TITLE: The U.S. Transition to T+1 – The Clock is Ticking

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Jack: Hello. I'm Jack Parker and the lead the industry development and advocacy group for J.P. Morgan Custody in the United States. Today we are discussing T plus one settlement in the US. Before we sort of jump into it, I just wanna give some background of sort of where we are. Over the years in the US, and as markets and regulators views on risk have evolved, and the technology capabilities have improved, so has the industry's desire to shorten the settlement cycle. For example, in 1995, the US settlement cycle shortened from T plus five to T plus three. And then shortened again in 2017 from T plus three to T plus two.

Underpinning the compression of settlement in the US is the general market view that reducing the period between trade execution and settlement reduces credit, operational, market and counterparty risk. While at the same time, it also reduces margin requirements, increases market liquidity, and allows more efficient use of capital.

With the backdrop of the market volatility associated with COVID-19 and the meme stock trading events over 2021, the industry, through multiple trade associations, came together to discuss moving the US market to a T plus one settlement cycle.

These industry discussions resulted in the publication of two white papers in 2021, which set out the technical requirements and potential regulatory amendments required for the implementation of T1. These white papers were followed by a proposed rule from the Securities and Exchange Commission, the SEC, around the shortening of the settlement cycle, and the proposals were issued in February 2022. Since February this year, the industry has been discussing and preparing the implementation of T plus one, which requires ongoing important collaboration by all market actors and participants. In today's session, we will be discussing progress towards T plus one settlement, some of the issues we are thinking through here at J.P. Morgan, and some of the issues which our clients may need to consider going forward. To do this I will be joined by Paul Bishop, Executive Director of our US Custody product team and Enza Megna, Executive Director of our Equities Middle Office team.

Paul and Enza, I wanted to start by discussing the implementation date. The SEC's proposed rule stipulates March 2024 as the implementation date for T1. In response to the SEC's proposed rule, the industry actually argued to push that implementation date to September '24. This position was reiterated by multiple trade associations in a joint letter to the SEC in October this year. The reason the industry sent that letter is because the SEC hasn't said anything really  since the February publication around maybe delaying that date.

So as things stand, the industry just has the SEC's March 2024 proposed date. Paul, maybe if I could just start with you. When, when do you think that the industry will get further clarity on the date? And, and how much of an issue do you see it being if the SEC stick to March 2024?

Paul: Yeah, thanks, Jack. And look forward to getting into it today on the audio recording. Before I answer the question specifically I think it's just worth taking a quick step back on something that you said. And that's basically that there's a number of things that we don't know, as much as what we do know, today. And today being December 8th, we're moving into 2023 still looking for some clarity on some things. And I think that's a good segue into your question, one of those being actual implementation date that's been proposed.

So I think to try to kind of answer the question, the SEC has taken on a bit of an aggressive schedule. And so there's been some, at least as we see it, there looks like there's some delays with when those rules will be finalized. We had originally anticipated December of this year. As it is now the end of the first week of December, it does not look like that will happen. It will most likely come in the first quarter. And the reason that's important is until they finalize those rules, the actual implementation date would not be identified.

In the rules proposal, they came back, as you said, they proposed March. The reason September for us made more sense as an industry was simply because it aligns to a three-day weekend. It also aligns to Canada, that is also moving to T plus one. They have a holiday on the same day in September. So, it was just a nice alignment that everybody could get behind. There isn't a profound difference. Nothing really happens between March and September except you get an additional six months. And we think that's gonna be important as we start to look for the test schedules, et cetera, and any of the changes that will need to happen.

So, at this point, J.P. Morgan is taking a, hey, let's- you know, we'll plan for the worst, we'll hope for the best. We will be looking at that March as the time frame. But if we get the additional time to September, obviously we would welcome that.

Enza, I don't know if you have anything else you wanna add to that that I’ve described.

