Impact of T+1 Move on ETF’s

Operational Challenges for Cross-Border ETF’s

A major challenge arises from the misalignment of settlement cycles. For example, while US-listed ETFs and their underlying US securities now settle on T+1, many international markets (e.g., Europe, Asia) remain on T+2. This can lead to increased settlement fails, as the ETF shares and the underlying securities do not settle simultaneously. The risk of failed trades is particularly acute for market makers and Authorised Participants (APs) who must deliver securities or cash within tighter timeframes.

Furthermore, this creates a timing mismatch when ETFs hold foreign securities, requiring Authorised Participants (APs) to bridge the gap—often by posting collateral until the underlying assets settle. This mismatch can increase funding requirements and operational complexity, particularly for ETFs with significant US exposure but domiciled in Europe or other T+2 jurisdictions.

Funding and Liquidity Strains

APs and market makers may face increased funding costs to manage the one-day gap between ETF share settlement and the settlement of underlying securities in markets still on T+2.

The one-day gap between ETF share settlement and the settlement of underlying assets can increase funding requirements for APs, potentially straining liquidity. ETFs may experience wider bid-ask spreads and premiums to net asset value (NAV), especially for those with cross-border holdings or during periods of market stress. This impact of one-day gap on higher premiums (the price above net asset value at which ETFs trade), has so far been modest (e.g., about 1.5 basis points increase in ETF premiums for some European ETFs with large US weightings).

FX and Operational Risks

The compressed settlement window creates challenges for foreign exchange (FX) transactions needed to buy or sell US securities, especially for international investors. The shortened settlement window compresses the time available for foreign exchange (FX) transactions, increasing operational risk and the potential for errors or missed deadlines. FX settlement is predominantly T+2, making it challenging to align cash flows for ETFs trading US securities on a T+1 basis.

Regulatory and Compliance Risks

European ETFs risk breaching UCITS rules on cash and overdraft limits due to the need to pre-fund US settlements or manage delayed receipts from T+2 markets. There is a risk of inadvertent breaches of regulatory limits, which can have compliance and reputational consequences for ETF issuers.

Market Structure and Liquidity Provider Risks

Market makers, who often borrow inventory to fulfil their roles, may face more frequent settlement fails and increased costs, potentially reducing their willingness to provide liquidity. This could result in lower trading volumes and less efficient price discovery during the transition period.

NAV Calculation Challenges for ETFs in a T+1 Operating Environment

T+1 settlement introduces significant NAV calculation challenges for ETFs, primarily due to timing mismatches, compressed FX and cash management windows, and increased operational risk. These factors can lead to NAV inaccuracies, greater reliance on estimates, and potential regulatory concerns, especially for cross-border and multi-asset ETFs

1. Timing Mismatches Between ETF Shares and Underlying Securities

• With T+1 settlement in the US and T+2 in many other markets (including Europe and Asia), the ETF’s portfolio may not be fully settled when the NAV is calculated. This creates a challenge in accurately reflecting the value of unsettled trades, especially for global or cross-listed ETFs.

2. Increased Complexity in Cash and FX Management

• The shortened settlement cycle compresses the window for FX transactions, which are still predominantly T+2. If an ETF needs to convert currencies for settlement, the timing gap can result in unsettled cash or FX positions at the NAV calculation point, complicating the determination of the fund’s true value.

3. Higher Risk of Operational Errors

• The compressed processing window leaves less time for trade matching, reconciliation, and exception handling. Any delays or errors in trade settlement or cash movements can lead to NAV inaccuracies, especially if manual processes are involved.

4. Potential for Overdrafts or Unfunded Positions

• If ETF creation/redemption orders are not settled in sync with underlying trades, there is a risk of overdrafts or unfunded positions. This can result in NAV misstatements or regulatory breaches, particularly for European ETFs subject to strict UCITS rules on cash and overdraft limits.

5. Valuation of Unsettled Trades

• ETFs may need to estimate the value of unsettled trades or use fair value pricing adjustments, introducing subjectivity and potential volatility into the NAV calculation. This is especially relevant when there are material unsettled positions due to cross-border settlement mismatches

No-Regret Actionable Steps for Firms to Resolve ETF T+1 Move Operational Challenges

ETF operators must invest in automation, enhance collateral and cash management, and collaborate across the industry to address the operational challenges posed by T+1 settlement. These steps are essential to maintain efficient ETF trading and reduce risk in the new settlement environment.

1. Automation and Technology Upgrades

• Implement automated trade matching, allocation, and confirmation systems to minimize manual intervention and reduce the risk of errors or delays.
• Upgrade legacy IT systems to handle compressed settlement windows and enable real-time processing.
• Accelerate the automation of ETF creation and redemption workflows, including trade matching, allocation, and reconciliation, to meet the tighter T+1 deadlines. Standardize processes and data protocols to reduce errors and exceptions.

2. Enhanced Collateral Management

• Develop and implement facilities for same-day collateral returns to minimize the opportunity cost for APs and market makers, reducing the capital held during settlement gaps.
• Establish pre-funding and collateral arrangements to bridge timing mismatches between ETF shares and underlying securities.
• The collateral challenge will persist as long as global settlement cycles remain misaligned. Full resolution will likely require more markets to move to T+1, aligning ETF share and underlying asset settlement cycles.

3. FX and Cash Flow Optimization

• Streamline FX processes to ensure timely execution and settlement, possibly by pre-funding FX trades or using netting solutions to reduce the number of transactions.
• Coordinate closely with custodians and FX providers to align cash flows with the new settlement cycle.
• Arrange credit lines or pre-funding mechanisms to ensure timely settlement of cash obligations, especially for redemptions where cash must be raised from foreign markets on a longer settlement cycle.

