May 27, 2024 will be a day like any other for most Canadians, blissfully unaware of the nuts and bolts of the securities trading and settlement system that securely moves the equities, debt, derivatives, other investments, and cash that make up their future retirement happiness.  It’s another story for pension fund managers, their broker-dealers, and custodians, along with clearing agencies, marketplaces, and service providers: for them it’s the first day securities will trade on a next-day settlement basis. Many pension funds appear well-prepared, but no individual investment industry participant can be fully ready unless other parties along their trade-execution-to-settlement track are also fully prepared. 

This article is the third and final in a series¹ preparing stakeholders in the Canadian investment industry for the journey from today’s two-business-days-after-a-trade standard settlement cycle (T+2) to a next-business-day standard (T+1) on Monday, May 27, 2024 in Canada, Mexico, and Argentina, and a day later (May 28) in the U.S. due to the American Memorial Day holiday. To quickly recap for late arrivals, this trip started February 23, 2023 when the U.S. Securities and Exchange Commission (SEC) issued a final rule requiring industry participants to move to a shorter settlement cycle. Canadian regulators and industry stakeholders, recognizing that since an estimated 25% by number and 40% by value of trades in Canada were in securities listed on both Canadian and U.S. marketplaces, concluded that Canadian markets must follow suit. Some expected, and others hoped, that the SEC would be pressed to delay the transition, however the T+1 train has left the station: nothing will prevent the U.S. or Canada from reaching the final destination in the last week of May 2024. 

To stay on schedule, pension fund managers will have to meet the following cut-off deadlines:

• By around 6:30 p.m. ET on trade date (T), pension funds and other institutional investors must submit allocations to their sellside broker-dealers and custodians for trades executed on a Canadian marketplace, so the custodians and broker-dealers, can deliver the allocated trades to CDS Clearing and Depository Services Inc. (CDS) by 7:30 p.m. ET on T in order to be matched for settlement on T+1.
• By around 3:00 a.m. ET on T+1, pension funds and other institutional investors can correct and confirm trade details so that the maximum number of confirmed trades can be sent by custodians to CDS for processing by 3:59 a.m. ET on T+1. At present, it seems unlikely that hours of operation for most institutional investors, including smaller pension funds, will change in Canada, however, those pension fund managers with operations in European, British, and Asian, locations will have a head start identifying and correcting errors. 
• A recommended recall notification best practice cut-off of 3:00 p.m. ET on trade date for securities lending borrowers and lenders, including pension funds. Sales notifications must be issued as close to market execution as possible to avoid delays or settlement failures, with attendant financial consequences.
• Changed ex date practices for dividends, distributions, and other corporate actions: Ex dates will move from one business day prior to record date to the day of record date.

First, the good news.  

• Major pension funds say they are well-positioned for the transition to the shorter settlement cycle.
• Canadian industry testing, coordinated by both CDS (equities and debt) and Fundserv (mutual funds and similar products), is now complete and went very well with no material issues being reported.
• The TMX/CDS has developed, and registered users are well into testing, a new automated securities loan recall portal, developed with Canadian Securities Lending Association (CASLA) input. One of the major areas of concern was the impact of T+1 on securities lending, which to date has involved considerable manual processing, adding to delays and errors. The new portal will fix all that, by providing loan recall interconnectivity among counterparties and third-party securities-lending vendors. Expected to launch by the end of May 2024, the portal will streamline the process of receiving sales notifications from beneficial owners enabling lending desks to act on a more timely basis.

Second, it’s a rougher road. 

• The move to T+1 is challenging for several reasons: 
  • The change is more complex than the 2017 T+3 to T+2 move because the opportunity to correct errors through overnight batch file processing will no longer exist.
  • Even though T+1 settlement will be the standard settlement cycle in North America, European, U.K., and most Asian markets will continue to settle on a T+2 basis, meaning North-American industry participants must cope with the potential for  mismatched settlement dates. This may result in industry members pre-funding, negotiating increased lines of credit, and/or managing increased failed trades when either cash or securities are not delivered on time.
  • With only the Canadian/U.S. dollar pairing settling on a T+1 basis today, there also will be an FX mismatch for trades denominated in another foreign currency that settles on T+2 or later
• While there are risks in any major industry-wide 'big bang' transition given the size and interconnectedness of our capital markets, the importance of the investment industry to the economy, there has been less time to implement the change than all major securities associations globally had recommended. The results of a ValueExchange survey completed in February 2024 showed an expected tripling or more in expected settlement fail rates: currently around 2% in Canada, they may initially rise to 6%-8% following transition, demanding a considerable amount of resources to return to today’s low fail rate. 

Check your T+1 kit one last time

While custodians have been working with pension fund managers for months to encourage T+1 readiness preparations, a number of custodians are concerned that institutional investors are not as engaged in T+1 preparations as necessary. Here are a number of questions to ask yourself to make sure all systems are a go for a smooth arrival at T+1 on Monday, May 27. 