Enza: Yeah. Thanks, Jack and Paul. And I would certainly agree, I think exactly as you mention, Paul, there's a lot we don't know. But what we are doing, you know, particularly on the executing broker side, is preparing as best we can. So, we are thinking about the different aspects of the rule as it is written today. We are working with our technology resources to make sure that we have people aligned to do the work, whatever that may be, and we're preparing for the work, anticipating what that might look like.

So, Paul, I think you said it perfectly, hope for the best, prepare for the worst. So, we expect to be ready by March, but we're hoping that we'll get that September timeframe. And really, one of the things that we're talking about today is for this to really be effective and really work smoothly, the whole industry has to be thinking about this and be ready, and that's a little bit of what we want to talk about today as well.

Jack: That makes sense. So, what we're saying is the current expectation is in Q1 2023, the SEC, we're hoping will get the final rules out there. In terms of planning and perspective, we are planning for our projects and programs of work for implementation date of March 2024, but we're supporting the industry's push to try and get that to September 2024.

Paul: Yeah, that's right, Jack.

Jack: Okay. That makes sense.

Paul: So from the broker-dealer side, hearing Enza talk and then I guess from custody, I would also say, we are obviously looking very carefully as if it is a compressed timeline, are we gonna be ready to go so that all of our work and all of our planning for that is also along those lines? I think the one thing that I just would highlight for clients is if it does end up compressed to March, we really have to look very carefully at the testing timeline, 'cause right now, you're now looking at potentially a year, as opposed to 18 months. And that does matter. If there are changes that a client needs to make to address some of the things we discussed today or if there's new things we're gonna put in place, whether it's on the broker side or the custodian side, that testing timeline really does matter.

I don't remember who gets the credit for the quip of, "Testing is never completed, only abandoned." So in this case, that compression in terms of when we have to implement does make a difference. I'd just kind of leave you on that thought.

Jack: Okay, great. Thanks, Paul and Enza. So, moving on to a different topic. There's been a lot of discussion around the T1 and discussion around same day allocations confirmations and affirmations. But before we jump into that, it'd be good to just give our listeners a bit of an overview of how the allocation confirmation affirmation process works today in the T2 environment. Enza, would you mind if perhaps you kick that off, if that's okay?

Enza: Sure. And we'll keep this pretty high level, just to talk through how it generally works today. So executions are done throughout the day. Then clients will send their broker their allocation. And really that varies a bit client by client on how they do that and when they do that, but we will say generally the allocations are sent to the broker by end of day on T. However, and I think potentially most pertinent to the group listening and for what we're focused on in T+1 will be that a lot of clients that are non US actually send that information on allocation on T+1 because of the various time zone differences.

What then happens is, once that allocation is received, the executing broker has to send a confirm, and this is largely because of the 10b-10 confirmations requirement. The broker will send that confirm out, and that confirm includes all of the main aspects of the transaction, all of the pertinent details. The client or an agent for their client will then affirm those details back on the confirm. This whole process is really aimed at trying to verify all of the details upfront to try to mitigate any risk of settlement or any delay in settlement. So, it pushes the verification of all the details as early as possible so that you can have a smooth settlement. And as we just walked through, right now, this is done, in some cases, on T, but often on T+1.

There is also, for the US markets, something called CNS, Continuous Net Settlement, which allows settlement to happen more efficiently. The current deadlines for CNS settlement are transaction date plus one. So it gives you a little bit of time to really get all of that information vetted and agreed and affirmed, and that's what we're working with in today's world.

Jack: Okay, that makes sense, Enza. And Paul, perhaps could you just give a little bit of detail around the current affirmation processes today and maybe the models that J.P. Morgan Custody offers today in the affirmation space?

Paul: Yeah, yeah, sure. I can, I can try to go through that. It- it's a bit of a mouthful, but I will certainly try to get through that as efficiently as I can (laughs). So yeah, I mean, I think what's interesting from Enza's perspective, right, talking about Continuous Net Settlement, and I don't know if a lot of people even pay much attention to the amount of netting that goes on in- in the US market today that never actually gets to a bilateral settlement. But despite that, even with all the netting, we still do somewhere to, the industry does, you know, somewhere to five million settlements on any given day. And so in that settlement, where the shares are actually not netted down, but they're going to move between two parties, the custodian ends up playing a fairly significant role in that.

