FX traders of all types need to understand the implications of the coming shift to T+1 settlement for North American securities. Greater use of automation will be vital, with a focus on technology solutions that can be configured to manage FX liquidity risk and optimize hedging strategies.
The end of November will see the start of a six month countdown to the implementation of T+1 settlement for US securities, a shift that is also being made by Canada and Mexico. The approach of the adoption of next day settlement for US shares and bonds on May 28 2024 has important implications for FX traders of all types.
Most spot trades in the $7.5 trillion a day currency market – the biggest in the world by volume – will continue to settle on a T+2 basis.
This will pose obvious challenges for non-US holders of US stocks and bonds who need to settle their transactions on a timely basis and manage the resulting FX exposure. Foreign holdings of US securities were worth just under $25 trillion on June 30 2022, the US Treasury said in April this year, in its most recent survey. That accounts for roughly 20% of all US stock and bonds, with foreign holdings of equities at $12.1 trillion the biggest component.
Pricing and managing the FX component of US – and Canadian and Mexican – securities transactions for non US dollar based market participants will become more complex when T+1 settlement comes into effect. Settling currency trades on the same T+1 basis will be operationally difficult and could have the effect of pushing large volumes of FX trades to a narrow window – effectively the end of the US trading day.
That will have liquidity and risk management implications for all FX traders, not just foreign investors who need to hedge their North American securities transactions.
Liquidity now..and then
At the moment, FX liquidity is best when all three global markets – Asia, Europe and the US – are open. Average FX volumes fall sharply at the end of the European afternoon and liquidity is generally poor towards the US close – which is just when it will be logical to hedge US securities trades once T+1 settlement comes in next year.
It is not clear whether FX liquidity towards the end of the US trading day will improve simply because of higher demand after T+1 US securities settlement arrives, or whether the near-term effect will be poor pricing outcomes for end customers. There are also potential knock-on effects for market conditions in Asia.
Legacy systems have end-of-day issues
Many legacy e-commerce systems require an end of day restart which ranges in time from several minutes to upwards of 30 minutes. Historically many foreign exchange end users have begrudgingly put up with this inconvenience by trading either before or after that window. However, as the markets move to T+1 settlement these outages will often be during the very limited time end users have to square their risks.
Remediating legacy systems is challenging and may not be accomplished in time for the shift in market practice next year.
oneZero’s systems, by contrast, have consistently operated uninterrupted at the end of day and present a distinct competitive advantage to our clients.
A switch to a system which was designed for continuous operation may accordingly be easier than an expensive retrofitting with an unknown outcome for those using legacy systems.
oneZero can help with configuration for execution
Automation can help solve many of the approaching challenges for the FX markets. oneZero’s Institutional Hub allows clients to set configurations in advance to adapt execution to expected liquidity by timezone, for example. These automated settings and similar solutions could help asset managers execute their FX risk simultaneously with the security trade, giving back-office staff more time to manage settlement. The execution can also be scheduled to happen at the time of peak liquidity, reducing costs for firms – in many cases the optimal period can be overnight for firms operating in the US.
oneZero also provides full backing for FX swap trading. This can further optimize execution by allowing US desks to trade on a T+2 basis, as normal, then executing a swap to roll their settlement to T+1 during times with better liquidity.
And oneZero will soon offer cut-off support, which will allow banks to quote FX prices on a T+0 basis as late as is practically possible, to ensure that they can provide maximum liquidity to their clients.
Automation also brings wider benefits for the back-office – trades executed electronically are significantly more likely to settle successfully compared to manually executed deals. oneZero’s Hub fully integrates with a wide range of STP and post-trade solutions, including for regulatory reporting, which can significantly smooth the journey to T+1.
oneZero also guarantees 24/7 follow-the-sun service
oneZero has a 14-year track record of developing new technology solutions that help our 250+ clients to adapt to changing FX liquidity conditions in all regions.
Algorithmic trading will be an important part of the toolbox for FX traders based outside the US if liquidity patterns shift. oneZero’s Algorithmic Pricing Module allows clients to insert their own native code for greater control of underlying data elements in constructing FX prices.
And oneZero’s solutions also allow clients to tailor their broader hedging strategies – not just trades that hedge specific US securities trades – to potential changes in FX liquidity.
From systematic FX hedging tools to passive hedging with peg orders that can reduce costs, oneZero offers a multitude of ways to use technology to automate aspects of currency trading – while still retaining the option to use the discretion of an individual risk manager to adapt to actual liquidity conditions.
Probably most importantly of all, oneZero offers genuine, tested continuity of operational support at all times in all regions. oneZero’s 24/7 follow-the-sun global operational support will help to give clients confidence that they can minimize any technology issues that could follow a shift in FX liquidity to US trading hours.
FX traders need better solutions, not more desks
The debate over the impact of the coming shift to T+1 settlement for US securities has led some observers to speculate that FX users such as mid-sized asset managers will be forced to outsource much of their currency trading.
Big banks and asset managers will be able to increase their presence in the US, including with new dealing desks and settlement staff, which would be too expensive for mid-sized funds, according to this argument.
There are certainly outsourcing options available. The FX division of the Global Financial Markets Association noted earlier this year that specialist currency managers might be able to help non-US FX users to both assist with execution and check whether settlement risk as T+1 comes in can be reduced with trades that use CLS, for example.
But a first stop for any FX user wondering how to adapt to the coming shift to T+1 securities settlement in North America should be to examine core technology that can provide cost-effective and tailored solutions.