T+1—A Step in the Right Direction

Change tends to come slowly to the financial services industry. That is unless it is mandated by the industry’s regulators. Change is synonymous with uncertainty and people’s fear of the unknown—and this industry especially does not like uncertainty. 

But, as the capital markets witnessed in the immediate wake of the three most significant periods of operational and regulatory upheaval over the past two decades—the Y2K crossover, the introduction of the Dodd-Frank Act in the US and the implementation of the revised Markets in Financial Instruments Directive, known as Mifid II, across Europe—these episodes were negotiated well by the industry, thanks to good preparation and planning. There were teething problems and new procedures and rules for market participants to comply with, but firms adapted fairly swiftly to the new dispensations.  

That same notion applies to the scenario the global fixed income market finds itself in. Currently, trades are typically settled on a T+2, or two days after trade date, basis. The cycle was longer—much longer—in the past, but incremental changes over the years have significantly reduced settlement cycles. However, there are not many valid operational or technology reasons why the settlement cycle cannot be further curtailed to T+1, although regulatory impetus might well be the catalyst the industry needs to ensure that T+1 becomes a reality. Perhaps the introduction of the Central Securities Depositories Regulation (CSDR)—scheduled to come into effect at the start of February 2022 with promise of stiff penalties for entities deemed responsible by the European Securities Markets Authority for causing failed trades across the European marketplace—is just what the industry needs to overcome its inertia and get it to its tipping point. 

New Opportunities

Camille McKelvey, head of post-trade straight-through processing business development at MarketAxess, argues that the operational and technological challenges associated specifically with the corporate bond market reducing its settlement cycle from two days to one are remediable. Much of the industry’s inertia, she argues, is rooted in tradition, the idiosyncrasies of human behaviour and the ‘if it ain’t broke don’t fix it’ mentality. “Anything that can make the market more efficient is good for industry participants,” she explains. “We might come up against the argument that we can’t settle trades in one day because there are so many processes that need to be completed, but really it’s just a case of reassigning resources. What you quite often see are multiple touchpoints within a trade—the salesperson, the trader, trade support, settlements, transaction reporting, and so on. The bond market is global: investors, issuers and market-makers run 24-hour books, making it much more complex than equity or exchange-traded derivatives markets, and the post-trade infrastructure has historically simply not supported that kind of market, but it is possible to be more efficient.”

The numbers of failed trades in the fixed income market have fallen steadily over the past two decades due to increased levels of electronification, generally improved processing and operational efficiencies within and between market participants. However, the percentage of failed trades is somewhere between 3–5%, compared with around 1% in the equity markets, which is why legislation such as CSDR might prove pivotal to introducing another step-change across the industry. A 3–5% fail rate may not seem a big number, but on a daily basis this represents hundreds of billions of dollars in failed trades notional.  

MarketAxess’ Play

According to McKelvey, MarketAxess has two hands to play in helping fixed income as an asset class move the bulk of its instruments to a next-day settlement regime. “We come at this from two angles,” she explains. “We’ve got our execution venue and then we’ve got our post-trade services. On the execution side, we facilitate electronic trading of fixed income securities, both on a disclosed and a non-disclosed basis. We’ve been a pioneer in the fixed income market through all-to-all trading. When it comes to post-trade, we have increased efficiency across both the fixed income cash and financing markets.” 

MarketAxess has clearly already played a key role in making the market more efficient through its electronification drive and by providing peer-to-peer access for participants, improving liquidity and reducing costs for clients. Efficient post-trade processes drive greater information and data, which in turn makes trading in secondary markets more efficient. Capital markets need efficient and effective secondary markets that have reduced operational risk.

Speed of Change 

If you leave the industry to its own devices, a significant amount of inertia inevitably builds up. However, if it is faced with change and no alternative, things can move surprisingly quickly. The perfect illustration of this point is how quickly the entire financial services industry adapted to the work-from-home dispensation shortly after the onset of the Covid-19 pandemic in the first quarter of 2020. Necessity, as they say, is the mother of invention.  

Change will come … even to the global fixed income market—there is an inevitability about the move from T+2 to T+1 and possibly even T+0 settlement. And, as we have witnessed time and again across this industry, when change is necessary, it comes about much faster than most might expect, which is why it’s so important for capital markets firms to get their houses in order in preparation for the inevitable move. Reducing settlement cycles is no trivial task although, when best practices, operational efficiencies and financial stability are at stake, the industry’s resolve and propensity to change should not
be underestimated.  

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