And in fact actually Enza called it out. She said, "Whether the client's doing the affirmation or an agent for the client," and oftentimes, the custodian ends up playing that role of agent for the affirmation process. So, you asked a little bit about those models, and generally speaking, right, as far as the industry goes, Jack, I think there's three models. I'll use the terminology that we use at J.P. Morgan. The terminology may differ slightly if you're talking to another custodian, but I think the process is generally the same.

So in the first, what we call the auto affirmation, and that is generally where as an agent, the custodian, the client will send me a settlement instruction after they've done the trade. I will take in the confirmation from Enza as the broker. I will actually compare the settlement instruction to the confirmation. If it's within tolerance, I will go ahead and I will affirm it back on behalf of the client.

The second method that you'll often see is what we call a direct affirmation. That's actually where the client affirms the confirmation themselves, so they're in that process. And I'm actually being told by the client, "Hey, we've affirmed this. Go ahead and settle it." And so I'll actually create the settlement record on behalf of the client to do that.

And the third model that you have today from custodians is the hybrid, which is basically clients doing both. The client will affirm, but they will also settle, send me a settlement instruction. And unfortunately, time is not gonna permit today for us to kind of really dig into why would you have those different models or what's the value of all those different models, et cetera. So, I guess just to keep it at that high level, what we are finding is that when trades are affirmed before we try to present for settlement, they have a much higher accuracy rate as far as being settled. There's less failure when we affirm.

So, there's been a lot of interest and, in not just from ... not speaking for you, Enza, but just, you're very interested in that Continuous Net Settlement, but obviously from a custodian as the agent, I want to make sure that if it has to be settled in the market, it has the best chance of accuracy. Enza, I don't know if you want to jump back in on anything I just said, but yeah, I just kind of want to make that point.

Enza: Yeah, Paul, and I would, I would 100% agree, and I think everyone would agree with that statement. Once we- we have a trade, we have an execution, we want to verify all of the details and give it the best chance of settlement on time. It's in everyone's best interest to do that. And we do that today, but we'll- we'll also get into why that becomes even more relevant as we look at an accelerated settlement cycle.

Jack: So is it fair to say that the confirmation affirmation process is very much around trying to increase the likelihood of settlement? But I think it's also to highlight that an affirmed confirmation, if you like, doesn't equal settlement.

Paul: Yeah. It's a great point, Jack, 100%. The settlement process is still that we receive instruction from a client to settle, right. We will present that into the market, but we still do all of the position check, the cash check. That whole process still has to happen regardless if the, if the trade is affirmed or not. So that is a, that is a great point. And again, in the models that we've described, we can actually do some of that on your behalf.

Paul: ... we can help you with settlement instruction. We can actually run the, the position and credit check as that needs to go, yeah.

Jack: Okay, perfect. Maybe we can jump into that a little bit later in the discussion.

That’s helpful to sort of understand the process and how various parts of that process fit together. But if we'd sort of shift now into a T+1 environment, in terms of the industry discussions around this, the, the industry is aligned behind kind of new best practices and cutoffs for T1.

So, allocations are going to be at 7:00 PM on trade date. And then affirmations by 9:00 PM on trade date. They're the kind of best practices out there in the industry.

The SEC in the proposed rule doesn't go into those sort of time periods per se, but what the SEC is doing is they're proposing same-day allocation confirms and affirms through its proposed exchange at rule 15C6-2, which applies to the broker dealers.

And then it's also got its proposed rule 204-2, which applies to the investment advisors. As we've talked earlier that the SEC has yet to publish the final rules. But we, we do expect them to still push for this, this same day confirm allocation and affirmation process in one way or another.

