trading, T+1 settlement | Fox Business

Tuesday’s move to next-day settlement for U.S. securities trading will force exchange-traded funds and market makers to juggle requirements and capital needs across multiple jurisdictions, market participants said.

U.S. trading will move to shorter-term settlement starting Tuesday, a move that regulators hope will reduce risk and improve efficiency in the world’s largest market but mean a temporary increase in trade failures for investors.

The biggest headache faced by many ETF issuers and their service providers is what happens when there is a “mismatch” between the settlement timeline of the ETF wrapper (the fund itself) trades and the settlement timeline of the ETF holdings traded outside the United States.

U.S.-listed ETFs are subject to new “T+1” settlement rules, but not all of their constituents face the same conditions. Meanwhile, European ETF issuers must wait two days for purchasers of their products to pay, but new orders for U.S.-traded ETF constituents take just one day to pay.

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John Hooson, managing director of ETF services at BBH, said asset managers running funds that include European assets would be primarily affected, as China and India have already accelerated their settlement periods and Canada, Mexico and Argentina also made the switch this week.

“The vast majority of ETF issuers are addressing this in some way.”

“Any such disruptions would need to be resolved by licensed providers posting additional collateral,” he added.

Authorized Providers, the market makers who buy or sell baskets of stocks in response to ETF orders, need to find ways to continue to create those ETF baskets in a timely and cost-effective manner or else their capital costs and short-term liquidity needs will increase.

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Todd Rosenbluth, head of ETF research at BettaFi, said time zone differences could put additional strain on the settlement process.

“We could see bid-ask spreads widen and liquidity dwindle as people try to address these mismatches,” Rosenbluth said, adding that he expects this to be a short-term challenge “that will work its way through the market over the course of a few weeks.”

Robert Humbert, global head of ETF products at BNY Mellon, the largest custodian and asset servicing firm, said about 30% of the order volume it manages is already settled on a T+1 basis and he expects that to rise to 70% when SEC-mandated rule changes take effect on Tuesday.

“Yes, the mismatch may be an issue for some, but on the flip side, T+1 is ultimately a more capital efficient process,” Humbert said, as market participants “only need to hold capital for one day instead of two.”

Both Hoosson and Humbert pointed to another area where ETF market participants will need to adjust: Currently, market makers manage their own inventory on a T+1 basis to create or redeem new ETF baskets on the old T+2 settlement cycle. The change means these liquidity providers will now have to move to T+0.

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But Humbert insists the industry is ready.

“We have been working with ETF issuers and their authorized participants over the past 12 months to resolve these issues,” he said.

Rosenbluth agreed, noting that asset managers “tend to be very good at getting ahead of known and expected events.”

(Reporting by Suzanne McGehee; Editing by Megan Davis and Chizu Nomiyama)