In April and early May:

• Do you have data from your custodian(s) and sellside dealer(s) regarding the timeliness and accuracy of the data you provide and is your firm increasing the number of trades and allocations reported to broker-dealers and custodians by 6:30 p.m. on trade date?
• Have you eliminated problems that exist today but will be harder to address in a T+1 settlement environment, for example, updated standing settlement instructions and identified if assets you manage include securities, such as restricted or legended shares, that require extra steps that could delay matching and settlement?
• Have you reviewed error avoidance and trade correction processes with your custodian(s) and sellside dealers?  Remember, even if you are ready for T+1, their other clients may be less prepared, which could have a knock-on effect on your ability to resolve issues that arise.
• Are you aware what part of your fund’s holdings will, won’t, and may be moving to T+1? 
  • Equities, as well as debt and derivatives not already settling on a same-day or next-day basis, should move to one-day settlement, but to check for more esoteric products, look at the CCMA’s list of T+1 securities. 
  • If you invest in segregated or other investment funds, you should know that Canadian Securities Administrators staff did not amend National Instrument 81-102 Investment Funds to require funds to move to a standard T+1 cycle, but rather issued a notice encouraging funds to move to T+1; insurance company segregated funds have generally followed the mutual fund settlement convention. At present, there is no easy way to know which mutual or segregated funds are moving and the CCMA is trying to co-ordinate making such a list more publicly available before the week prior to implementation when Fundserv, a clearing agency for funds and similar products, will publish a list of funds moving to T+1.
• If your fund has Mexican or Argentinian holdings, have you identified what is changing? Mexican securities eligible for the move to T+1 include local securities and those listed on BMV’s International Quotation System (SIC) that declare the U.S. or Canada as their main market (Mexican government securities and SIC securities using Europe, Asia, or any market not yet be moving to T+1 are not eligible).² Argentina has announced it will move stocks and bonds to T+1 on May 27.
• Can you manage the additional complications surrounding securities denominated in non-CAD/USD currencies (T+2 or longer settlement convention), e.g., MXN/USD (see The Financial Markets Association Briefing Note and the FX Professionals Association’s Buy Side Guidance in Preparation for T+1 Settlement) for recommended approaches?
• Do you have a change management strategy? Many expected industry participants to cope with the loss of a day in the trade-through-settlement process by technology upgrades, however, the bigger and harder-to-manage changes are process adjustments to manage to new deadlines and behavioural.
• Have you identified key performance indicators (KPIs) to monitor now and post-transition? Trade fail rates are expected to reduce after an initial rise, however, to avoid a “new normal” of higher errors and fails during the T+1 market adjustment period, now is the time to develop strategies for managing through this phase effectively and reinforcing operational resilience in the new world.

For the transition period:

• Have you planned to avoid non-T+1-related systems changes for the period around May 27, 2024? 
• Have you arranged to have extra staff on hand or on call to help manage any uptick in errors, mismatches, and failed trades?
• Have you confirmed error escalation processes with your custodian(s) and sellside dealers?
• Are you ready to pay for two days’ worth of trades on Tuesday, May 28, 2024 when you will have to pay for securities you bought on both Friday, May 24 and on Monday, May 27?

If you can check off every item above, you’re in good shape.

You can simply watch the CCMA’s online T+1 timer counting down to Monday, May 27. Then for good measure, deduct three days: all preparations must be made by the end of Friday, May 24 so custodians, CDS, sellside dealers, and service providers can focus on implementing and testing systems changes through the May 25-26 weekend. 

Public service announcement – what’s at stake if safety checkmarks are missing?

How well you’ve prepared, and the magnitude of your portfolio held in securities of T+2-settling jurisdictions, will determine the extent of the risks you face.  The less automated pension operations are, the more likely manual work and trade corrections will be needed. Besides increasing reputational risk if the percentage of failed trades escalates, there will be additional labour and liquidity expense. Settling mismatched trades, especially if denominated in a non-CAD/USD currency, comes at a cost that is higher today than in the past ten years. This will be higher still if the trade fails late in the week and funding costs are incurred over the weekend or longer if markets are closed for a long weekend. This could be worsened by an inadvertently wrong or missed file or system outage.  After an implementation period, a fund manager continually missing deadlines can expect to have to pay for additional costs born by custodians and dealers. These costs can also be a drag on performance.

And if anything seems to be going a bit off the rails? 

Your first line of defense will always be your custodian(s) and sellside dealers³. However, cross-industry support also will be provided by the CCMA, which has published a two-week T+1 Transition Support Plan, running from Tuesday, May 21 to Friday, May 31. The plan is available, and updates will be published daily, on the CCMA website under Project Info. 

Full steam ahead!

1 The other two are And then there was one… T+1 (October 2022) and (It takes three to do the T+1 Settlement Tango (April 2023).

2 Roberto Gonzalez Barrera, CEO, Post-Trade Division, Grupo BMV (Bolsa Mexicana de Valores ) in summary said: Between 50% and 60% of what is traded in Mexico are foreign securities, with over 3,000 foreign securities dual listed. The two challenges the Mexican move to T+1 are local securities, where U.S. participants are dominant when trade instructions comes from a US fund to a US broker to a local broker and after execution, the confirmation and settlement instructions must reach the local custodian same day in order to enable the delivery of the securities the next day (T+1). The second is the need to speed up the current trade confirmation and post-trade. 

3 You can also check if the service providers you rely on directly or indirectly are expected to sign a Project Acknowledgement Form (as done in the 2017 move from T+3 to T+2) or are direct CDS participants and will be similarly signing off on readiness with CDS.

Keith Evans, Executive Director, Canadian Capital Markets Association (CCMA)

Keith Evans was appointed Executive Director of the CCMA in July 2015, and represents the CCMA in the co-ordination of the CCMA’s Board-approved initiatives.

Mr. Evans led the Canadian financial industry’s transition from T+3 to T+2, which was successfully implemented in the fall of 2017. Since then, he has been working with industry participants to support modernization of CDS’s systems for clearing and settlement, as well as for entitlement and corporate actions processing. He now also heads cross-industry and cross-border co-ordination of Canada’s T+1 efforts.

Mr. Evans is a senior operations executive in the financial services industry, with extensive experience in clearing and settlement, corporate actions, and project management. He worked for The Canadian Depository for Securities Limited (CDS) for 36 years, most recently as Executive Director, Operations. There he was responsible for the day-to-day operations and strategy of Canada’s national depository and clearing corporation.