TMX POV - T+1 Settlement in Canada, the quest for Groundhog day

Canada will transition to a T+1 settlement environment on May 27, 2024, one day before US markets. Any shortening of a transaction lifecycle inherently requires process and automation improvements to realise efficiency benefits. Consistency and predictability on a daily basis are key tenets to achieving this goal and building in resilience to deal with unexpected challenges. In T+1, more than any settlement compression to date, we ideally are looking to create a "Groundhog day" scenario, like the movie of the same name. This scenario will involve nearly identical morning, afternoon and evening routines – repeating again the next day. Any deviation of a predictable pattern will apply pressure to ensure that there is smooth and managed workflow coordination across the industry within a more tightened timeline.

Settlement cycle compression (from T+5 to T+3, to T+2) has been well co-ordinated and successfully implemented within the Canadian market. In each case, the market (and by extension each player in the settlements ecosystem) ‘loses a day' to process data, run reports, and reconcile records. This daily processing includes ensuring funding is in place, making sure the right securities are at the right location for settlement, and addressing a host of other challenges. In the Canadian market, some asset classes already settle on a T+0 basis. The majority of asset classes, however, both in terms of value and systemic importance, do not – and instead settle efficiently with an average annual fail rate of between 1.5% - 3%. In fact, the move from T+3 to T+2 dramatically reduced fail rates as more automation and co-ordination in the market ensued. This is an important point to consider - once a change, to the settlement cycle or otherwise, becomes business as usual, things eventually get much better.

The connected ecosystem of the post-trade capital markets means that knock-on effects of any deviation of an automated "business as usual" process grows into sharper focus. The day of settlement should ideally look identical in most cases. However, the run-up to settlement day differs between T+1 and other cycles due to the ‘lost day' in T+1. This extra day is often used to ensure everything is in place for the next day's settlement, allowing for most settlement days to look like each other. The lost day activities were crucial, especially if there was a problem in securing funding or making sure the securities required for settlement had been delivered, loaned or borrowed as necessary. Compounding matters is that most firms rely heavily on extensive batch processes for reconciliation, reporting and ensuring a smooth next step in the settlement cycle. The move from T+3 to T+2 still allowed a day to resolve outstanding issues, but it required up to 33% more precision in automation and processes (effectively one lost day out of three). In sharper contrast, moving from T+2 to T+1 not only loses that extra day but also requires up to 50% more automation and precision (one less day out of two), without an additional day (a reduction of approximately 19 hours to 4) to address issues. This cycle compression highlights the challenge of ensuring resiliency for all participants in the connected market ecosystem, as many are already moving towards real-time continuous batch processing in anticipation of needing each day to operate like the day that came before.

In January, 2024, TMX Group collaborated with the Value Exchange to survey the Canadian market, and we found that substantial progress had been made since the transition to a T+1 settlement cycle was announced. Upwards of three-quarters of the industry considered themselves to be ready, or on the path to readiness, with custodians and broker-dealers in the high 80-90th percentiles of readiness. This mirrored achievements in important metrics like trade matching by 3:59 AM on trade date. The unknown factor in Canada is likely to be the impact of limited engagement of smaller firms to date. Lastly, industry testing within CDS and the connected market ecosystem has continued, yielding positive results. So far, so good.

Overall, the industry has coordinated as well as could be expected given the relatively short timeframe (for an industry project) to implement a T+1 settlement cycle. Predictably, not all automation efforts have been completed, with 43% of the industry relying on automation versus 87% focusing more on process transformation, and approximately a third of in-flight projects expecting to complete after the T+1 transition. It is fair to acknowledge that the lost day is probably the biggest challenge in achieving the ‘Groundhog Day' scenario for settlements. The industry has highlighted a number of key issues which the lost day mitigated:

• Matching, and allocations, with the buy-side, by 3:59 AM on T+1 in Canada, provide somewhat a of a reprieve compared to our US counterparts, who have a same-day, end-of-day cut-off
• FX funding, typically aligned with a T+2 settlement cycle, now has an asymmetry which will require innovative solutions to realign
• Securities lending recalls in Canada have been manual to-date; the lost day was used to escalate emails and phone calls to ensure securities could be recalled in time for settlements
• The creation and redemption of ETFs, which often rely on the lost day, also now faces an asymmetry, much like FX.

The fail rate, anticipated to be approximately 4.1% (per the Value Exchange survey from January, 2024) remains likely to be the most important indicator to monitor. Reliance on manual operations post-T+1 transition is a cause for concern; survey results indicated that 36-51% of exceptions are handled through phone calls and emails. Working to automate as much as possible post-T+1 transition, therefore, should remain a top priority. TMX is fully committed to supporting the market in various ways in the short, medium, and long term. The replacement of the current depository, clearing, and settlement system at CDS is in its final stretch of testing, with the intent of going live subsequent to the T+1 transition, and will further automate back-end processes. In addition, TMX Group and our affiliates are building several notable ancillary initiatives:

• TMX Recalls Hub has been specifically established to automate securities lending recalls in the Canadian market in response to T+1, and is intended to go live over the summer of 2024
• The Canadian Collateral Management Service (CCMS), jointly offered by TMX Group and Clearstream, is now live, and its T+0 and unlimited substitution mechanism will be a key enabler in meeting trade and settlement obligations across fixed income and equities
• Continued market socialisation of matching solutions, post-T+1 transition
• Investigation of innovative new solutions to provide more automated and predictive capabilities within the market to provide the market options in order to meet settlement obligations before they fail.

TMX Group is committed to reducing risk, improving efficiencies, and delivering market driven solutions in collaboration with the post-trade industry, and will continue to promote collaborative improvements with and across our participant and stakeholder ecosystem, both in the context of the T+1 transition and into the future.

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