Buying a boat, trading globally? Impacts of the T+1 rule change

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While ultra-high-net-worth investors gain many potential benefits from a new “T+1” settlement rule that took effect in Canada on May 27, which halved the previous T+2, or two-day settlement rule for institutional trades, there are some potential downsides.

“The biggest pro is you have way quicker access to funds,” says Paula Sexsmith, chief compliance officer with Viewpoint Investment Partners Corp. in Calgary.

“If you need to raise money for, say, you’re buying a boat, and you need to put a down payment on it in one day, now you can sell a security and have that cash the following day, and it’s done,” she adds.

“T+1 is just the natural progression of trying to tighten up the time for settlement for securities transactions globally,” says Arthur Salzer, founder and CEO of Northland Wealth Management in Oakville, Ont.

The trading settlement period was set at T+3 in 1995, and reduced to T+2 in 2017. The fact that a subsequent drop to T+1 has taken place in only seven years, compared to the previous 22-year gap, “shows how quickly technology is enabling us to move faster with less human intervention and less human error,” says Sexsmith.

Sexsmith says reducing the time it takes to settle trades will create operational efficiencies that reduce market risk, in addition to reducing the collateral that dealers need to hold.

“When you’re trading with a broker dealer, or banker, or whoever, and you have a long settlement period, they have to put up collateral during that time. So, as the settlement time is reduced, whoever you’re dealing with has to put up less collateral. That’s much more efficient in capital markets and in cash management from a broker/dealer standpoint,” she elaborates.

Moreover, the United States followed suit with its own T+1 settlement rule a day later, on May 28, after markets there were closed for the Memorial Day holiday, coordinating trading rules for North America.

Logistical difficulties

However, certain situations might present logistical difficulties. For example, family offices may face challenges to settle back to their prime accounts for certain types of investments, says Salzer.

He explains that while most high-net-worth families in Canada tend to use a single bank or brokerage advisor or other dealer regulated by the Investment Industry Regulatory Organization of Canada, more sophisticated investors will utilize multiple brokerages.

That could be because of the specific research such firms conduct, or their ability to trade in a certain name, particularly smaller-cap stocks in an industry or sub-sector where this kind of specialization would be helpful in matching buyers and sellers.

“Needing those trades to get settled a day sooner will be a challenge,” Salzer says. “Those trades are called delivery against payment or receipt against payment and ultimately the securities would end up in your prime custodial account on settlement time, so having a day, or two extra days, makes it much easier for those trades to settle.”

Sexsmith says multi-family office asset managers and ultra-high-net-worth families who manage their own investments that have exclusively Canadian or U.S. investments, given the coordinated T+1 timing between those two jurisdictions, “probably have very little to worry about.”

The issue with global assets and forex

But when dealing with an international portfolio, as high-net-worth portfolios tend to do, and with other parts of the world, including Europe and part of Asia, which are still operating on a T+2 settlement timing schedule, that timing will not be coordinated.

Cash management will need to be adjusted for those different settlement times, taking into account, for example, fluctuating foreign exchange rates that could arise for a spot trade in jurisdictions with different settlement cycles.

“You can get into a cash management quagmire in terms of realizing, ‘My euros aren’t going to come for two days. But now I have Canadian and U.S. dollars sitting. I have to keep them. I have to wait,’” says Sexsmith.

“So it’s a lot more complicated on the cash management side, and on the foreign exchange side of things. That, I would say, is a con to T+1. I think from the high net worth institutional investors and the big asset managers, there is going to be some global exposure,” she adds.

Furthermore, “if we had a large redemption today and we had to raise funds by selling our securities down, we could potentially be offside [and] not able to receive all the funds from the non-North American trade in order to meet a T+1 redemption time,” she explains.

Who a family office deals with, and the level of involvement they have, can also impact transactions that settle under T+1.

“Especially if you are a multi-family office and you instruct your own trading, if you’re using a broker dealer that internalizes trade flow, I think there is very little risk of trade fails,” says Sexsmith.

Tech upgrades expensive and complicated

However, when a family office is trading with broker dealers that are going to the market, that involves a different counterparty risk and potential for trade failure without the systems in place to facilitate what is known as straight-through processing, says Sexsmith.

The process of originating a trade, through to going to the custodian for settlement, and then to the broker for allocation, takes time, she explains. In fact, in many places, this is currently done through manual processes, such as having to call someone on the phone and verbally explain what is happening, or by needing to e-mail specific instructions.

A technology outlay is required for same-day trade matching, but this will be expensive and complicated. “I don’t know if we had enough time for everyone to get there before announcing the T+1 rule change, although this will definitely encourage people to do so,” adds Sexsmith.

Even if other parts of the world coordinate with the T+1 timing in North America, Salzer predicts there will likely be significant challenges ahead for investor managers, just by virtue of operating in different time zones.

For example, he notes, European managers that are several time zones ahead of Toronto or New York could conduct a business transaction at the end of the business day in Europe, but do so in North American markets with several more hours to operate that day.

“They would then have the next morning to do the foreign exchange (FX) in order to settle the buy or the sell a day later. But if you’re trading at the end of the day in the last hour overseas and it’s the first half hour of the morning in North America and you need FX settled for the next day, that’s going to be a lot tricker. So I think they’re going to be running into challenges on that basis,” he elaborates.

Being aware of different settlement times and venues is very important, Sexsmith says.

“Although the broker dealer has an obligation to report the trade for settlement through the clearing corporation, the person/firm instructing the trade also has a responsibility to provide accurate allocation and settlement instructions to their broker dealer and/or custodian in a timely manner to ensure the trade is matched and settled on the new T+1 deadline,” she stresses.

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