The impact of T+1 Accelerated Settlements on Corporate Actions – don’t underestimate the complexity!

The financial services industry is preparing to shorten the settlement cycle for several financial instruments from T+2 to T+1 (i.e., 3 days to 2 days).

In the US, the roadmap has now been laid to implement this change by mid-2024. The Canadian Capital Markets Association has confirmed transition to a T+1 settlement cycle on same day as the US markets. Mexico is also exploring a move to T+1, but any formal plan has not yet been announced.

In the European context, AFME published a paper in September 2022 to discuss if EEA should also move to a T+1 settlement regime. UK has also now put a foot forward in this direction with the government launching an Accelerated Settlements Taskforce in December 2022 to assess the potential for accelerated settlements of financial trades in the UK.

This tectonic shift in the settlements process will put a huge strain on banks as existing post trade operating models built upon legacy technology and siloed operations will be put to the test. It would, therefore, require a coordinated effort from market participants to make this transition a success. 

While this change may appear painful in the short term in terms of operational and technological overhauls but in the long term, the industry will reap the benefits of reduced counterparty & market risks, increased liquidity and reduced volatility. The end client (street investor) also stands to gain as they would have access to the proceeds of their trades on the next day itself, reducing the market risk faced and improving liquidity.

There will likely be several legal, regulatory, technological and infrastructural challenges that will require a coordinated effort. These challenges include: 

• Increased operational complexities for global participants stemming from time zone differences (i.e., a single global ‘close of business day’ process) and cross-currency FX transactions.

• Securities lending impact as the timeline to identify and recall securities is reduced which can increase settlement fails and penalties.

• Impact on asset servicing functions such as corporate actions because of changes to ex-date, cover/protect period. 

This article focuses on the impact T+1 will have on how corporate actions are handled in the settlement process. 

So, what is the fuss around Corporate Actions?

Corporate actions, owing to their high volumes, variations and manual/semi-automated operational processes will be under stress. As part of moving to T+1, some potential impacts on Corporate Actions processes are:

• Ex-date calculation and cover/protect period changes

• Dividend reinvestment process adjustment

• Distinct processing of different corporate actions (mandatory, voluntary etc.) owing to different timelines and processes

• Entitlement capture process-related adjustments

• Reconciliation and reporting processes would need to be reviewed for T+1

How are Corporate Actions managed today?

Corporate Actions can be mainly classified⁴ as mandatory or voluntary as listed below:

A typical Corporate Actions lifecycle is illustrated below:

_{4 - There can be other terminologies used for Corporate Actions like monetary(dividend)/non-monetary (changing the name of the firm) across different organisations. For the purpose of this article, mandatory and voluntary corporate actions are referenced.
5 - Event Date: Date company announces corporate action
6 - Ex-Date: Date on (or after) which security trades without Corporate Actions benefits
7 - Record Date: Date of determining eligibility. This is Ex-date +1 business day in the current T+2 settlement cycle. 
8 - Pay Date: Date of actual payment to eligible shareholders}

1. Mandatory Corporate Actions – These are automatically applied to the investments involved. 

In a T+2 settlement timeframe, the ex-date is generally set as the settlement period minus one from the record date as buying the stock from the ex-dividend date onwards will not entitle the investors to the dividend applicable. Moving to T+1, the ex-dividend date would need to be revised by exchanges and made the same as the record date.

2. Voluntary Corporate Actions – These allow investors to decide if they want to participate in the event and inform their respective brokers accordingly. 

For example, when it comes to rights subscription voluntary Corporate Action, there is an additional cover/protect period wherein customers who miss the election period due to not having the shares in their possession, can typically submit a letter of guarantee that entitles them to participate in the corporate action through the delivery of their positions. Moving to T+1, the cover/protect period will be calculated as the expiration date plus one day versus the expiration plus two days in the current T+2 settlement regime. Firms will have to manage the risk of increased settlements failure because of the cover/protect period moving ahead by one day.

So, what is the likely impact on Corporate Actions?

The below illustration summarizes some of the impacts on different events of a Corporate Action lifecycle because of moving to T+1:

In summary, market participants would have to re-adjust their Corporate Actions specific processes to cater to the re-aligned Corporate Actions dates with the major impact on account servicing institutions (CSDs, custodians, brokers) given that they will have higher volumes to process around the key Corporate Actions dates.

And how is the industry impacted?

Although T+1 would impact almost all intermediaries in the overall ecosystem, the magnitude of impact would be different based on their function under consideration. 

