By Laura Matthews and Sinead Cruise
NEW YORK/LONDON- Participants in the United States’ multitrillion-dollar securities markets face an early test of their ability to cope with regulatory reforms to speed up trade settlement, as a major index rebalance scheduled to occur just days after the planned switch risks causing a spike in failed trades.
Starting May 28, US stocks and corporate bonds must settle one business day after trading instead of two. Markets in Canada and Mexico are also adopting the reforms, which have been designed to reduce counterparty risk and improve market liquidity.
But just three days after this new standard – known as T+1 – takes effect, MSCI global indexes will rebalance in a quarterly event, leaving some participants concerned that one of the largest trading days of the year could strain markets adjusting to the new regime. The rebalance means funds must readjust their holdings to keep their mandates tracking the index.
“This really is the rubber hitting the road immediately after T+1 goes live,” said Gerard Walsh, who leads Northern Trust’s Global Capital Markets Client Solutions group.
“The MSCI rebalance occurs across thousands of funds, ETFs, portfolio structures,” Walsh added. “It’s a big deal.”
The industry should brace for an immediate spike in failed settlements on account of several “separate-but-related market events,” including the rebalance, Walsh added.
During the last rebalance, average global volumes spiked 120 percent in what was a $47 billion trading event across both developed and emerging markets, data from Northern Trust shared with Reuters showed. In the US those volumes rose 199 percent .
“The concern is what hasn’t been thought of rather than those things that have been solved for,” said John Oleon, managing director of clearing and settlement operations at Clear Street, who also expects the fail rate to increase over the first week of the switchover.
Trades fail when a counterparty cannot deliver the securities or funds to meet their settlement obligations, which heightens the risk of financial losses, raises transaction costs and damages reputation, according to financial tech firm Gresham Technologies.
The US Securities and Exchange Commission said faster settlement will make markets more efficient, but foreign investors will have less time to recall their US securities and gather the dollars necessary to trade.
