T+2 in Canada: Affirmations in the Headlights Again

Canada and the US are in lockstep to shorten their settlement cycle from three days to two days on September 5, 2017, but Canada is taking its preparations one step further when it comes to the critical post-trade function of matching trade details.

The Canadian Securities Administrators (CSA), the umbrella organization representing all of Canada’s provincial securities watchdogs, wants to amend current legislation which sets the timetable and percentage threshold for the affirmation of trade details between fund managers and broker-dealers. The measure, known as National Instrument 24-101, was implemented in 2007.

The CSA was seeking industry comments by November 16 on whether to accelerate the deadline when Canadian firms must affirm trades in Canadian securities with non-North American counterparties to noon on the day after the trade is executed (T+1), instead of noon on T+2. The T+1 deadline would represent the same period required for domestic transactions — those between two Canadian counterparties.

The CSA also asked for feedback on whether it should require registered firms — fund managers and broker-dealers — to increase the total percentage of trades they execute affirmed by noon on T+1 to 95 percent from the current 90 percent rate. Fund managers and broker-dealers that do not meet the threshold would still have to file an exception report explaining the reasons for the shortcoming to their respective regulatory agencies.

In addition to seeking changes to the affirmation timetable and threshold, the CSA is considering whether it should require the country’s central securities depository CDS to impose financial fines or buy-in procedures when firms don’t meet the shortened settlement cycle. US market players have vetoed such requirements.

As FinOps Report went to press only comments from the Canadian Capital Markets Association and the Investment Industry Association of Canada (IIAC) were publicly available. The CCMA, Canada’s trade association for broker-dealers, fund managers and banks, is spearheading the country’s preparations for T+2, while the IIAC represents strictly broker-dealers.

Meeting a shorter affirmation timetable — if not same-day affirmation — is one of the stepping stones to complying with a two-day settlement cycle. The faster fund managers and broker-dealers acknowledge the details of a trade with each other the faster it can settle. Optimally, that would be on the day the trade is executed — a process called same-day affirmation. The US roadmap for meeting a T+2 settlement timetable also calls for financial firms to affirm the details of their trade with each other by 11:30AM EST on  T+1.

Given that the US is Canada’s largest trading partner, it was logical for Canada to follow much of the US preparatory measures. But there is a critical discrepancy reflecting regulatory differences. Unlike in Canada, the US mandate for T+1 affirmation is voluntary and there are no regulatory reporting requirements for those who don’t meet a minimum threshold of affirmed trades by 11:30AM EST on T+1. That is because the US does not have any regulation requiring affirmation of trade details before settlement. Nor does it plan to create any.

US trades not affirmed by 11:30AM EST on T+1 are simply not automatically forwarded to the National Securities Clearing Corp. (NSCC) and Depository Trust Company (DTC) for processing. NSCC is the US’ central clearinghouse while DTC is its national depository. US trades which are not affirmed at all, or affirmed after the T+1 timetable, must be submitted separately and are treated as exceptions. As a result, they incur higher processing fees.

It’s a Breeze 

Canada’s regulatory reporting requirements do provide fund managers and broker-dealers with the impetus to improve their operating systems. However, by all accounts, no one seems worried about meeting the T+1 affirmation timetable for either North American or non-North American counterparties. Considering that only a fraction of Canada’s trading volume comes from firms outside of North America, shifting to the noon T+1 cycle might not be difficult to accomplish. Based on figures provided by Canada’s central securities depository CDS for October 2016, about 92 percent of equity trades were “ready to be settled” or already confirmed by custodians by noon on T+1. The figure is about 89 percent for fixed-income transactions.

The CDS, owned by Toronto stock market operator TMX, says that its analysis does not include trades matched through central matching utilities. SS&C Technologies and Omgeo, a subsidiary of US market infrastructure Depository Trust & Clearing Corp., offer rival third-party platforms whereby fund managers and broker-dealers can match their understanding of the details of trades with each other before they are settled. Both firms are recognized as matching utilities under Canadian law and are exempt from registering as clearing agencies.

“While custodians are responsible for confirming the vast majority of trades, many fund managers run their own local matching or use matching utilities independent of custodians for risk mitigation,” says Bob Shaw, director of SSCNet, the matching service operated by technology giant SS&C Technologies. SS&C does not disclose the number of SSCNet’s users nor the percentage of trades matched on its platform that are affirmed on the same day or the next day. However, Shaw says that the firm’s own analysis confirms CDS’ findings.

“High levels of automation and the central matching model mean that domestic and cross-border trades both achieve same-day affirmation rates of above 90 percent,” says Matthew Nelson, managing director of Omgeo. About 98 percent of trades which are matched through Omgeo’s Central Trade Manager are affirmed on the day they are executed.

Lou Lesnika, assistant vice president of settlements at Canadian custodian CIBC Mellon, reports that his North American and non-North American clients are already meeting the T+1 deadline for affirmation. “We have been sending out information to all of our customers related to the new timetable and have not heard back from any clients that they will have difficulties meeting it,” he says. Most of CIBC Mellon’s fund manager and institutional clients do not rely on central matching services, but on the custodian to act as a middleman to help ensure that the details of trades they receive from buy-side clients are matched up to those reported by brokers to the CDS.

