Mutual fund companies and other investment firms are not prepared for the SEC's forthcoming "T+1" requirement that they clear and settle trades within one day of the initial trade, fund industry executives said.
Fully aware of the obstacles, costs and the challenges of T+1, the SEC does not expect to enforce the T+1 regulation until 2004, said Dan Michaelis, assistant vice president for corporate communications at the Securities Industry Association. The association, the trade organization of financial technology service providers, and the Global Straight Through Processing Association are working with the SEC on T+1.
T+1 will be difficult, industry executives said. The transition will be more difficult than that to T+3, which took place five years ago, they said. It will be akin to and on the order of Y2K, said Barry McConville, director of sales and marketing for Global Investment Services of Hackensack, N.J. Global Investment Services is a fund accounting service company.
T+1 will require a great deal of time, talent, and technological overhaul at asset management firms, industry executives said. The industry will spend about $8 billion preparing for T+1, approximately the same amount it spent on Y2K, according to a study by Andersen Consulting of New York for the Securities Industry Association.
The benefits will be considerable, however, once the trading cycle is advanced from T+3 to T+1, fund executives said.
The industry will recoup its $8 billion investment within three years and will save an additional $2.7 billion a year indefinitely, according to the Securities Industry Association study. This annual $2.7 billion savings would shave 28 percent off of trade-processing expenditures industry-wide, according to the association study.
A two-day reduction in the settlement period will also dramatically reduce the industry's risk exposure, said Joseph Gramlich, chairman of PFPC Trust Company, a fund accounting, custody and transfer agent service company in Westboro, Mass. Approximately $1 trillion worth of trades are made in U.S. securities each day, and the potential for error on those trades is great, Gramlich said. Because T+1 is premised on near-total automation, it would reduce the potential for errors on those $1 trillion worth of trades, Gramlich said.
Clearing and settling equities trades would also bring settlements in the equities markets up to the speed of settlements of other types of investments, Gramlich said.
"In the U.S. today, equity securities are settled at T+3, Treasury bonds, bills and notes are settled at T+1, and commercial paper is settled at T+0," Gramlich said. "Increased coordination will enable more flexible trading that will benefit investors."
T+1 would also make the U.S. investment markets competitive with others worldwide that already are at T+2 or even T+1, Gramlich said. Hong Kong and South Korea already process trades in T+2, and Taiwan and Switzerland are at T+1, Gramlich said.
Not only will T+1 enable the U.S. markets and mutual fund industry to remain competitive with the rest of the world, but it will enable mutual fund service providers and post-trade fund accounting firms to remain competitive and continue to lead the world, according to the association study.
T+1 "will enable the U.S. market to continue to maintain its global competitiveness by serving as a catalyst for enhancing the current post-trade processing and settlement process," according to the study. "The changes will result in a significant economic benefit to the industry."
Just as the move from T+5 to T+3 helped the markets handle investors' increased appetite for ever more complicated trades, the move from T+3 to T+1 will enable the markets to handle an even greater volume, said Sam Sparhawk IV, vice president at PFPC.
T+1 could help mutual fund companies and others serve both their retail and institutional customers better, according to the study.
"T+1 will enable trade participants, exchanges, DTCC [The Depository Trust and Clearing Corporation] and industry infrastructure providers to communicate electronically . . . in a seamless and cost-effective manner," according to the study.
But to be ready for T+1 in 2004 and the move to T+0 that is likely to follow, fund companies will have to begin preparing either by the fourth quarter of this year or the first quarter of next, according to the study.
It will also require a tremendous amount of cooperation among technology and fund service vendors, fund companies and the trading parties they do business with (including both customers and brokers) and the clearing corporation, which will need to rewrite its continuous net settlement process, said Gramlich of PFPC.
The securities industry will also have to standardize reference data and move to shared protocols, said Gramlich. This entails the standardization of formats and values for such trade-related data as commissions and Financial Information Exchange standards, a trade protocol introduced in 1995. These changes will transform how industry participants communicate, Gramlich said.
SunGard, the financial technology company of New York, just added a straight-through-processing, cross-border-matching capability to its line of business integration products. SunGard announced the added capability Sept. 12.
Uniform trade processing and computing standards are "crucial because of the plethora of new markets, new instruments and new technologies," such as new Internet standards and new types of mutual funds, said Sparhawk of PFPC.
However, the various mutual fund service providers and technology partners are not going to readily agree on a single, or even a few protocols, said Norbert Boon, sales director with Asset Control of Beetsterzwaag, The Netherlands.
"It is going to be a little bit of a war," Boon said. Asset Control has software that integrates data written in various protocols, Boon said.
Right now, there are two competing protocols that could be used to accomplish T+1, Boon said. One is from Capital Markets of Belgium and Andersen Consulting, and the other is from Cap Gemini of Paris, he said.
T+1 will mean fully electronic transmission of data from trade through settlement, industry executives said. To accomplish this, "middleware," a type of software that can link various computer systems written in different code, is required, Sparhawk said. It will also mean that instantaneous processing of individual trades will have to replace batch processing, Sparhawk said.
To achieve T+1, financial information technology vendors such as PFPC will have to build straight-through-processing-based systems, Gramlich and Sparhawk said. These systems will have to be flawless and powerful enough that they will be able to handle sudden surges in trading, Sparhawk said.
"T+1 is something the fund industry will, very soon, have to put a lot of effort into," said McConville of Global Investment Systems. "But like the Y2K event, people will get there. People may get there in the last six months, as many organizations did with Y2K, but they will, without question, get there."
"Once T+1 is in place, we will look back at the dinosaur days of T+3 and ask, Why didn't we do this sooner?'" said Gramlich.