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Financial markets are about to embark on a global stress test, essentially imposed by the superpower that is the US. Lots of institutions, particularly those outside the US, will fail it.
From late May, in North America, the trading process for assets including stocks, corporate bonds and exchange traded funds, will speed up. Right now, it takes two days from the point where an investor hits the button to buy or sell, and the point when the related money exits one account and lands in another, a process known as settlement. In between lies a gap for confirming trades, double checking them, fixing errors, making sure assets are in the right place, calling them back in if they have been lent out, and sorting out any currency exchange transactions.
All this involves a vast network of achingly tedious but crucial plumbing that generally troubles only the tens of thousands of people directly employed in the field or serious markets anoraks.
But on May 28, that two-day process will become a one-day process, or T+1. The aim is laudable — time is risk. It also drags financial markets in to the TikTok age — younger retail traders struggle to understand why deals are not signed, sealed and delivered instantly. Slashing the process is a step towards a glorious but still faraway real-time future.
The upgrade stems from the wild scenes of January 2021, when such a huge number of punters placed bets on lowly consoles retailer GameStop, and a few other stocks, that broker Robinhood froze up. Opinions on the role of two-day settlement in this differ, to put it politely. A great number fail to see the point of the rejig at all. But US regulators decided cutting settlement times would be beneficial, and so here we are. Canada and Mexico are joining in, but the dominant global role of US stocks means this is the changeover that really matters, regardless of whether the UK and Europe join in later on as expected.
For US investors and other intermediaries, this is a hassle as it crams the settlement process into just a few hours after markets close. Working hours on the east coast will have to lengthen a little. Further east, it is much more of a pain, and a costly one at that, in large part because the Earth turns at a specific pace and currency exchange trades are better priced and more liquid when their home market is awake. To get trades done, asset managers may have to accept rubbish currency exchange rates, especially on a Friday. Or they may need some kind of stop-gap measures from their banks.
Night shifts or extra US staffing — hardly cheap options — are proving popular. “For them, it’s better to put bums on seats and take on that cost than to run the risk of liquidity shortfalls,” said Gerard Walsh, head of client solutions at custody bank Northern Trust in London. “I don’t think the market has grasped it properly.” Some will opt to buy or sell foreign currency in advance of securities trades — a clunky and undesirable outcome.
The other issue is that settlement processes are, as consultant Virginie O’Shea put it, “pretty crap”. The biggest, best resourced asset managers have top-notch tech that makes it run smoothly. Some of the smaller shops, however, rely on excel spreadsheets and, believe it or not, faxes. In a recent report, custody bank BNY Mellon said a third of client trades did not yet meet the future criteria. “It’s going to be an absolute mess,” said O’Shea. “Failure rates will go up . . . Transaction costs will go up.”
Banks may decide that some of the more antiquated asset managers are simply not worth the bother. The “deal with it” view is: Those unable to execute client orders and redemptions smoothly should not be doing this job. Cash buffers in mainstream European funds are limited but should be able to cushion most of the blow. Also, faxes? Seriously?
In addition, the magic of capitalism will provide solutions. Custodian banks can step up and offer liquidity to asset managers that need it. That is true. But it comes at a cost, one that will be borne largely by those in and east of the London timezone that are already struggling to keep pace with the US investment powerhouses. Currency trading in London — the jewel in the City’s crown — is also likely to suffer.
Sticking with the pain of speeding up settlement is worth it. But this whole exercise illustrates that for all of Europe’s efforts to flex its financial muscle, if the US says jump, global investors ask how high. Other markets are, as Jim McCaughan, former chief executive of Principal Asset Management, said, “more fragile than people recognise”. This apparently minor plumbing upgrade puts the ecosystem under another layer of costly strain and further cements US dominance.