T+1 impact on different corporate action events and intermediaries is detailed below -

• Announcement - Corporate Actions events are created by the issuer CSD. Depending on the markets and countries, the event can be announced at an official publication date and time, rather than only once it is official and complete. The announcement cycle will not be shortened in any way as already the most predictable Corporate Actions are announced 2-3 weeks before the payment date. Though, CSD / custodians may be willing to revise their position load configuration, triggering more Corporate Actions announcement for new positions (from 0 to something). As stock exchanges are also announcing some Corporate Actions, they will have to ensure these documents are carrying the correct information (e.g., ex-date, record date).

- Expected impact = Low because it lies on the IT configuration side of the Corporate Actions process

• Entitlement - Entitlement calculations are based on settled positions. Pending trades are not going to impact the process. However, there may be more intraday changes in the settled position balances and an increase in the volume of preliminary entitlement notifications triggered by new or updated positions (toward the custodians). We do not expect financial institutions to receive more final entitlement notifications (e.g., intraday) if the settlement cycle is shortened by one day.

- Expected impact = Low because it lies on the IT configuration and performance side of the Corporate Actions process

• Instruction Management - Corporate Actions instruction period length will not be impacted. However, the date on which the buyer protection is guaranteed (cover/protect period) will be changed toward the instruction market deadline. Though, if the Corporate Actions requires a position blocking, an increase in the volume of rejected instruction may incur, impacting both CSD, custodians and investment managers (more willing to trade their positions easily than end investors)

- Expected impact = Low, if the current workflow can notify the instruction rejection according to the ISO 20022 standards. Could be medium if the flow would have to be revised.

• Payment - Corporate Actions payment will be instructed based on settled positions irrespective of the settlement cycle duration. 

- Expected impact = None

• Transaction Management - Transaction management encompasses all the automated or manual processes intended to reallocate the proceeds of a distribution or a re-organisation to the contractually entitled party (e.g., a buyer stuck with a pending trade on a security distributing a cash dividend). These processes, if automated, will have to be adjusted (and improved) to cope with the new settlement cycle. Retail investors and institutions should not be impacted too much, but account services (CSD, custodians, brokers) should be highly impacted by an increase of the pending trade volumes around the Corporate Actions key dates. Investment managers avoid trading around these dates and should be less impacted than the others.  

- Expected impact = Low to high

1. High: for CSD, Custodian and Clearing houses confronted to a spike of pending trades, requiring more manual processing on the back of the Corporate Actions proceeds payments
2. Medium: for Investment Managers affected by these proceeds reallocation, impacting their valuation and performances
3. Low: for retail and end investors for the same reasons as investment managers but lower volumes 

• Reconciliation & Reporting - CSD role may be "investor CSD", requiring reconciling entitlements and payment amounts confirmed by the issuer CSD. A shortened settlement life cycle should only require a few technical adjustments. custodians and investment managers will probably have to revise their data feed configuration for their reconciliation and adjust their standard operating procedures.

- Expected impact = Low to medium

1. Medium: for custodians and investment managers required to revise their reconciliation process, with a probable workload increase
2. Low: for CSD as an investor CSD 

Way forward

The move to T+1 will require changes in existing operating models across multiple participants involved in the Corporate Actions process. In preparation for T+1, we outline a list of recommendations spanning across 4 key priority areas:

Data

• The reference data related to cover/protect date, ex-date and record date calculations needs to be correctly configured

• Financial institutions should assess their static data quality and initiate remedial actions as necessary, given that settlement fails / errors are majorly due to poor static data quality

Systems 

• The systems would need to be updated to configure changes to ex-dates, cover-protect dates 

• The event announcement systems need to be updated to relay information to other intermediaries in timely manner

• Booking and reconciliation systems would need to be reviewed and adjusted for T+1

Business model 

• Dividend reinvestment process would need to be reviewed and readjusted 

• Stock borrow positions would need to be evaluated to reduce exposure to Counterparty risk

• Security lending arrangements between borrowers, lenders, custodians, other service providers need reassessment given that timeline for recall/return of securities will be compressed

Operating Model 

• Reviewing processes and workflows that currently require manual intervention. With move to T+1, manual process will have the half the time to run as well as batch processes will be stressed

• -Entitlement/cover protect date to be correctly calculated to avoid financial risk

• -Scaling and training workforce on new deadlines and cascaded impacts in planned manner across trade life cycle

Next stop: T+0?

The final frontier post T+1 is likely to be T+0 which could be fuelled by the latest technological innovations including distributed ledger technology in achieving same day settlements. However, this would require fundamental changes to existing post-trade settlement systems and the successful T+1 migration will go a long way in paving the way for real-time or end-of-day settlements.