US regulators’ plan to speed up settlement times in securities markets will come at a cost for investors around the world — more than $30 billion annually, according to a new report from Bloomberg Intelligence.
Settling trades in one day instead of two — under a system dubbed T+1 — will strain the business of loaning and recalling shares used for short selling, require financing to ensure deadlines can be met and, along the way, risk telegraphing pending stock sales to people betting prices will fall, the researchers found.
The resulting impact could amount to about $24 billion in securities lending costs, their report estimated. Investors in foreign-exchange markets could also face $6.2 billion in added costs.
“The shorter settlement cycle pushes centralized costs, which the banks and the clearinghouses are now managing, onto institutional investors,” Larry Tabb, head of market structure research at Bloomberg Intelligence, said in an interview. “It’s also leaking a lot of information to folks who borrowed securities as well as increasing operational pressure just to execute a trade.”
US regulators aim to speed up settlement times in late May to lower the risk that buyers or sellers might default on transactions before they’re completed. While investors will get their assets faster, and sellers can redeploy their cash sooner, the transition is widely acknowledged to pose big operational challenges for the industry.
‘Information Leakage’
The largest cost may come from quickly recalling shares that have been loaned to bearish investors — who may glean that sales are afoot. “Information leakage” alone may cost investors $17 billion annually, Bloomberg Intelligence estimated.
“Recalling securities before they’re sold increases leakage by not only informing custodians that investors are preparing to sell, but also giving notice to the borrowers, who are already short,” Tabb and co-author Nicholas Phillips wrote. “Investors who short are typically the most sophisticated, and leaking information to them will only raise selling pressure and likely have an adverse impact on stock prices.”
Cutting the days between trading and settlement could also lead to more failed trades, which would leave investors on the hook for $4.1 billion, the researchers found. They estimate that 10% more borrowings could fail under T+1, “increasing both fail-funding costs and overall borrowing rates as urgency increases.”
US banks, brokerages and investors will have to review all of their post-trade technologies and procedures to ensure they’re ready for the new pace of stock trading. The changes also pose a challenge to investors outside the US who need to buy dollars as part of their equities trades.
The shortened settlement cycle will require a change in behavior from all market participants who are forced to adapt to the tighter window. The time will be even less for European and Asian market participants operating in different time zones.
“Banks wiring systems generally aren’t open 24 hours a day, nor are there staff to handle those transactions at all hours,” Tabb said.
The FX market, which still settles in two days, also faces increased costs associated with the move to T+1, as traders are given a shorter window to convert foreign currency to dollars in order to buy stock on US venues.
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