who is also vice president at US fund manager T.Rowe Price in Baltimore. “DTCC should also consider the efforts firms currently have underway to prepare for T+2 in Europe as well as global reporting requirements such as reporting of derivative trades and the US Foreign Account Tax Compliance Act.”

The US has sporadically dabbled with the idea of a shorter settlement cycle, but rejected the concept in 2002 in favor of straight-through-processing. The notion was resurrected in 2012 when DTCC hired Boston Consulting Group to carry out a thorough cost-benefit analysis on shifting the US to a same-day, T+1, or T+2 timetable.

The two-day cycle emerged as the clear winner — far less costly and likely an easier sell to C-level executives at its member firms. Switching to a two-day settlement cycle would cost the US industry about US$550 million, while one-day settlement would cost a whopping US$1.77 billion. The payback for T+2 would be three years compared to ten years for one-day settlement. Boston Consulting Group declined to comment for this article.

Acknowledging the details of their trades on the same day they are executed was cited by all of the fund managers, broker-dealers and custodians that FinOps contacted as their top priority in complying with a T+2 settlement cycle. The process — known as same-day affirmation — is pivotal because if fund managers and broker-dealers can’t acknowledge the details of their trades on time, they can’t attach the necessary settlement instructions to exchange cash and securities in time.

Just how US fund managers will meet same-day affirmation is a topic of much debate. Omgeo has won over hundreds of fund managers and brokers to use its central matching service in the US with the argument it can substantially increase the same-day affirmation rate. Use of CTM could increase the percentage of trades which are affirmed on the same day they are executed to 94 percent, according to Omgeo. The figure stands in sharp contrast to the 36 percent, the DTCC subsidiary says would apply to the domestic US market when using local matching. But the later option is promoted by the FIX Trading Community and global messaging network SWIFT as an operationally viable and far less costly alternative.

Reducing the time it takes to recall securities out on loan to meet a settlement obligation and cutting the time it takes to settle a foreign exchange transaction emerged equally as the second most important changes US fund managers must make. All five of the broker-dealer and custodian bank operations specialists who spoke with FinOps noted these two were on their to-do lists, while seven of the fund manager operations experts  did so.

ISITC’s Zoller offers fund managers the following three recommendations to meet a T+2 timetable:

Optimize technology infrastructure: Firms should ensure they are delivering trade execution details from front-office systems to the middle office in real-time or near real-time to facilitate more timely trade matching, he says.

Review key service-level agreements: A shorter settlement cycle will compress the time fund managers have to complete their matching and pre-settlement processes, so they should consider establishing same-day matching and affirmation standards with counterparties to allow sufficient time to identify exceptions and resolve them.

“It’s equally important that managers understand the deadlines their custodian banks establish for reporting trades,” says Zoller. “This becomes more critical for firms managing accounts on behalf of European or Asian institutional clients.” The reason: the impact of time-zone differences may compress deadlines required by custodian banks even more.

Refine lending and FX practices: Fund managers need to document whether their current securities lending practices permit a T+2 settlement cycle and what the potential foreign exchange implications are for accounts based on a currency other than the US dollar. Should fund managers need recall or call back securities out on loan to settle a trade, they will have to communicate that requirement to their custodian banks a lot sooner than is now the case.

Using the CTM or any post-trade matching process is just a piece of the total picture. In addition to considering how their technical resources will support T+1, firms must also be prepared to revamp their operational practices.  Back-office operations experts at fund management shops will have to investigate and fix unmatched trades immediately, rather than waiting the next day to do so. that means leaving the office at 5PM EST might no longer be an option.

“Firms need to proactively establish procedures that leverage current technologies and support real-time matching and exception resolution,” explains Zoller.

Although most large fund managers do have an infrastructure that supports a T+2 settlement cycle in the US, they aren’t acting like it, as Zoller explains. With that timetable now becoming real, fund managers have to get real about correcting the causes of affirmation and other post-trade processing delays.