ETFs
T+1 won’t be a ‘sure hit’ for ETFs, industry insiders warn
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The exchange-traded fund industry will face a perfect storm on May 28 when the United States cuts trade settlement times – with the transition taking place over a holiday weekend and amid a series of major rebalancings clues.
Gerard Walsh, who heads Northern Trust’s global banking and markets client solutions group, said he was having urgent last-minute discussions with asset management clients, some of whom still appeared unaware of the looming task at hand. accomplish.
“Our main aim at Northern Trust is to speak to as many people as possible to at least make them aware that this is not a piece of cake. This will have little to no impact on front office portfolio managers,” he said.
The U.S. Securities and Exchange Commission said in February 2023 that it would require trades to settle one day after the trade deal (known as T+1, a change from the current T+2 regime ) by May 28, but Walsh is among industry figures who say that hasn’t given the ETF industry enough time to thoroughly evaluate and prepare for all risks.
Walsh pointed out that most ETFs are passive index trackers and will therefore have no choice but to swap their underlying constituents in order to align with upcoming changes in the index.
“It seems like I’ve been the only one worried about ETF trading, but I’ve seen a lot of people become interested in it over the last month,” he added.
The choice of the transition date may seem particularly ill-advised. Announcements from Russell Annual Reenactment and the semi-annual rebalancing of the FTSE All World Index will be carried out after the US market closes on May 24, which is also the last day the US will trade at T+2.
The US heads into a long weekend next, but Canada and Mexico will move to T+1 on Monday, May 27 (a public holiday not only in the US but also in the UK).
When the United States reopens on May 28, settlement staff will still be handling final transactions from Friday under the old T+2 schedule and any outstanding issues related to Canada and Mexico movements. But at the same time they will be hit by a tidal wave of new orders at T+1 due to index announcements.
To top it off, Walsh said, before the new system has a chance to take hold, May 31 is the deadline. MSCI Rebalancing Day — “usually one of the biggest trading days of the year.”
“The real problem is these rebalancings. The rebalances that occur that week will immediately put a strain on the system,” he said.
Sarah Simmonds, a partner at Alpha FMC, an international consultancy whose clientele includes the world’s 20 largest asset managers, said she too had concerns.
“Public holidays will mean this happens at a time when staff are not working,” she said, adding that many customers had already responded by canceling support staff leave.
“We expect a higher volume of settlement failures,” she said, adding: “I agree that [the rebalancings] will only make the problems worse. Furthermore, she pointed out, the additional liquidity that European Ucits ETFs accept in order to be able to bridge the period before the settlement of the ETF envelope could mean that the funds would respect the cash limit rules, which which would result in a fine.
ETFs face particular difficulties due to the potential mismatch if their underlying components – traded on the so-called primary market by authorized participants who create and redeem ETF shares to meet demand in the secondary market – settle their trades at a different time than the ETF wrapper itself.
A European ETF, for example, must wait up to two days after a buy order to be paid by the ETF investor, but if it has US components, it will have to pay for the components a day earlier .
Walsh explained that some ETF managers may not be able to take on or fund the risk that their authorized participants will need to adopt, particularly over the impending 72-hour long weekend.
James Pike, acting chief executive of Taskize, a Euroclear-owned web platform that aims to quickly resolve issues between counterparties, said there were also technical difficulties to resolve.
He said manual routing of exceptions, for example trade information inconsistencies such as custodian name, remained far too prevalent and would not be scalable to handle an increase in trade failures.
“Non-US based market participants must also implement the ability to ‘hand the book’ internally to other operational teams. [in different time zones] so problems do not persist beyond the end of the trading day,” Pike said.
Worst of all, Walsh pointed out, was a potential capacity problem, even if leaders moved quickly to try to resolve last-minute issues.
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“The industry has deep pockets, but they are not unlimited,” he said, adding that all executives should ask themselves whether they have adequate credit lines, overdrafts and access to cash-type instruments, as well as the cost of the latter if they do so. are suddenly needed in the middle of the night.
Not everyone in the sector is as worried. Frank Koudelka, global head of ETF solutions at State Street, said there had been significant planning and while opinions were mixed, there would be an “element of waiting in the first couple of months”.
But even Koudelka said that from a custodian perspective, State Street was “counting on investment managers” to prepare for May 28 and ensure they had updated their settlement cycles and were had adequate funding.
“What we will only be able to see in the rearview mirror is the failure rate and the impact of those failures,” Walsh said, noting that failed deals attract fines in Europe and some Asian markets are penalized. . “no-fail” markets, meaning trades are void if not settled on time.