Originally featured in Asset Servicing Times.

As we reach the halfway point of 2023, the US transition to T+1 remains one of financial services’ most talked-about topics.

David Smith, managing director and capital markets practice lead at Broadridge, has been carefully observing the industry’s preparations for the transition — and he has comments, concerns and questions about the progress being made.

Challenges Remain

Considering the main challenges around a T+1 implementation in capital markets, Smith highlights cutoff times as a central issue.

“DTCC has a recommended best practice of 11:59pm. for issuing stock loan recalls,” he explains, “but the majority of firms don’t necessarily know until about 2 or 3am. exactly what they’ll need to recall and borrow.” Such a tight turnaround could be a major barrier for the industry, and is “a topic that’s being debated across organizations and across the globe”.

That’s not the only issue hindering T+1 adoption. Harmonization of data across systems is another problem for firms, Smith says, with increased need for straight-through processing and the removal of manual workflow requiring “a lot of cleanup of data across [companies’] various systems and platforms.”

“Trying to get more real-time views into the firm’s inventory and trade exceptions is another focus point,” Smith continues.

“These are open topics, and solutions are undergoing. The problems are not solved yet, but solutions are coming along. We’re making progress.”

Operational Opportunities

While T+1 requires technological upheaval and the introduction of new methods and strategies, the move is prompting firms to consider other areas of their operations that could do with a revamp.

“There are currently two views on the sell-side,” Smith outlines. “There are those looking to do a minimum viable product, just doing the bare minimum to be compliant. Then there are other firms who are using the opportunity to see where they can continue to build greater capabilities and more real-time capabilities across their organization.”

Taking this approach will allow them to “potentially achieve a competitive advantage over their peers,” Smith continues, helping them not only to work more efficiently but to get ahead of potential future changes, such as T+0.

“Originally we thought that T+1 was going to be a big catalyst, with everyone doing a ‘big bang’ overhaul of their infrastructure to become more efficient,” Smith states.

However, this has not been the case. Instead, a more componentized approach has been adopted, with companies “solving problems tactically rather than having a bigger strategic change in their overall architecture.”

“They’re looking for solutions that are going to give them a benefit not just today but in the future,” Smith explains. “Firms are looking ahead to T+0, working and building their infrastructure to be able to support that.

” On the buy-side, the main challenge is getting essential details to sell-side firms faster, he adds. “They have similar complications, but most of those clients are being serviced by sell-side firms.”

For larger firms, any hiccups in implementation can be critical. Being down for any number of hours is a risk during any conversion, and one that companies are understandably reluctant to take. One solution is to adopt the modular rather than ‘big bang’ approach.

With this strategy, “you still get the overall architecture that you want to build, but you can manage the risk in a much more efficient manner,” says Smith. “If you have multiple layers of infrastructure, multiple systems, platforms that have been built over the years — it’s easier to take a functional approach than trying to change everything all in one go.”

With a ‘big bang’ approach, all new elements of the transition must be ready at the same time. This can significantly slow down time-to-market, with firms having to wait for development schedules to align before the new system can be implemented.

“If you break it into components, you’re going to get their benefits right away,” Smith explains. Client experience can be improved, manual processing can be minimized, and disruption is reduced.

On top of that, “you continually increase those benefits as you continue to release modules. Everything can be fully beta tested, making sure that it’s ready to support the organization.”

Testing, Testing

It’s not long before T+1 goes live in the US, with industry testing — “the next big hurdle” — set to begin in August. Where are market participants in their preparations, and are they on track to be ready for go-time?

“It really varies from firm to firm,” Smith reports. “A lot are in the middle of their impact assessments and are getting an understanding of what changes actually need to be carried out.” But, on the other side, “there are some folks who are really just kicking off,” he adds.

Considering whether there are any pain points that the industry has not yet prepared for, Smith reflects that “we haven’t seen any major unforeseen issues yet. But the unexpected is always bound to happen — “I think we’ll start seeing [new pain points] in testing, if they’re there.”

In order to be prepared for the transition, there are a number of areas that need to be addressed, Smith affirms. One of these is the continued reliance on manual processes.

“No matter how little or big firms are, it’s coming to light that there are a lot of small processes that continue to be done manually.” Although each of these activities may only take an hour or so, when you look across the organization “the breaks in workflow quickly add up”, Smith warns.

Additionally, “although the buy-side needs to hand over their trade details and allocations sooner, there’s really no incentive for them to do so.” A recent DTCC survey found that 60 per cent of buy-side firms were unprepared or had not thought about T+1, assuming that their fund administrators or prime brokers will handle the bulk of the operations. Without penalties or real repercussions for sending late trade and allocation details, and no motivation provided to make any operational changes, this could prove a challenge.

“I think we may see additional rules from the U.S. Securities and Exchange Commission (SEC) post-go-live, if fail rates get out of control,” Smith predicts. “If not, it may stay as it is and continue to bring down fail costs with no penalties.” There’s a historical trend of fail rates spiking immediately after a settlement cycle transition, after which things settle down to more expected levels. Allocations and timestamps will be carefully reviewed by the SEC — “but what they do as a next step on that is another question.”

Outsourcing the Strain

Outsourcing is an increasingly popular option across the industry. “It’s a great service for many banks and broker dealers,” Smith says.

“One, they’re getting industry experts to work on their operations team; and two, they’re optimizing their efficiency. The industry has a real problem with staffing right now specifically in operational roles. The talent market is becoming increasingly competitive, “and even though things are becoming more automated, you still need expertise.”

Third-party services can offer committed resources, expert knowledge and a responsive approach. In the face of T+1, they can also provide round-the-clock services to keep up with after-hours activities. This can be particularly important for smaller firms who don’t have follow-the-clock office locations across the globe. Breaks can be researched when they happen rather than being an unpleasant surprise at opening, and companies will be able to match the demands of an increasingly rapid industry environment.

What Comes Next?

It seems obvious that the next step after T+1 will be T+0. It’s widely acknowledged to be on the horizon, and Smith agrees that it’s certainly in the pipeline. However, “personally, I’m not sure what the benefits of a T+0 environment really are for the investor,” he divulges.

The ‘breathing room’ that T+2 and T+1 provide allows checks and balances to take place, and works to reduce marketplace risk. “When you move to instantaneous settlements, there’s no time for errors. How will regulation work in a T+0 world, given the pace of transactions that would happen? What are the limits, what are the rules of transaction?”

T+0 may not make enough of a difference to end investors to be worth the upheaval, Smith affirms. Rather than increasing efficiency, “it may be a technology solution to fit a need that’s not necessarily there.”

Whether or not T+0 is right or wrong is up for debate. The fact that T+1 still requires extensive preparations, however, is not. As the US enters the T+1 testing phase later this year, firms will have to stay vigilant to ensure that their operations and technology are up to scratch for the speed of the future.