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MarkeTalks: The impact of the US Securities Settlement Changes
36 Plays2 years ago
In this podcast we discuss the impact of the recent ruling from the SEC to shorten the US settlement cycle for securities from two days to one. Listen as Neil Atkinson, Global Head of Banks & Broker Dealers, Client Management & Sales and Gemma Laman, Global Head of FX Solutions Sales, talk about the impact this will have on the FX conversions required as part of the trade lifecycle and some of the key considerations for Asset Managers.
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Transcript
Introduction to HSBC Global Viewpoint
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Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
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Make sure you're subscribed to stay up to date with new episodes.
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Thanks for listening.
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And now onto today's show.
Market Talks Podcast Overview
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Hello and welcome to the latest in our Market Talks podcast series.
Impact of SEC Ruling on FX Conversions
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Today, we will be discussing the impact of the recent ruling from the SEC to shorten the US settlement cycle for securities from two days to one.
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I'm joined by Neil Atkinson, Global Head of Banks and Broker Dealers, Client Management and Sales, Security Services, who will talk to us today about the impact this will have on the FX conversions required as part of the trade lifecycle
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and some of the key considerations for asset managers.
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Neil, thanks for joining us today.
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Gabriella, thanks very much.
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I'm delighted to be here on the podcast.
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When discussing FX, I'm pleased to be joined by an expert in FX.
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So I'm delighted today to have Gemma Lehman, HSBC's Global Head of FX Solutions Sales.
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Gemma, thanks very much for joining us today.
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Hi, Neil, and thank you for having me.
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So Gemma, I think there's been a lot of industry discussion, panel sessions at conferences and such, like focusing on the securities element.
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But I think one area that we'd really like to learn a bit more about is on the FX side and how that might impact some of our clients.
Settlement Time Reduction Effects
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So the proposed SEC rule due to be implemented from May 2024 shortens the settlement timeline to one day, potentially.
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What does the reduction mean for the FX component of the trade lifecycle when it comes to US securities?
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Thanks, Neil.
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And so to answer your question, the shortening of the settlement cycle for U.S. securities essentially means that the window for matching the security trade and then generating and executing the efforts conversion will become very tight.
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And these changes will be most acutely felt by managers in Asia and Europe who are not transacting in U.S. dollars.
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So putting it into context, the US Treasury recently released data showing that a quarter of all investments are transacted in non-US dollars.
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And it's these overseas investors who will feel the impact of the changes to the FX funding process the most, mainly because the time zones they're in will make the FX cycle much harder for them to manage, given the shortening of the window in which they can transact the FX, and their ability to do so within the currency cutoff times required for successful settlements.
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So what are the implications of the shorter timeframes for FX?
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It's one of the most liquid markets out there.
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So it's a good question and not always a well-known answer.
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So with the changes to the settlement cycle, all trades will need to be settled on the day after they've been traded, which means the window to execute the FX has been made smaller.
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So, as I mentioned, European and Asian managers will feel this change the most and will need to be able to support execution either during US hours after Europe is closed or early the next day during Asian hours.
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But that will be for same day settlement, which is not always possible given the current FX settlement deadlines.
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So liquidity and coverage has to be a key consideration.
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So let's say, for example, Aussie dollars.
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If you're a European asset manager with an Australian-based fund and you execute a security transaction in the US at 5 p.m.
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London time and then try to execute an Aussie dollar conversion, you'd struggle.
Challenges of Early Currency Cutoff Times
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The liquidity may not be sufficient, but if you wait to execute away from your custodian the following morning when liquidity improves, you'd have missed the Aussie dollar cutoff time.
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So for clients who wish to retain the FX execution process themselves, executing currencies with early cutoff times will become challenging.
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The existing processes do not currently accommodate same day execution for some of these markets.
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And managers will need to look to adapt in order to continue to comply with funding requirements and current settlement deadlines.
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So definitely some impact there, Gemma.
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And maybe you can describe to us the different execution methods that clients currently use.
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Yeah, of course.
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And I think it's important to note because the different methods of managing FX will have a direct relationship on how clients were impacted by these upcoming regulations.
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So clients currently manage their currency conversions in two distinct ways.
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They either manage the execution themselves by trading directly in the market with multiple liquidity providers or
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or they outsource the process to their custodian who will utilize an automated process to identify the FX requirements needed on the back of the security transactions executed by the client.