4. Industry Collaboration and Standardization

• Participate in industry initiatives and working groups to develop standardized solutions and best practices for T+1 settlement, particularly for cross-border ETFs.
• Share information and coordinate with counterparties, custodians, and clearinghouses to ensure smooth settlement across different markets.

5. Operational Resilience and Testing

• Conduct robust operational testing and scenario planning to identify and address potential bottlenecks or risks in the shortened settlement cycle.
• Establish contingency plans for settlement fails and ensure adequate resources for exception management.

IT and System Adjustments Needed for ETFs to Adapt to T+1 Settlement.

Firms are recommended to prioritise the following IT enhancements that are essential for ETF issuers, administrators, and market participants to operate efficiently and mitigate risks in a T+1 settlement environment.

1. Automation of Trade Processing and Reconciliation

• Implement straight-through processing (STP) to automate trade matching, allocation, confirmation, and reconciliation. This is critical because the post-trade processing window is significantly reduced under T+1, leaving minimal time for manual intervention or error correction.
• Enhance real-time exception handling systems to quickly identify and resolve discrepancies, reducing the risk of settlement fails.

2. Real-Time Position and Inventory Management

• Deploy tools for real-time position monitoring and automatic call time arrangements for securities lending and collateral management. This is especially important for ETFs with cross-border holdings and multi-listed instruments.
• Introduce automatic position realignment mechanisms to ensure that inventory is available for timely settlement and to minimize settlement mismatches.

3. Intraday Liquidity and Collateral Management

• Develop intraday liquidity pools and collateral management systems that can support same-day collateral returns, helping authorized participants and market makers bridge settlement gaps and reduce funding costs.
• Integrate systems for pre-funding and collateral posting that can operate efficiently within compressed timelines.

4. FX and Cash Flow Automation

• Automate FX trade execution and settlement processes to align with the shorter T+1 window, especially since FX markets may still operate on T+2 cycles.
• Synchronize cash flow management systems to ensure timely availability of funds for settlements across multiple time zones and markets.

5. Standardization and Data Synchronization

• Harmonize and standardize operational workflows and data protocols (e.g., MIC code and place of settlement) across all systems and counterparties to reduce exceptions and ensure consistency in settlement instructions.
• Upgrade systems to support multi-listed ETFs and ensure seamless communication between different clearing and settlement platforms.

6. Fund Administration and NAV Calculation

• Review and upgrade fund administration and transfer agent systems to accommodate faster NAV determination and share creation/redemption cycles, ensuring all mandatory tasks are completed within the compressed T+1 timeline.

Closing Remarks

There is a stark gap in automation and standardization between the primary market (ETF creation/redemption) and the secondary market (ETF trading). Legacy systems, often adapted from mutual funds, are not optimized for the speed and complexity required by T+1, exposing inefficiencies and increasing the risk of errors. The primary market for ETF shares does not always operate during the same hours as the secondary market. This complicates timely creation/redemption, especially for US-listed ETFs with international holdings or active management strategies.

In essence, T+1 settlement can improve ETF market efficiency over time but introduces new operational complexities and risks for the creation and redemption process, especially for cross-border products. Addressing these challenges requires investment in automation, standardization, liquidity management, and industry-wide collaboration to ensure the ETF ecosystem remains efficient and resilient.

Furthermore, in regions like the EU, the fragmented post-trade landscape—with multiple central securities depositories (CSDs), currencies, and trading hours—adds further logistical complexity to achieving timely and accurate settlement.

Let’s Start the Conversation

Onepoint is uniquely positioned to support ETF operators, asset managers, and market participants as they adapt to the operational, regulatory, and technological challenges introduced by the move to T+1 settlement in the UK and EU. Our integrated approach spans advisory, technology, and hands-on implementation, ensuring clients can manage risks, maintain compliance, and achieve operational efficiency in this new environment.

Advisory Services

• Assess the impact of T+1 settlement on clients’ existing ETF operations, with a focus on cross-border settlement mismatches, liquidity management, and regulatory compliance.
• Develop tailored strategies to mitigate risks associated with compressed settlement windows, such as funding gaps, FX misalignments, and NAV calculation complexities.
• Advise on regulatory requirements, including UCITS rules and cross-jurisdictional compliance, to prevent breaches related to cash and overdraft limits.

Technology Solutions

• Design and implement automation solutions for trade matching, allocation, and reconciliation to minimize manual intervention and reduce operational errors under T+1 constraints.
• Upgrade legacy IT systems to enable real-time processing, straight-through processing (STP), and robust exception handling, ensuring timely and accurate settlement.
• Deploy real-time position and inventory management tools, supporting efficient collateral management and intraday liquidity monitoring.
• Integrate FX and cash flow automation to align with shortened settlement cycles, reducing the risk of failed trades and funding mismatches.
• Standardize data protocols and workflows across systems and counterparties, enabling seamless communication and reducing settlement exceptions.

Implementation Support

• Lead end-to-end project management for T+1 transition initiatives, from gap analysis to solution deployment and post-implementation review.
• Collaborate with industry partners, custodians, and clearinghouses to implement standardized processes and best practices for cross-border ETF settlement.
• Conduct operational resilience testing and scenario planning to identify and mitigate potential bottlenecks or settlement risks in compressed timelines.
• Provide training and change management support to ensure internal teams are equipped to operate efficiently in the T+1 environment.

For further insights or to discuss how your institution can not only comply with the new T+1 requirements but also turn operational challenges into opportunities for efficiency and growth, please contact us.