Tim Batho
- Knock-On Effects: The T+1 shift in US equity settlement could affect global market participants, especially index fund managers struggling with replicability challenges due to new settlement cut-off times.
- Monitoring Market Structure: FTSE Russell closely monitors equity market changes through its country classification process, focusing on regulation quality, dealing landscape, and settlement procedures within individual markets.
- Ongoing Review Process: Conducting annual and interim country classification reviews, FTSE Russell ensures a transparent and consistent methodology to assess market practices, including the impact of T+1 settlement changes.
As a global index provider, FTSE Russell’s role is to offer an objective view of markets’ behaviour. This means creating and managing a wide range of indices, data and analytical solutions to meet clients’ needs across asset classes, styles and strategies.
It also means looking behind the daily headlines of market movements and into the way those markets operate, particularly from the perspective of non-domestic participants. The clearing and settlement of equity trades may not sound like the most exciting subject, but it’s an important one. And this year something big is happening.
On May 28, 2024, the US equity market moved to a shorter settlement cycle: resulting in, trades in US stocks being settled the day after the trade date (i.e., “T+1”), rather than two days after trade date (“T+2”). Trades in US corporate bonds and unit investment trusts will also move to the shorter cycle, as will the national equity markets of Canada and Mexico.
This will place the US equity market on a shorter settlement cycle than most other developed markets, which operate on a T+2 or T+3 cycle.
Faster settlement protects market participants by reducing systemic risks, operational risks, liquidity needs and counterparty risks. It also helps reduce margin requirements and allows investors quicker access to the proceeds from a sale trade.
Faster exchange of securities for cash is in line with technological advances and may have still further to go: if we can send money instantaneously (as most of us now can via faster payments systems), why can’t we move the cash associated with our equity trades in real time as well?
The answer is that money and securities move on different settlement “rails”, with different operating procedures. Beyond that, we still operate in a world of national currencies and national securities markets. Moving money between them is not always seamless.
Why does this matter to a global index provider?
This all matters because our job as a global index provider is not just to look at an equity market from the perspective of local traders and investors. In fact, a US trader or investor buying and selling Amazon or Microsoft shares probably won’t notice that much has changed at the end of May.
But it’s when we consider non-domestic investors in US shares that some of the complexities surrounding T+1 is revealed.
For anyone outside the US buying or selling US shares, there will likely be an associated foreign exchange (FX) transaction. A buyer of US shares may need to sell his/her currency to buy US dollars to acquire the shares. Equally, a seller of US shares will probably want to convert the dollars received into another currency.
The FX market’s convention is for T+2 settlement. So, while the FX and equity settlement timeframes are currently similar, there will soon be a mismatch between the two cycles.
For more detail, read our Q&A on the market and index impact of the shorter US equity settlement cycle.
We have also written two blogs on the impending change: one from the perspective of a hypothetical Asian investor, the other from the perspective of a European investor in US equities.
LSEG has also published a white paper on the challenges and opportunities for the global FX market brought about by the T+1 shift.
In summary, the shortening of the US equity settlement cycle may have various knock-on effects for other financial market participants around the world. This may be exacerbated depending on the time zone in which the investor operates.
Among those affected could be index fund managers: the replicability of regional or global benchmarks may be tested if the new settlement cut-off times are unattainable for a typical index-tracking portfolio (and remember that US shares currently represent more than 60% of global equity indices by weight).
Keeping an eye on equity market structure
Changes to equity markets’ operating procedures are inevitable and ongoing. They are something FTSE Russell monitors closely via our equity country classification process, one of whose main themes is the quality of regulation, the dealing landscape, custody and settlement procedures within individual equity markets.
We conduct a formal annual review of country classification within the FTSE global equity indices each September using a comprehensive, transparent and consistent methodology, as well as an interim country classification review each March. We publish the results of each review shortly afterwards.
In the last three decades we’ve seen a welcome shift towards more seamless post-trade procedures and a shortening of settlement times. But the changes to market practices resulting from the impending contraction of the US equity settlement cycle is one area we will be following closely.
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