The IIAC insists that Canada’s excellent track record proves that it should not change either its threshold for trades that should be affirmed by noon on T+1 or change the timetable for affirmation to the day the trade is executed. The reason: “Our members’ view is that in a T+2 environment industry trade matching performance will likely change little from what is being witnessed currently,” says the IIA’s managing director Jack Pando in a letter to the CSA. “Changes to the deadline or threshold could unnecessarily divert our members’ attention and resources from their many other daily responsibilities.”

No Penalties Wanted

Although Canada’s quick affirmation timetable isn’t enough to prevent  two percent of trades from failing to settle on time, no one wants CDS to impose any buy-ins or fines on laggard members. “Our mandate is to prepare for a two-day settlement cycle and not address settlement fails,” explains Keith Evans, executive director of the CCMA.

Likewise the IIAC says that it doesn’t want changes to current market practice whereby counterparties work out the details of buy-ins with each other. “The daily fail rates demonstrate that settlement fails are not symptomatic of the Canadian marketplace,” says Pando in his letter to the CSA. His stance matches the US securities market perspective and differs from that of Europe, where legislation has mandated a uniform approach for national depositories to fine members that don’t settle on time. Most European markets adopted a T+2 settlement cycle in October 2014 following Germany’s footsteps.

What are Canadian securities firms really worried about? Apparently, much of the same as their US counterparties. Some broker-dealers say that fund managers are not automated enough to allocate trades to their underlying funds on the day the trades are executed — a practice which could help ensuring the trades would be affirmed quickly. Yet others say that not enough fund managers are using the available central matching services because of their high costs.

In its letter to the CSA, the IIAC appears to lay some of the blame on the dependence of fund managers on paper-based communications as well as the lack of timely reporting from TMX and CDS. “Our members indicate that a source of delay relates to the various reporting of trade details from the stock exchange (s) or CDS. Some of the reporting is received by members at the end of the day or as part of an overnight batch process,” says the IIAC’s Pando. “This slows down the dealers’ ability to identify any trade issues in need of remediation and working with counterparties to get them resolved. The industry would benefit from more real-time reporting such as intraday files from the exchange or CDS.”

However, the biggest concern of some Canadian market players, based on their responses to the CSA’s request for comments, is the timing of the required reporting of failure to meet the 90 percent threshold for affirmation on T+1. Registered firms must report failure to meet the threshhold to their securities regulator no later than 45 days after the end of the calendar quarter.

In its letter to the CSA, the CCMA’s Evans says that the reporting requirement will become operationally challenging because the target date for implementing T+2 is on September 5 — a day that falls mid-month and mid-quarter for a reporting period. What’s so hard about that? Here is how Evans explains it: “There would have to be a current system to account for July 1 to September 4 for non-North American trades, then a system reporting change to eliminate the extension of the calculation [for trade affirmation] from September 5 to September 30 for non-North American trades and then a permanent change to the new standard as of October 1, 2017 for all trades.”

Any programming for the first two periods would be of no value, says the CCMA. In fact, it would be harmful to broker-dealers. “The need to make the change in the first instance for sixty days, then remove the change for a report of 26 days, before moving to the full quarterly reports going forward will slightly increase project risk and take resources away from T+2,” says Evans in the CCMA’s letter to the CSA.

Instead, the CCMA proposes that firms should be permitted to delay exception reporting until the first full quarter that all trades must be matched by noon on T+1. That means that the first applicable quarter would be Q1 2017. The IIA took the same stance.

While Canadian market players address their internal operational weaknesses, Canada’s central depository has its own gameplan in place for meeting the shorter settlement cycle. Those preparations include industry-wide testing with TMX and its member firms next April 13 to May 26, which will cover the entire trade lifecycle from the time of trade execution to the time of settlement. The testing will incorporate exchange traded and non-exchange traded transactions as well as corporate actions such as dividends and stock splits. CDS member banks and broker-dealers will be required to tell CDS whether or not they will participate in the voluntary testing by November 30.

What happens if the TMX or CDS discovers that financial firms aren’t ready by the go-live date for T+2? The CDS apparently isn’t ready to consider such a scenario. “We will only change the timetable if the US does,” insists Fran Daly, a senior advisor to CDS. “We plan on being prepared for the September 5 timing.”

The CDS is also now considering abandoning its initial stance of having members certify or attest they are ready for T+2. The change of heart comes in the wake of the US depository’s decision to do the same, according to Daly. “We might just ask for a voluntary admission,” he says, adding that the CDS will abide by the wishes of its members before making a final decision. The CCMA’s Evans hopes for a mandatory requirement to encourage its members to be prepared. DTC says that instead of asking member firms to certify their readiness for T+2, it will simply monitor the industry’s preparedness through member surveys, the results of the US’ own industrywide testing and direct member contact.