19 March 2018
Gary Wright

Gary Wright

Gary Wright - BISS Research

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The Cost of FX in T plus 2

16 November 2012  |  3554 views  |  2

T+2 settlement looks like it’s on its way to a market near you in the next few years and although I accept that in many markets its not much of a problem in some financial instruments in domestic markets, the problems intensify considerably for cross-border investing.

It’s not really a Eurozone issue, as we all know that London is the biggest international financial market in the world and already transacts a massive amount of euro settlements and trades. As the Eurozone looks to work its way out of the current economic climate, the key will be to attract foreign investment and that inevitably will entail foreign exchange (FX) dealing to cover risk exposures.

Arguably, there is less FX trading today than of yesteryear, simply because of the introduction of the Euro. However, in reality since the Eurozone was created, there has actually been a massive growth in international trade around the world, especially with the introduction electronic trading or should I say gambling, on miniscule currency movements, which has introduced greater levels of volatility.

Against this backdrop, a shortened settlement cycle in securities, of T+2, looks to me like this will cause an increase in FX dealing for cross-border international investors. Increased FX dealing to cover T+2 positions and settlements in the securities world will surely increase risks and costs, if FX settlements do not marry up exactly to the underlying securities transactions.

Indeed, failure to settle on the contracted date in the securities market will create increased risks and costs through exposure of the FX transaction. To eliminate risks and costs for both securities and FX the two must operate in tandem.

Today, the securities settlement structure in Europe but also internationally, is a hotch potch of disparate clearing and settlement processes and organisations, leaving contracted date settlements difficult, expensive and risky at best. At worst, impossible for various reasons and therefore significantly increasing costs and risks for the unfortunate investor.

Moving to T+2 on paper looks a reasonable step, certainly from a counterparty risk reduction aspect. But in reality we may see the risks switched from counterparty risk into settlement failures with a potential huge escalation in overall risks, in both the securities and FX markets.

There will be penalties for not settling on the contracted date in the securities market via a buying in process. This is the most expensive form of covering failed settlements and ultimately the costs will be passed back to the investor. So the investor is going to be paying through-the-nose for the a change  that is ill advised and has a single risk focus, whilst the overall risks and costs of which I have described boundlessly increase.     

TagsTrade executionRisk & regulation

Comments: (3)

Dave Grace
Dave Grace - Capco - London | 16 November, 2012, 13:59 Interesting view and one I had not really considered. I would have assumed this to have little real impact on fx settlement for a few reasons. Firstly fx spot settlement is already t+2 so see potential netting opportunities and transaction cost reduction. In the securities market specifically majority of volume is settled in currency but accept out of currency volumes are growing. The problem of failed settlement exists today both from cash management perspective as well as geographical timing issues and mechanisms in place such as credit lines and prerelease agreements to combat this. The issue appears to be the punitive penalty regime expected to follow but I would argue the same issues would apply in the current t+3 regime. As well as cp risk reduction t+2 sett should also drive greater settlement efficiency and behavioural change in conjunction with buy-in/ fine regime. Very thought provoking and worthy of more analysis certainly! Agree any costs picked up by end investors.
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Roy McPherson
Roy McPherson - Macroy Consulting - Maldon | 27 November, 2012, 09:14


I dont agree at all on this issue; the FX market and bullion market has functioned on 2 day settlement since way back and settlement issues do arise but with the stringent credit checks they are more often due to errors than lack of liquidity.The 2 days give all global players sufficient time to issue payment instructions irrespective of the location of the two counterparty's.  



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A Finextra member
A Finextra member | 27 November, 2012, 11:18

The concern comes from the retail market where there are masses of investors still certificated. In the UK this is about 10-20% of volume.Also there is still many issues arround trade confirmation where paper contracts are still used. We are not talking 21st Century here believe me. Its in the environment where FX deals will not work.Before measuring one market with another you must understand that not all markets operate the same all have different domestic structures laws and rules. So i still maintain that FX is going to be a big problem and a cost and risk

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CEO of B.I.S.S. Research, founder of the BISS Independent Accreditation for all systems and services provided to financial services companies internationally. Guest Lecturer at Reading University and...

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