When the stock markets in the United States open next Tuesday after the long Memorial Day weekend, everything will look the same at first glance. However, a very important, long-announced, and, according to many, controversial change will take place: halving the time to complete every transaction on American securities to a single day.

The transition to T+1 securities settlement will officially occur on May 28, 2024, and American stock exchanges and numerous financial firms are preparing for it and the potential complications it may bring.

What is T+1 Securities Settlement?

T+1 securities settlement refers to shortening the standard settlement cycle for most securities transactions from two business days after the trade date (T+2) to one business day after the trade date (T+1).

The T+1 cycle will apply to stocks, corporate and municipal bonds, ETFs, certain mutual funds, and other exchange-traded securities. Under T+1, if you buy or sell a security on a Tuesday, for example, the transaction must be fully settled by the end of the day on Wednesday.

The move to T+1 is expected to reduce counterparty risk and potentially increase automation in post-trade processes. However, it will require market participants to update systems and processes to comply with the compressed timeframe, and according to industry representatives, it may be associated with new, previously unknown risks.

It is no surprise that the largest banking institutions, such as Societe Generale, UBS, Citi, and HSBC Holdings, are transferring staff, hiring new people, and building entirely new systems to cope with this significant change.

The US stock exchanges, which will be the first responsible for implementing and maintaining the changes, are also preparing for the transition.

Cboe Ready for Transition to T+1

In its latest communication, the Cboe US Equities Exchange informed that it is ready for the transition to the shortened standard settlement cycle, effective May 28, 2024.

"The Cboe U.S. Equities Exchanges will also shorten the period for which transactions in stocks are ex-dividend or ex-rights," the exchange explained.

Presently, Cboe starts trading ex-dividends one day prior to the record date for dividends or other distributions. With the introduction of the new settlement cycle, ex-dividend trading will occur on the same day as the record date.

Although the other major American exchanges, NYSE and Nasdaq, have not yet issued similar statements, they are certainly also preparing to transition or are already ready to do so.

Self-regulating financial organizations in the US also announced such readiness. One of them is FINRA, which reported the adoption of appropriate rules at the end of February 2024.

FX Risks Loom

The transition to a T+1 settlement cycle in the US securities market has raised concerns about potential foreign exchange (FX) risks, particularly for the millions of foreign investors trading on Wall Street, whose capital now amounts to $25 trillion. The time zone differences between various global markets make managing the FX cycle more challenging under the new settlement regime.

Nearly a year ago, the FX division of the Global Financial Markets Association published a report titled "FX Considerations for T+1 US Securities Settlement," highlighting the increased risk of transaction funding dependent on FX settlement not occurring in time. This is due to the requirement for matching, confirmation, and payment of trades to be completed within local currency cut-off times, which may be more difficult to achieve with the faster settlement cycle.

The end of the trading week has become a significant concern due to the convergence of several factors. As the US, European, and Asian markets prepare to wind down their activities, liquidity in the currency markets tends to diminish drastically. This reduction in available funds is further compounded by the fact that these markets remain closed over the weekend, leaving little room for maneuver should any last-minute adjustments be required.

This confluence of factors has led to heightened concerns about the potential impact of the T+1 settlement cycle on FX risk management and the ability of market participants to secure the necessary funding for their trades in a timely manner.