So  Enza, perhaps you could just sort of give us a bit of info around what you think this same day allocation confirm affirmation process will mean for the broker dealer sides of the industry and our clients.

Enza: Sure, Jack. And, and as you said, I think this is one of the areas where we're saying, okay, we don't know what the final rule will look like. But we're really starting to focus on and think about with what we know, what's out there right now, how are we thinking about if things are proposed to be done on T?

So what does that mean? What are we looking at as a broker and what, what do we think clients should really start thinking about? It's, well, think about what it means to do all of that, right? Receive your confirmation, provide your allocation, and provide an affirmation all on T in the US time zone.

And that's really the biggest thing. So that means that a client will need to send their broker their allocation, the broker will need to send the confirmation, and the client will need to affirm on that confirmation all on T.

For any client that is in a different region, that is two, three, six, 10, 12 hours ahead of the US market where they're already into the next day, this is really something that needs to be considered and thought about. How to functionally adhere or send information on T.

Now in terms of affirmation, we also just wanted to make, make a distinction because there are some clients that are on electronic platforms when they allocate their transactions. So there are some platforms, consider CTM where you send something electronically and the client and the broker match trade details electronically on T.

That is actually just an allocation process. When we talk about affirmation in this context, it is the affirmation and the acknowledgement officially of the trade details off of the broker's confirm. So it's after the confirmation is sent where you officially affirm back.

We also just wanted to touch on the fact that there are a couple of ways that you can affirm. Either electronically, through Trade Suite, or if you don't have electronic confirmation, you can provide a paper confirm. But the impact of not using an electronic confirmation goes back to some of the things that we were discussing earlier. You can miss the CNS deadline. It takes a lot longer. You can miss these deadlines that are being discussed and proposed.

So really, it delays the potential of identifying a problem and could potentially be more costly to do it in that paper confirm fashion. So we really are looking at, what does it look like to do things on T. And we're, we're posing that clients think about, what does that mean for you in where you're based and what your time zone is? And what are some options for you to potentially use or become more electronified or potentially have coverage in different areas so you can meet or adhere to those new deadlines.

Jack: So it sounds, it sounds like there needs to be a, an increased focus, if you like, on the kind of automation across, across the industry end to end. Paul perhaps you could sort of give a bit of a view as well from your side.

Paul: Well, you know what, I think Enza said it really, really well. I mean, there's not a whole lot I would add except, as you switch over from where we leave off at the broker and you pick up from the custodian and that whole affirm model and what we're doing on your behalf.

So selfishly, a custodian's ask is, hey, get me your settlement as early as you can. Right? The more we can get in on, on trade date in the T+1 environment, the better off we're going to be. It may be more cost effective, both just for the industry but also directly to the client, depending on how transaction charges are managed.

But it also then does give us an opportunity to fix anything before we're running up against the T+1 deadline. If everything's coming in on T+1 and it's not in good order, we have much less time now to actually get it repaired before we're actually crossing threshold and now we're failing settlement.

So I think, you know, that's really the big, the big issue. And then I guess the only one I would kind of come back on quickly, Enza was mentioning Trade Suite. I know we've heard an uptick in this new program that the DTCC has available, which is Match to Instruct. So again, this is something that J.P. Morgan will be looking at to identify if this is going to increase or improve. It has a lot to do with, with the way the rule change is actually gonna be finalized. Can the DTCC actually fulfill some of the obligations that either the broker may have or the client may have.

And until those rules clarify, I'm not sure we're gonna get complete.. We want to have that ascertained. But I think, um, there's been a lot of interest lately that we've seen with, where this goes. And again, Jack, I think time is gonna be limiting here on, on how much we can really go into on, on how the program works.

But at, but at 100,000 feet basically it's the confirmation and the affirmation process are happening at the Trade Suite level within the DTC, and then they are notifying the custodian about the settlement or the result of the affirmed confirmation.

