What T+1 risk? Dealers shake off FX concerns

For over a year, trade associations and industry working groups have been warning that the transition to a T+1 settlement cycle for US, Canadian and Mexican securities would be one of the biggest structural changes to hit the foreign exchange market in years.

There were even doomsday predictions that 40% of daily flows from European asset managers – worth between $50 billion–70 billion – could be forced to settle bilaterally outside of the CLS platform, leaving them without the protection provided by payment-versus-payment (PvP) settlement.

Well, the May 28 deadline came and went, and to many FX participants the transition was one of the biggest non-events in recent times.

Dealers and custody banks say the supposed bilateral settlement risk, increased operational strain, stress in the overnight swaps market, illiquidity and wider spreads from trading later in the New York day – all resulting from the shortened timeframe in which to transact the FX-related trades – have yet to occur.

The industry also seemed to have passed the test three days later when MSCI rebalanced its family of indexes, a quarter-end event that affects thousands of mutual funds, portfolios and exchange-traded funds and which normally sees billions of dollars of stocks traded and any associated FX hedges adjusted.

One FX dealer recalls sitting at their desk at 5pm on the day of the rebalancing all set for the phone to ring. It didn’t.

There was also a public holiday in Australia on Monday, June 10. This sparked fears that if an Australian fund executed a US securities trade on the preceding Friday evening, the FX component wouldn’t be exchanged because the country’s central bank would be closed and the currency transaction could not be settled. That would have resulted in the underlying equity securities trade falling through. But dealers reported no major issues there, either.

Some custodians opted to move their cut-off times to give clients more time to meet CLS’s multilateral settlement deadline. This meant fewer securities trade fails, as reported by the Depository Trust & Clearing Corporation where total affirmation rates had actually increased to 94.89% as of June 7.

What does all of this suggest? You could argue the trade bodies and working groups successfully did their job by making market participants aware of the changes to their workflows and operations that the transition would require. And that asset managers made all the necessary preparations of moving staff to the US east coast to handle the FX trades during the appropriate hours, or outsourced a lot of the trading to custodians.

But could it be that this is just the calm before the storm? The feeling is that many firms had put in place contingency measures to handle the immediate switch to T+1. But when the market returns to business-as-usual activities and volatility resurfaces, then more obvious challenges could arise.

One potential concern cited by dealers is the impact on liquidity if clients start to demand pricing later in the trading day, especially if flows are one-way. Banks will then have to rely on counterparties based in Tokyo to come online to offset these trades. Otherwise, spreads could begin to widen significantly.

So for now, the industry could be forgiven for popping a cork in celebration of a rare success story in the history of market structure shake-ups. But let’s give it a month… 

Editing by Lukas Becker