Yuichiro Araki discusses operational considerations for Japanese investment managers preparing for an accelerated US settlement cycle.
The US move to a T+1 settlement cycle for transactions in cash equities, corporate debt, and unit investment trusts will impact global investors, given its capital markets are the largest and among the most liquid in the world, with an estimated 35 to 40 percent of investment activities originating from overseas markets. It is not surprising then that firms worldwide have widely discussed and reviewed the impact of shortening the standard settlement cycle by one business day. For all the benefits that T+1 could bring to the financial system, how would an accelerated US settlement cycle impact markets like Japan? And, as preparations are underway for the T+1 go-live date on 28 May 2024, what operational concerns do Japanese firms face?
In Japan, the involvement of trust banks for the provision and supervision of investment related services is a regulatory mandate aimed at protecting the end investor. This means that appointed trust banks oversee their underlying investment managers’ trading activities and that they are included in the pre-settlement, post-trade communications chain. This a unique setup for Japan to address T+1, as the US Securities Exchange Commission (SEC) requires institutional trades to be allocated, confirmed, and affirmed as soon as is technologically possible and no later than trade-date, also known as Same Day Affirmation (SDA). In the US, trade affirmation is an action by the institutional investment manager or its appointed custodian to validate and agree to the economic details of a trade as confirmed by the clearing broker for processing at the Depository Trust Company (DTC). In Japan, this means that, with less than 24 hours to achieve SDA due to time zone differences, Japanese firms will need to remove human intervention and leverage solutions to automate manual post-trade processes.
As time is of the essence, most of the larger and non-Japanese firms have opted for a “soto-soto” arrangement with trust banks where investment managers send settlement instructions directly to their custodians without waiting for the trust bank’s clearance. The trust banks will be given a copy of the settlement instructions for record keeping purposes. While this arrangement – with technology as the enabler – will help to meet the affirmation deadline, mid-sized to smaller firms that do not have sufficient automation capabilities may still rely on trust banks to facilitate, or be involved in, the post-trade process. The “soto-soto” option is just one of the numerous arrangements that Japanese firms can choose when preparing for T+1.
All things considered, Japanese firms should review their internal processes with their trust banks and global custodians and decide on the best option to meet the US T+1 deadline.
With the compressed settlement schedule, the recommendation is for trades to be allocated by 7:00 p.m. ET and affirmed by 9:00 p.m. ET on trade date. Given that Japan is about 13 hours ahead of the US Eastern Time Zone (ET), Japanese investment managers have several options available to them. They can leverage the “soto-soto” arrangement, adopt a follow-the-sun model to assign offices outside of Asia to oversee post-trade processing and the affirmation of trades, or they can switch to intraday processing where US trades are given priority in the morning local time. Japanese investment managers can also continue to rely on their US based custodians to affirm trades on their behalf, subject to the custodian’s agreement.
An optimal solution to address the tight post-trade processing window is to leverage automated solutions that streamline the central matching of cross-border trades to increase efficiency in the allocation, confirmation, and affirmation process where trades are auto-affirmed after they are matched-confirmed between the investment manager and the executing broker. With this process, a matched-confirmed trade is considered affirmed and is immediately sent to DTC for settlement to meet the 9:00 p.m. ET cutoff time on trade date – free of manual touch points or any back-and-forth communications and accelerating the trade lifecycle. These best practice solutions are already available for firms to leverage.
Increased automation aside, it is also important that Japanese firms ensure they have accurate standing settlement instructions (SSIs) to complete and finalise the settlement process. Having access to an automated, standardised database of golden source SSI data that includes security and location, designated depository settlement accounts and bank account details, helps to ensure consistency between the investment manager and custodian and facilitates accelerated settlement by minimising instances of exceptions due to incorrect SSIs from one or both parties to a trade.
With the tight window to achieve settlement finality, the number of trade exceptions should ideally be reduced to zero. In the scenario that exceptions do occur, they should be managed via a central platform that quickly identifies the root cause and enables faster resolution while communicating and monitoring settlement activities and preventing exceptions.
Japanese investment managers should have already commenced the necessary groundwork to prepare for T+1 settlement. Understandably, the analysis process may be lengthy when considering such a complex and significant initiative like T+1. Aside from leveraging internal resources, Japanese investment managers can also look outwards – seeking guidance and advice from experts with experience in post-trade processing and meeting shorter settlement timelines.
With approximately six months left to prepare, the time to get ready is now. Firms must prioritise efforts to modernise and transform existing systems, processes, procedures, resources – not only for T+1 readiness, but also in anticipation of future regulatory demands and unexpected market events.
By Yuichiro Araki, Executive Director and Head of APAC Sales and Japan Relationship Management, DTCC