So it's happening earlier in the stage and as a result, we think that means that the settlement instruction has a much higher chance of getting to us from an earlier perspective. I'll leave it there unless Enza, unless you think I've missed something that was key on that.

Enza: Yeah. So the one thing I would just add, Paul, definitely to really highlight. Jack, you summarized this as well. The real focus here and what we, we are considering and what we propose clients are considering is leveraging tools that are electronic will really help in the overall process. And really thinking about what is out there, what are you leveraging today, what are the other tools.

So from a broker side, we're already using things like FIX. We are looking at M2I as one of the other solutions. So it's, what's out there that will make the process most efficient and help us to do things as quickly and accurately as possible on T.

Jack: That makes sense. And I think, I suppose there's, there's something here for our clients to just think through the different models, think through the different methods of automation, and we're open to having conversations with clients about what model works best for them but it's a sort of two-way conversation if you like around what works for the nuances of different clients if that, that makes sense. That's how I, how I see it.

Paul: Yeah. And I think that's right, Jack. I think there's so many different iterations you can run through with the way our clients interact today. There may just be the need and I think that's something we need to key up on as we go-

Jack: Yeah.

Paul: ... through this, uh, over the next few months.

Jack: Great. Okay, thank you. So I just wanted to go into something I think Enza you mentioned, the time zone side of things. And I think one of the largest concerns for our clients who have domiciled outside the US is their ability to meet US eastern time cutoffs and things here.

Paul, if I could turn to you. What does a client, in your view, that's maybe in plus six or eight or 12 hours ahead of the US, need to do for the moment, or need to think about, um, to sort of manage some of these changes?

Paul: Yeah. (laughs) I wish I could give you a complete list of what you need to do.

Jack: (laughs)

Paul: And I think that's what clients are all after. Unfortunately, we don't quite have that yet. But we'll continue to work on trying to make some clarify for that.

But yeah. There's no doubt. I mean, if you're sitting in plus time zone from, from east coast, I could spend a lot of time on this Jack. But I think as I look at it, there's a couple of things clients should probably be thinking about now.

First, what are you trading today? How does your business model work today? Are you just doing some bilateral equity moves? Or maybe you're doing some repos, or maybe you've got stock loan and borrow issues that you have to consider. Or is there collateral concerns you may have? I mean, the list goes on and on.

All of those things are gonna have some implication in a T+1 environment based on how that needs to process through and then how that relates to these cutoff times being compressed.

The other key thing I think that's out there for our clients to think a bit about is, how do you do this today? Do you already have a trading desk that is US-based or at least is easier on the time zones? If not, and again, by the way, that is by no way- means me suggesting that clients should be looking to put boots on the ground here. That is, that is not the indication.

It just makes a difference about the way you trade today and how those trades end up into a settlement file. That's the part that needs to be thought through. So we have clients that have a whole different types of setups in terms of how they actually trade. I think that's a key thing that clients should probably be keyed up and thinking a bit about.

I guess from the custodian's perspective, Jack, just so that, that I'm clear. We don't see anything fundamentally changing like from settlements that are versus payment. Yes, it's being compressed by a day. But today, as you asked earlier about, affirm trade not being a settle trade. Our settlement process remains the same. We will still do position and cash checks just like we do on settlement date. That's the way the US model works today, we'll continue to do that.

So yes, you're funding a day earlier. But it's not that you have to be funded earlier from a standpoint of what goes in on settlement date is still what goes in on settlement date. That is still where our checks and balances would be kicking in.

So then the thought is, okay, well what's wrong then? Why is this such an implication? Well, clients need to be very careful about everything else that goes on in their accounts. That's where you run into some concerns. So for example, and just one example, what if you're using a cash sweep, right, and you're waiting to use your cash sweep proceeds to fund? Is that going to be done on time so that your cash is available so that you can actually transact your business? Right?

