T+1 Settlement and Implications for Principal and Agency Transactions

Regulations are in place in various jurisdictions to deal with principal and agency transactions that present conflicts of interest between an adviser and its clients, both in terms of managers trading assets for their own benefit as well as for clients. The applicable legislation in the US, Section 206(3) of the Investment Advisers Act of 1940 (“Advisers Act”), prohibits any investment adviser from engaging in or effecting a transaction on behalf of a client while acting either as principal for its own account, or as a broker for a person other than the client, without disclosing in writing to the client before the completion of the transaction, the adviser’s role in the transaction and obtaining the client’s consent. With the reduction in settlement time to T+1, policies and procedures to obtain consent may need to be examined to meet the new timeframe.

The Maples Group provides Conflict Advisory Review Services (“CAR Services”) to help clients seeking to manage and resolve conflicts of interest, often arising in the context of trade allocations and transfers between affiliated investment portfolios. Our fiduciary professionals are highly experienced and qualified to independently review proposed trades and, as appropriate, to provide consent.

With a large and experienced Cayman Islands based team, the Maples Group is well placed and has established processes to ensure that transactions can be reviewed and signed off in the tight timeframes required to meet the demands of the North American markets and to properly assess any risks relevant to shortened settlement cycles. In addition to the Cayman Islands, our broad global network includes a major presence in the key European fund jurisdictions of Ireland and Luxembourg, so clients always receive optimal support.

Next Move Europe

Attention on T+1 is now focused on Europe – and after a period of uncertainty – the European Securities and Markets Authority (“ESMA”) announced in November 2024 that T+1 migration would take place in Q4 2027, with an optimal ‘go-live’ date of 11 October, highlighting the need for systems to be updated in alignment with the US.

Although Europe had moved its systems to T+2 ahead of the US in 2014, the fragmented nature of European markets and legislative complexities at a national level created more challenging circumstances for the T+1 initiative. Now three years behind the US, industry working groups both in the UK and the EU appreciate the need to be realigned as soon as is practically possible.

From an investment fund standpoint, concerns regarding foreign exchange trading and settlement are paramount. The majority of FX trading takes place on a T+2 settlement basis, but with North America moving to T+1, foreign buyers would need to deliver US dollars on T+1. This introduces a need to pre-purchase US dollars a day prior to buying securities, while cash requirements for non-margin trades represent a drag on potential earnings. Among other related issues, foreign working hours may need to be extended to cover the US trading day, while reporting requirements to regulators should be considered for any cash breaches due to late wires and/or failed trades.

Some 50% of global foreign exchange transactions are settled through CLS (“Continuous Linked Settlement”) and CLS Bank International, which reduces counterparty credit and liquidity risk by netting trades between counterparties to a single transfer in each underlying currency. The system uses a PVP (“Payment versus Payment”) connection to the clearing networks of each currency, ensuring the required net amounts are paid, once payments are remitted and received. With no decrease in CLS average daily settlement value or volume since T+1 went live in the US, concerns over a drop off in trading by foreign dealers were unfounded. In fact, the month after T+1 implementation in June 2024, a new record average daily value of US$7.8 trillion was set.

Some change in trading behaviour has been recognised, with a notable increase in trades from
2:00pm CET onwards, concentrated between 10:00pm and 11:00pm CET. This increased afternoon trading activity likely represents execution of the foreign exchange component of a security trade before trade confirmation has been received, while the late day trading spike suggests that securities related payment instructions are being submitted due to enhanced automation in trade processing, supported by global custodians. These institutions worked diligently in the lead up to T+1, amid fears managers would face last minute rushes to adjust operations and trading to avoid pre-funding bilateral settlements and moving team members from home locations to the United States.

North America’s successful transition to T+1 during 2024 only amplified calls for Europe to accelerate its own timeline in a coordinated approach, culminating in ESMA’s recent target date and indications that the UK and Switzerland will also be ready by the end of 2027. There is a recognition among regulators that the current situation may impede efforts to encourage EU residents to invest more in international markets and evidence has shown that European funds investing into US products report lower returns than the same products in the US. Ultimately, the alignment of settlement cycles will reduce friction across global and European portfolios, lowering funding costs and bringing returns closer together.

Automation versus Follow the Sun

It is also noteworthy that exchanges in India adopted T+2 settlement in 2003, much earlier than the US or Europe. India then implemented T+1 in 2021 and is now moving to T+0 and ultimately real-time settlements, by embracing digitisation and a sophisticated payments infrastructure. Unsurprisingly, many large investment firms have built out extensive back-office operations in India, benefiting from the technology and highly skilled staff present.

India’s success offers a positive lead for Europe, with automation key to reconciling trades as they occur, identifying and clearing breaks, and instructing cash movements for settlement. As the level of automation increases, it remains to be seen if machines will be able do the all the work managers and custodians require, or if ‘Follow the Sun’ teams working in other time zones, as many institutions have put in place, will be needed. Ultimately the solution may be a combination of both, as trade settlement cycles inevitably shorten.

If you have any questions regarding CAR Services for principal or agency trades, or any other fiduciary matter related to T+1 settlement, please reach out to any of the professionals below or your usual Maples Group contact.

For legal and regulatory disclosures, please visit maples.com/legal-notices.