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Home Compliance and Risk

Shorter settlement cycle means banks’ brokerage services face challenges

April 21, 2022
Reading Time: 5 mins read
Shorter settlement cycle means banks’ brokerage services face challenges

By John Hintze

The industry initiative to cut in half the time to settle equity trades is progressing at rapid pace, and bank investment units, even those that outsource most activities, should be considering the potentially significant changes ahead.

In 2017, the SEC shortened equity trade settlement to T+2, or trade-date plus two days, reducing the risk of trades failing and the amount of capital firms must deposit as collateral at the Depository Trust and Clearing Corp. The DTCC proposed in February 2021 to shorten settlement time to T+1 and noted several benefits, including cost savings, greater operational efficiencies and less market risk, especially in times of high volatility and stressed markets.

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The move to T+1 represents a highly complex shift, and banks will be affected in different ways. The largest bank brokerages may execute and clear their trades internally and interact directly with the DTCC to settle them, while others clear trades through a third party, as still others outsource most of their brokerage, back office, operations and even sales. Nevertheless, the functional impact of the move to T+1 on their brokerage services will largely be the same.

“The question will to be, Who is responsible to make the changes?” says Bob Walley, who leads Deloitte’s risk advisory securities and exchange industry services. Deloitte was engaged by industry groups last spring to facilitate numerous working sessions of market participants over the summer to analyze the plusses and minuses of moving to T+1 and solutions for the transition.

Those organizations, including the Securities Industry and Financial Markets Association and the Investment Company Institute, published a report Dec. 1 detailing 10 areas that will impact firms in different ways in the transition to T+1 and recommends how to solve for them.

Many regional and community banks outsource most or much of their brokerage services to vendors, such as Infinex, Raymond James, Securities America or another third-party broker-dealer. They face less urgency than firms contending with significant in-house technological and operational changes, but they are ultimately responsible for the related operational functions. “They’re not off the hook with that,” Walley says.

David Smith, capital markets practice lead, Broadridge Consulting Services, says that bank brokerages relying heavily on vendors should start asking them about their plans to adapt their platforms to T+1, any related new services, whether costs will change, and when they can begin testing their T+1-enabled systems.

For firms that run their brokerages internally but still rely significantly on vendor technology, Smith said, management needs to start asking about the extent to which their systems can already handle T+1 settlement or not.

“Those are CEO and CFO ‘asks’—what is my new trading cost, my new technology spend and what will our new service-level agreements look like?” Smith said, adding that service-level agreements affecting core functions will need to be reviewed, updated and agreed upon, as to what the level of service under the new timeline is going to be. “Those C-suite questions should be coming down the pipeline to the operations managers and technology folks,” he says.

More changes on the way

In addition, bank personnel must be prepared for customers’ questions, since the shorter settlement cycle will make checks and inconsistent ACH payments no longer possible and may require customers to pre-fund their brokerage accounts, Walley said.

Transactional documentation must be delivered faster. The December report recommends relying on e-delivery for the official booking record, and that may require more communication with and education for customers, especially the lingering segment who still prefer paper documents.

“That may translate to more staff on help-center calls, more education to the financial advisers, staff training, all those things,“ Walley said. “Banks will have to think about what the first points of connection are with those types of customers.”

Banks that retain more of their brokerage activity in-house but outsource functions such as trade execution and/or clearing to third parties will face bigger hurdles, and even more so the biggest banks that self-clear trades and settle them directly through the DTCC. Their systems will have to collect and accurately process trade-related data much faster before sending it to be cleared and settled.

“Today firms have 48 hours to fix mistakes, and tomorrow it will be only 24,” Walley said. “So firms have to get the trade-detail information in their brokers’ hands sooner to try to resolve those errors.”

In fact, banks may be wise to prepare mitigating measures in case the face some early missteps. “Initially I expect to see more non-delivery issues—shares that don’t show up on time—because of pledging and share-lending issues on behalf of the broker-dealers,” says the treasurer of a New England regional bank. He added that T+2 still gives parties time to claw-back and fix mistakes, and under T+1 it may “take time to work out the kinks and automate those systems.”

Smith says that some of the many activities firms now have up to 48 hours to complete, including resolving exceptions, trading matching, understanding what will settle the next day, finding and securing funding, and compliance approval for new accounts. In addition, he adds, the window for security recalls and locating and delivering securities will be compressed for broker-dealers engaged in securities lending.

Bank brokerages servicing retail customers must be especially vigilant about accomplishing those tasks correctly, since the SEC and the Financial Industry Regulatory Authority pay particular attention to those investors.

Those servicing institutional clients may face the biggest hurdles. Walley said the post-trade allocations that happen between the sell-side and buy-side are a precursor to broker-dealers’ ability to affirm and settle trades. So the allocation information must get into the systems sooner, requiring faster coordination between customers and the executing firms.

“So where you have 36 hours now, you’re basically down to less than 12 under T+1, because the affirmation timeline is proposed to move up to 9 p.m.,” in order to meet the net settlement window, Walley says. Trades that miss that window will still settle but may incur more costs.

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“All your allocations and reconciliations have to be done on T, all of your exceptions need to be figured out on T,” Smith says whereas today “a lot of that stuff now gets pushed to T+1, and you have the whole day to figure it out fix it.”

Addressing issues may require significant people and monetary resources. Walley recommends that bank brokerages “take apart” the December analysis and start looking at their operations and reviewing their trading and sales volumes and the types of allocations they facilitate in the context of a T+1 environment. He adds that he sees 2023 as the year to build the technology and operations, in order to start testing in the fourth quarter and into the first quarter of 2024.

Banks face other significant changes to their technology and operations infrastructures over that period, including the migration to a new messaging standard for payments, so resources may be tight. Smith recommends a more aggressive timeline to move to T+1, starting the technology and operations changes in the second half of this year so testing can take place in 2023.

Bank broker-dealers have different mixes of customers and systems solutions, so preparing for the challenging move to T+1 will be different for each, and an early start leaves time to address the unexpected.

“Firms need to review their whole business model for anything that looks like it could be impacted and really start putting that view together,” Smith says.

John Hintze is a frequent contributor to the ABA Banking Journal and its digital channel ABA Risk and Compliance.

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