In February 2022, the Securities & Exchange Commission (SEC) suggested reducing the settlement period for US securities from two business days after the trade date (T+2) to one business day after the trade date (T+1), aiming for implementation by March 31, 2024. The industry proposed a later implementation date, suggesting post-Labor Day weekend in September 2024.
By February 2023, the SEC confirmed the adjustment to the standard settlement cycle to T+1, set to take effect by May 28, 2024. As scheduled, T+1 is set to go live for North America on May 28, 2024, for the United States and May 27, 2024, for Canada and Mexico.
Key changes for equity derivatives if choose to elect for the T+1 settlement
Effective Date Adjustment: Upon entering an equity swap, the effective and accrual start date will transition to T+1, reflecting the new settlement cycle.
Operational Live-Cycle Events: The settlement cycle for equity swap cash flows—including unwinds, assignments, performance and resets—will also transition to the T+1 timeline.
Impact on OTC Derivatives
In past efforts to reduce settlement cycles in North America and other markets, the customary practice involved aligning the settlement cycle of OTC equity derivatives with that of the referenced in-scope security. This was done regardless of whether the OTC equity derivatives were considered in-scope securities. The main aim was to prevent settlement discrepancies between the OTC equity derivatives and their corresponding hedges in the referenced in-scope securities.
Equity Swap Derivatives
Although equity swaps are not required to move to T+1, clients may move to a T+1 settlement referencing the in-scope security underlying from both a performance leg and financing leg perspective. This shift would apply a change between the trade date and effective date, and between the reset and/or termination valuation date and reset cash payment date and/or termination settlement date.
For the swap’s floating legs, RFRs (Risk Free Rates) are used to calculate financing referencing an overnight rate including the period from the last effective date to the settlement date. Therefore, electing to move to a T+1 settlement will shorten the settlement cycle and floating amount by one day.
Because of the shortened timeframe for calculating cash flow amounts and managing settlement processes, clients may encounter operational constraints when making payments on T+1, particularly if they are situated outside North America. Consequently, parties may opt to settle equity swap cash flows using a longer settlement cycle.
Other Swap Derivatives
Choosing T+1 settlement will also impact other securities like variance/Vol Swaps, OTC options and basket swaps, aligning OTC derivatives with their underlying securities' payment schedules. Due to varying complexities and non-standard features of derivatives, clients might adopt a case-by-case approach, potentially leading to frequent operational challenges.
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