And there's a host of those, Jack, we could go through. Whether it's when do you run your FX's or are you using proceeds from a sale of a different market to be able to move on in the US market and now we've got a difference between T2 and T1. All these thoughts that start to kind of kick around I think is stuff that, that we really have to give some consideration to.

So from a pure, hey, you're doing T+1 settlement in the US, no, I don't think that that's the fundamental change. I think it's everything else that goes into the business book that really starts to make that concern and something that clients should think about.

And I'll pause there just, Enza, I don't know if you had anything that you wanted to add or, or Jack, if there's a follow on. But I think that kind of high level.

Enza: Yeah. Sorry, Paul. You know, I think you really covered all aspects. I really want to reiterate is at this point, there's a lot of unknowns. And there are so many nuances about where clients are and, and the way you are doing your business.

So the ask at this point is to really consider, as Paul was saying, all the aspects of your business. We're throwing out some ideas, some of the things that we are thinking about. How do we automate, what's the best way to automate depending on the activity you're doing, where are people located, can we leverage people in different locations, is there something that can be done with extended coverage?

These are the things that we are thinking about and giving, and offering people some thoughts on. However, certainly the ask at this point is for you to consider your business, those aspects, and see what might work best for you. And this will be an ongoing conversation for months to come as we prepare for this.

Jack: Yeah , I agree. I think another area of discussion out there is around the securities lending, and recall and cutoffs. I think from a J.P. Morgan perspective our securities lending team is engaged in the initiative and in the industry, involved in trade association discussions around for instance the, uh, I think the industry's aligning behind a best practice of, uh, 1159 is the cutoff on T for, for loan recalls.

I think that for this stage we're assessing the impacts of that and enhancing our processes in vendor integration essentially to support the changes. But I think like many of these topics, it's probably a topic in itself.

And, I, I was talking to the team and they plan to do a securities lending session similar to this perhaps, uh, in, in Q1 next year. So maybe a way for our colleagues in that group to go into more detail on the SEC lending aspect.

Okay so great. I mean, we've covered a fair amount here in this sort of last half hour or so. And there's definitely more conversations to be had in 2023 as we get into a bit more detail on some of these issues.

But before I finish off, Enza and Paul, I think it would be good maybe if you were able to maybe highlight some key actions or key points from today's discussion that, that you think our clients should maybe focus on right now or think about. Enza, maybe you go first?

Enza: Sure. As we said, we spoke about a lot. The main message if you come away with anything for today is, T+1 is coming in the US. There are a lot of open questions. However, there's a lot to really think about. So consider the things that we've put out there, think about what is your current framework, what you're doing today, and how you can leverage, or what changes would need to be done to comply with the rules as they're currently being proposed. And then certainly, keep an eye out as these things are ratified on what changes may be out there to the current proposals.

Jack: Thanks, and Paul?

Paul: Yeah, I mean, that pretty much nails it I guess. (laughing) The only thing I would, I would highlight is once these rules get clarified and we know what, what we're doing, and whenever that implementation timeline's gonna be I think the client, as we will be doing the same, the client needs to be thinking about test, test, test to make sure you're okay with anything that you think needs to change as a result. And obviously, J.P. Morgan stands by that to assist us any way that we can. So please, reach out to your client service reps or whatever that you're k- you're key contacts, if there's additional questions.

As you pointed out already, Jack, I think this is one of maybe several in a series of discussions or recordings we will be looking to do. Whether it's on combined effort broker, or in custody, or each of us independently. But I think we'll, we'll have more information coming out for sure over the coming months.

Jack: Great. Paul and Enza, thank you very much. I think it was a good discussion, and hopefully our clients listening will find it informative. Thanks everybody who's listening, and I think it's fair to say that T+1 in the U.S. is going to, uh, take up a fair amount of our time in 2023 (laughs).

Paul: (laughing)

Jack: And as Paul said, like, we're here to engage.

Paul: Yeah, for sure.

Jack: So yeah. Thanks, everyone.

Paul: Thanks, Jack..

Enza: Thanks.

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