The financial markets are heading towards a decisive turning point. From 28 May, trades in the USA, Canada and Mexico will be settled in just one day instead of two. The transition is making market participants nervous. Asset managers in Europe and Asia will also have to adapt to a shortening of the American settlement cycle from T+2 to T+1. It is an enormous project, Basu Choudhury said in an interview with Börsen-Zeitung. He is Head of Strategic Initiatives at Osttra, the post-trade joint venture between S&P Global and derivatives exchange CME. Under the new regime, these market participants will have extremely limited access to Continuous Linked Settlement (CLS).

The overarching clearing and settlement system for global financial institutions was created in 1997, and the leading foreign exchange trading banks believed it would overcome settlement risks. However, the European Fund and Asset Management Association (Efama) recently warned that the change in the settlement cycle could put dollar trades by European market participants worth 50 to 70 billion dollars at risk every day. A significant proportion of trading takes place at the close of the New York Stock Exchange at 4 p.m., but the CLS submission deadline is at 6 p.m. Eastern Standard Time - which is midnight in Frankfurt.

As long as the USA, like Europe, relied on T+2 settlement, this was not a problem. After all, there was always another day available to submit foreign currency transactions for settlement via CLS. Now there will be insufficient time for up to 40% of European asset managers' trades in dollar currency pairs, an Efama industry survey shows.

There is now a strong focus on how to meet changing deadlines. ‘While European and Asian market participants are currently buying and selling shares in cash via stock exchanges, they will tap the market for synthetic securities to a much greater extent in the future," the Osttra executive predicts. In other words, they will use equity or total return swaps, and even contracts for difference.

However, in situations where investment managers cannot hold synthetic securities, Choudhury says they will trade the stock in cash, and resort to bilateral settlement. This was common before the CLS era. „If you make structural changes in one market segment, you trigger knock-on effects in others,’ he emphasises. Another way for international market participants to collateralise their large dollar transactions - namely by holding large amounts of reserves in the greenback - is seen by market participants as an inefficient use of capital. As the T+1 era begins, there will probably not be big defaults, but costs for buy side customers are certainly going to rise.

In order to minimise costs and the counterparty risks that would otherwise arise, Osttra is now launching a new settlement service for foreign exchange trading based on the principle of „payment versus payment“ (PvP). The platform will run on distributed ledger technology from fintech Baton Systems, and will be used to settle capital flows that are not currently settled or cannot be settled via CLS - including in the offshore renminbi. Osttra also aims to offer banks and non-deposit-taking intermediaries greater intraday settlement flexibility through the new service, reducing reliance on CLS trade submission deadlines.

CLS is extremely robust and handles a large part of the market extremely well,’ says Choudhury. However, the system was not designed, for example, for specific use cases such as emerging market currencies. CLS today provides significant liquidity backstops for banks -and in any multilateral model, at least one party must take responsibility for the risks.

Choudhury acknowledges that other large market operators such as Deutsche Börse or the London Stock Exchange could also become active with their own platforms. „But the question is whether they want to build the necessary systems themselves, cooperate with a fintech, or enter the market by buying a start-up,“ he says.

Osttra is well positioned to compete, as it already has its own tried-and-tested order matching, confirmation and processing systems. „This makes it easier for us to tap into the trade and create a golden record," emphasises Choudhury. Such so called golden data records are considered particularly important to convince banks of the efficiency of post-trade platforms.

Osttra made plans for a new PvP settlement service for foreign exchange trading even before the US SEC's decision to shorten the settlement cycle to T+1. „This has been at least a three- to four-year journey for us, starting a year ago with a thorough market review and due diligence,“ says Choudhury. Osttra selected Baton as a partner because the DLT provider already processes payments worth billions every day, with the total value of trades chained to date totalling over 8.1 trillion dollars.

„Distributed ledger is a key aspect for us, and HSBC and Wells Fargo have been using it for live settlements for years,’ says Choudhury. „For Baton, the partnership with us was interesting in order to be able to scale the platform.“ It is particularly important to connect other large banks to the settlement service. The integration of such a service means a certain commitment from the institutions - large institutions such as Deutsche Bank and Commerzbank must "be able to trust that the companies they work with will still be around in five to ten years' time.“

However, the shortening to T+1 in the US is only the first step in a broader global development. „The EU will follow suit and shorten the settlement cycle; in the long term, even T+0 is inevitable," says Choudhury. The key issue is how the market will get to atomic settlements - because these are impossible without a tokenised or synthetic central bank currency.“ The path to T+0 will therefore still have many twists and turns.