The imminent adoption of a shorter settlement cycle for North American securities markets poses short-term risks to the industry but will benefit the markets in the long run, according to a new report from Moody’s Ratings.
The move to T+1 (trade day plus one) settlement later this month is a complex exercise for both clearing firms and the brokerage houses, the rating agency said — particularly with Canada, the U.S. and Mexico all making the same move.
“The switch requires extensive planning, testing, systems development and integration, which pose considerable operational challenges,” the report said.
The move will also create added liquidity risk for asset managers in markets that are still operating on a T+2 basis when accessing markets that have moved to T+1, as they “would need to fund buy orders one day before their clients are required to post funds with the manager,” it noted.
Additionally, the demand for liquidity could increase for foreign-exchange trades involving markets with different settlement cycles, the report said.
“We expect these risks to present operational and liquidity hurdles for market participants in the short term, but over the long term the benefits of the shorter settlement cycles will be credit positive,” Moody’s said.
It noted that the move to a shorter settlement cycle was motivated in part by the “meme stock” episode in early 2021, which sharply boosted volatility and systemic risk.
Reducing the settlement cycle is intended to reduce clearing counterparty risk, it noted.
At the same time, the move is expected to reduce the liquidity risk driven by large margin calls, which “would benefit the safety and soundness of the overall financial system,” Moody’s said.