A tide of change is rising within the trade settlement landscape. The upcoming switch to a T+1 (trade-plus-one day) settlement system in the US next May doesn’t come without strings attached.
While the move aims to cut back on credit, market, and liquidity risks, critics argue that it carries with it a heavy financial burden. The brunt of this shift, alarmingly, may fall squarely on the shoulders of ETF investors, especially those outside the U.S.
An Unsettling Change for ETFs
Although the US Securities and Exchange Commission contends that the T+1 system can ward off potential risks for market participants, there’s a clear divide in perception.
A primary concern? The ETF industry, especially entities with international market exposure, is forecasted to grapple with amplified costs. Why?
Because while the US hurries forward with the T+1 protocol, the rest of the world will remain settled in the T+2 framework. This divergence isn’t mere semantics but carries tangible implications.
In the meticulous world of ETFs, there exists a network of primary market ‘authorized participants’ (APs) who spot and seize upon price discrepancies between ETFs and their underlying assets.
Regular investors, however, engage in secondary market trades involving shares from these APs. With the T+1 mandate, a disconcerting mismatch emerges. European-based ETFs, for instance, will operate on T+2, but any US-based assets they cling to will be bound by the T+1 regimen.
Let’s decode this. If an AP crafts an ETF share during this incoming era of mismatched timings, they will either foot the bill for a day, escalating costs for investors, or an ETF issuer might be left leaning heavily on a broker’s overdraft to synchronize with the T+1 schedule.
No matter the route, the outcome isn’t pretty. Investors will be the ones diving deeper into their pockets.
Ripples Beyond the ETF Market
This isn’t merely an ETF ordeal. The foreign exchange markets are also gearing up for turbulence. As of now, a significant number of non-US managers lock in their trade matches, only to then initiate and conclude the settlement of FX orders in the T+1 period.
This ensures payments can be executed by T+2. This intricate dance is commonly orchestrated using platforms like CLS Bank. However, with the incoming T+1 mandate, this well-oiled mechanism hits a snag.
Further complicating matters are the operational nightmares on the horizon. As the trading clock advances, EU firms might find themselves burning the midnight oil or expanding their US operations, just to keep up with the new deadlines.
But what of the managers in Asia? With regions like Australia and Hong Kong already operating ahead of EST, the new T+1 mandate might prove too daunting. There’s a high likelihood of an upswing in botched trades for Asia-Pacific investors engaged in US ETFs.
The core of this debacle remains a pivotal question: Who bears the brunt of this shift? An overwhelming consensus is emerging that the major load will be shouldered by investors outside the US.
While some professionals downplay the potential impact, suggesting that costs might only be a marginal increase, the fact remains that this disproportionate weight falls on non-US ETF investors.