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So clients who currently utilize this automated solution will be less impacted than those managers who execute the FX themselves.
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Those executing themselves will need to be able to comply with the tighter currency cutoff times, and they will need to ensure they have coverage in each region as needed.
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Failure to execute within the settlement deadlines will mean they may not have sufficient funds to complete the transaction, which can result in overdraft fines and failed settlements.
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Got it.
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Thanks, Gemma.
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So you've said that those who optimize their custodians' automated solutions will be less affected.
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But will there be any impact to them from the SEC changes?
Outsourcing FX Execution
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Yes, but definitely to a much smaller degree.
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So for those who outsource, there will be a greater focus on connectivity to their custodian to ensure trades are communicated and confirmed within the tighter timeframe in order to enable sufficient time to instruct the effects.
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In parallel, the automated solutions currently provided by custodians to their clients will also come under increased pressure to be transparent and flexible as more clients look to adopt them for probably the largest market.
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And clients will need to ensure the solutions provided by their custodians support them within the new framework.
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So, for example, do they support all required global benchmarks?
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Do they provide alternative execution models when needed?
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Do they provide analytics to show transparency around pricing?
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And do they provide solutions for clients who might need to fund on a non-dollar bank holiday?
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Just a few examples.
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So these solutions mean that clients won't have the same concern over currency cutoff times as those reliant on external settlements when they execute away from their custodians.
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Okay, thanks, Gemma.
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So that's automated FX.
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What about clients that manage the execution of currency conversions themselves?
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What do they need to think about?
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So clients who execute the FX themselves will unarguably face more challenges to their current processes.
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They need to ensure that their setup still enables them to execute away from their custodian, but within the currency cutoff times.
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They may need to adopt technology and increase their global coverage teams to support the reduction in that settlement cycle.
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So the two primary challenges I feel they will face will be around liquidity and settlement.
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So liquidity is a key challenge.
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And as I briefly illustrated in our earlier Aussie dollar example, the expectation is that liquidity pools will need to move and widen as pressure on the extended execution times increase.
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But it's not a certainty and we will need to see how the market responds.
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So as an asset manager who currently relies on the European sales team to execute the currency conversion on T plus one, for example, they will need to decide whether they need to implement local coverage within America and also potentially Asia.
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So as we've mentioned, the shorter timeframes will increase the risk of failed settlements when executed away from the custodian due to the need for settlement between the banks.
Pre-funding and Liquidity Challenges
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So it's essential that clients who wish to retain the execution process themselves
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have the right coverage and the technology in place to support them.
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Yeah, got it.
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Thanks, Gemma.
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So pre-funding, I mean, can clients pre-fund to eliminate the risk of missing those cutoff times?
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Yes, in theory, some can, yes.
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And pre-funding may be viewed as an alternative, but it's not always an optimal solution.
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And cameras aren't cash being tied up unnecessarily for longer.
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You know, also, it's worth noting some clients are not able to pre-fund and can't hold excess cash on their accounts in all currencies.
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It might be more attractive in the current rates environment, but long term, it may not prove to be a viable or practical solution.
HSBC Product Development and Solutions
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And in situations where a client may feel that they are unable to operate within the tighter timeframes, the adoption of the automated outsource solution may be the best model for them.
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OK, thank you.
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So what are HSBC, other banks and custodians doing to support clients?
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So HSBC is actively engaging with clients in order to understand how they will be impacted by the decrease in timelines and what their need for automated solutions are.
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So, you know, this in turn really does help us drive our product development roadmap and it ensures we continue to be dynamic and innovative in developing solutions that work for them.
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So, you know, as a result of the conversations we've had with clients so far, there's a few key areas we're currently focusing on.
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So for clients who wish to continue to manage the process themselves, we're looking at the possible viability of extending settlement deadlines to help facilitate the shorter execution frame.
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But it kind of needs to be an industry-wide solution to work.
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If HSBC extend our Hong Kong dollar cutoff time, for example, but no other custodian does, then it would effectively be a pointless extension as we still wouldn't be able to settle with anybody else up to the later extended timeframe.
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We're also working with our teams in America to provide extended execution coverage where needed to support our clients'
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and a shift in the liquidity pool.
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Great.
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So clearly custodian banks need to work together to find solutions.
Automation and Counterparty Risk
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All right, lots of challenges, Gemma.
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What about the positives?
