The road to T+0 – Gradually then suddenly

Not often I get to quote Hemingway but this excerpt from one of his novels struck a chord:

“How did you go bankrupt?” Bill asked. “Two ways” Mike said. “Gradually, then suddenly”

The same could be said for the ever-quickening move from T+2 equities settlement to the inevitable T+0 settlement or “cash up front” model.

The starting gun was fired when the SEC announced in Feb 2023 that the US equity markets would transition to T+1 settlement on May 28, 2024 (Yes that’s next month!). The reason why the SEC is shortening the settlement cycle is “better protect investors, reduce risk, and increase operational efficiency” [1] furthermore, the change is designed to lay the groundwork for moving to T+0 settlement in the future.

Therefore, it is not unreasonable to assume that T+0 will be in place in the US well before the end of the decade and more pertinently before the ASX CHESS replacement program is completed here in Australia. According to UBS, The US commands a mighty 60.5% of global market size [2], therefore where the US market goes, all other markets tend to follow, and most other major global markets will likely move to a similar timeline.

Australia is a leader in this space though right?

There was a time not so long ago when this was absolutely true. When the ASX announced that it would adopt distributed ledger technology to replace its aging CHESS infrastructure in 2015, Australia and the ASX were seen as innovation pioneers. Alas, it was not to be.

A report by Mandala Partners published in 2023 found that:

In the early 2000s, Australia was at the forefront of global financial markets capabilities. The stock exchange had adopted electronic trade execution, clearing and settlement ahead of many other global markets. Sydney was ranked 7th on the Global Financial Centres Index (GFCI) as of 2007.

However, Australia’s financial market infrastructure and related regulatory architecture has failed to keep pace with global changes, specifically as new innovations such as distributed ledger technologies (DLT) emerged. This is starkest in Clearing and Settlement (C&S) where the Clearing House Electronic Sub register System (CHESS) was world leading when introduced in 1994 but its underlying technology is now outdated, limiting Australia’s ability to continue to improve the service levels and performance of post-trade services. Sydney is now ranked 13th, behind cities in the US, Europe and Asia, while Melbourne had fallen from 18th in 2007 to 31st in 2022.

To validate these further, recent announcements from ASX now suggest that the full CHESS replacement is unlikely to be in place before 2029.

What does this mean for T+0?

It means that Australia is now behind the eight ball and likely to lag significantly behind other global exchanges in the coming years by being stuck in an outdated T+2 settlement environment. There is a solution though and, although no one has whispered it yet, there is the option for the Australian market to now skip the move from T+2 to T+1 altogether and move straight to T+0 as part of the CHESS Replacement project.

That sounds drastic, what does it mean in practice?

This is where the “Gradually and Suddenly” bit comes in.

For a generation of stock market investors, T+0 is already here and is a normal way of life. FinClear clients, Stake, Superhero, Think Markets and Grow Markets have been leading the market in innovation in recent years and T+0 is their only method of settlement. Their customer base of younger investors has no issue with this and, in fact, would be surprised and even inconvenienced by the traditional “Analog” T+2 settlement cycle.

So, the technology exists, and it is entirely possible to implement T+0 today on the retail client side. The process will however be more gradual for traditional stockbrokers and their wholesale clients and more importantly for ASX Clear to update CHESS to facilitate this change.

Gradual but entirely possible. The question is why bother to move first from T+2 to T+1 rather instead move straight to T+0 as an objective of the CHESS Replacement Program? The traditional arguments against a move to T+0 have or had some validity but continued rapid technological advances in payment processing mean that same day payments even on a cross border basis are entirely possible.

Yes, it means that large financial institutions and global custodians will be forced to invest in new processes and systems, but they will have seen this coming for years and know full well that the time would eventually be nigh. There is of course the thorny issue of why our large domestic and global banks do not immediately adopt instant payment protocols that have been available for years but that’s a longer conversation for another day.

What does the journey look like?

FinClear is a good example of how the change could be affected over a number of years. We have a wide range of clients ranging from more traditional firms facilitating various settlement methods (including direct debits and BPay) to FinTechs who operate “cash on platform” as their core operating model. We will continue to support all of this settlement methods and endeavor to facilitate any required regulatory chances for our clients using our learnings from being the largest Australian wholesale servicer provider in this space.

We are already assisting some of our clients with T+1 settlement for their global equities’ transactions. We do this by using the existing “FinClear rails” whereby we facilitate cash payments directly from end client bank accounts and also provide a real time competitive FX conversion and payment to US service providers.

We have already transacted live trades and funded US domiciled providers direct from end client bank accounts within approximately 2 hours. We will continue to grow this new service line via a new “FinClear Cash Hub” using third party software and sitting over our banking provider, ANZ.

This will allow our clients to set up dedicated trading cash accounts for their end clients on our platform and achieve a T+0 settlement operating model for domestic and international equities. This will be an optional service for all FinClear clients and will reduce costs to our clients via reducing failed settlements and more importantly allowing them to avail of cheaper pricing via STP trading.

What is the end game for FinClear?

Regardless of whether ASX decides to be bold and follow the rest of the world to T+0 as part of their CHESS Replacement Project, we at FinClear are committed to offering our clients the option and efficiencies of T+0 settlement.

Our FCX platform is now live and operational and facilitates atomic settlement for private markets. Our objective is to extend this capability to listed equity markets and other asset classes over the coming years. We already have considerable interest from fund managers looking to list their products on FCX to facilitate a more modern secondary liquidity market rather than the traditional cumbersome and time-consuming redemption and application processes.

At FinClear, we agree with the SEC “Given the ever-increasing pace of advancements in technology, including distributed ledger technology, further shortening the standard settlement cycle [to T+0] in the near future may be both desirable and feasible”. 

There is only one possible end game for listed equity markets and that is T+0 settlement. It has significant advantages around customer experience and cost efficiency for brokers and other intermediaries.

The rest of the world has already started to move there, and Australia will (maybe eventually) have no option but to follow. At FinClear, we have already started this journey and are committed to staying this course.

Author: Tony Lynch CFO, FinClear