The ETF sector will be up against a “perfect storm” on 28 May when T+1 comes into force, predicts a report by the Financial Times. The article gathers opinions from industry insiders, who identify two major factors that are likely to contribute to a surge in failed trades on implementation day: the timing of the transition, and the nature of ETFs.
Bad timing
The choice of transition date seems “particularly ill advised”, writes Financial Times. It points out that both the annual FTSE Russell reconstitution and the semi-annual FTSE All World index rebalancing are being held on 24 May after the US market closes – the last day that trades will be made on T+2.
What will then follow is a long weekend due to a public holiday, with the markets opening only on Tuesday, 28 May, on T+1. “Settlement staff will still be dealing with the last trades from Friday on the old T+2 schedule” while simultaneously being “hit by a tidal wave of new T+1 orders due to the index announcements”.
“Before the new system has had a chance to bed in” – and before settlement staff could catch a break – another challenge will come up: MSCI rebalance day on 31 May. Gerard Walsh, global head of client solutions, banking and markets at Northern Trust, calls it “typically one of the largest trading days of the year”.
Risky undertakings
Walsh also points out that “most ETFs are passive index trackers and will therefore have no choice but to trade in their underlying constituents in order to align themselves with the forthcoming index changes”.
Sarah Simmonds, partner at global consultancy Alpha FMC, is concerned about the additional cash that European UCITs ETFs will have to take on to bridge the period before the ETF wrapper settles. ETFs face “particular difficulties” because should their underlying constituents settle at a different time from the ETF wrapper, the risk of potential mismatches is high.
Having managers act quickly to iron out last minute problems isn’t a cure-all, Walsh says, as he believes that some issues are simply a matter of capacity. “All managers should be asking themselves if they have adequate lines of credit, overdrafts and access to cash-like instruments, and the cost of these if they are suddenly needed in the dead of night.”
James Pike, interim chief executive at Euroclear’s Taskize says that non-US-based market participants should implement a “pass the book” system with operations teams in different time zones “so that issues don’t persist beyond the end of the trading day”. Unfortunately, the manual routing of exceptions are currently “far too prevalent and would not be scalable to handle a jump in trade failures”.