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Are there any?
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Yes, definitely.
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I promise there are.
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So the way to look at it, anything that brings in the length of time you have to wait for settlement should be viewed as a positive move.
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Now, shortening the settlement timeline also reduces counterparty risk.
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And therefore, we do expect lower margin requirements, which will, of course, help increase funding liquidity.
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I also really genuinely believe that the changes will accelerate the need for the automation of internal processes, as clients will need to be able to perform tasks more efficiently under the shorter timeframe.
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Quite simply, there will be less time for errors.
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The challenge will be how quickly the market can modernise the sheer volume of legacy and incumbent technology that sits around the globe in institutions, in central pieces of market infrastructure, especially in such a cost-sensitive environment that we're in at the moment.
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So whilst it may lead to a period of pain, I personally feel it will help drive new and innovative solutions and increase automation.
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And again, personally, anything that reduces manual processes has to be viewed as a good thing.
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Now, we should also remember the US are not the first market to move to a T plus
Future of Settlements and Digital Assets
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one settlement.
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If we look at China, they have T zero model and it's already widely used in the market.
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The difference with the US is that the volumes are significantly larger, but we can and we should take comfort that operating within a shorter settlement deadline is successfully used by other markets within the world already.
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Yeah, thanks, Gemma.
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Yeah, we've seen that in India as well, of course, recently.
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So what's next?
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These changes are for the US securities market.
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Are they sufficient enough to reduce settlement risk?
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That's a question.
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And then could we see Europe aligning themselves or ourselves with the US at T plus one?
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I'm stacking questions here, but could we ultimately see the market move to T plus zero?
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And then what about blockchain and distributed ledger technology?
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So many questions, I'll try and answer them in order.
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So the Bank for International Settlements 2022 survey cited that the amount of FX that is actually subject to settlement risk totals $2.2 trillion a year.
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These data points aren't always entirely accurate, but no one can argue that that number is huge.
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But I also think it's really important to highlight that the FX market is a very mature market.
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You know, CLS, for example, is integral to the settlement process currently and manages a lot of netting around FX exposures and helps to mitigate these settlement risks, which is why the reduction in the window for FX execution in this case is so important to understand and for clients and custodians to ensure they put a structure around it so they continue to work effectively as it does now.
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We also have to remember, as we've mentioned, the US aren't the first market to reduce the settlement timeframes.
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And I also don't believe they'll be the last.
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Europe, however, it's a challenging beast, right?
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It has many different legal frameworks within it, which aren't always uniform.
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So shifting anything takes a lot of consensus and time.
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But do I think there's an ambition for it to happen in Europe?
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Yes, I do.
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But executing on that won't be an insignificant process.
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To your next point around moving to T0 settlements, the markets are continuously evolving and the rise of digital assets, including central bank digital currencies, and as you highlight the increased use of blockchain, all add to highlight a desire in the market, I think, to push to instantaneous settlement.
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And intellectually, it does make a lot of sense.
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I don't think this is a question of whether T0 makes sense.
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I think the challenge for the industry is
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will be how quickly and successfully they can modernize the legacy systems which are so ingrained in today's processes and everything they have around those processes.
Adapting to New Settlement Frameworks
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So maybe to finish, I think it's important to note that the key for clients to remember
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you know, it's really there are solutions already available to support them in this transition, that the biggest cost of them may be in accepting that the most optimal solution, you know, might be to utilize the outsource models already provided by their custodian, rather than try to fit within the new framework and adopt their processes to work in the new environment.
00:14:31
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Thanks, Gemma.
Conclusion and Future Topics
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This has been fascinating.
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There's clearly a lot of challenges that need to be addressed, but some opportunities that we can seize together as an industry.
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And, you know, we look forward to continuing this conversation with our clients.
00:14:42
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Thanks again, Gemma, today and Gabriella, back to you.
00:14:45
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Yeah, agreed.
00:14:45
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Thank you so much, Neil.
00:14:47
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Gemma, Neil, this was super interesting for me as well.
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It's quite interesting to hear what the US is doing, as India was one of the first ones that started out.
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So I would like to thank you and everyone in this audience for joining us in today's Market Talk session on US security settlement changes.
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Stay tuned for more from our podcasts as we explore more trends in the coming weeks.
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Thank you for joining us at HSBC Global Viewpoint.
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We hope you enjoyed the discussion.
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