As T+1 looms ever nearer, Alex Knight, head of EMEA at Baton Systems, delves into the effect of the shift on FX s
As T+1 looms ever nearer, Alex Knight, head of EMEA at Baton Systems, delves into the effect of the shift on FX swaps, highlighting the opportunities they hold for market participants, as well as further establishing the importance of more sophisticated settlement technology.
In the fast-paced world of capital markets, every fraction of a minute really does count. The next milestone in this journey is the move to T+1 settlement for US equities and bonds, set to take effect in May 2024. It is a long time coming, when you stop and think about it in the context of our daily lives – considering that Amazon now offers same-day delivery to consumers, how are certain areas of the wholesale financial services market infrastructure so archaic?
The shift to T+1 represents a quantum leap in the quest for faster and more efficient transactions. One of the primary catalysts behind this movement is the reduction of counterparty risk, alongside the natural desire for speed and agility. In a world where information travels at the speed of light and markets can swing in the blink of an eye, the ability to settle trades in the necessary currency within a single day becomes a strategic imperative – and not just for US cash equities and bonds.
Once T+1 comes into play, attentions will start turning to other asset classes. In FX, take the more esoteric world of swaps as a prime case in point. Intraday FX swaps unquestionably offer a level of precision and efficiency that could transform the way businesses handle their intraday cash flows. Standard FX swaps involve pairs of trades between two counterparties with cash flows in two different currencies, each with specified value dates, based off the same spot FX rate. But while these transactions provide flexibility, they lack a crucial element: a specific time of day for settlement. Intraday FX swaps introduce the concept of settling not just by date but also by the time of day, opening up new avenues for treasurers and intraday liquidity managers to optimise their funding positions throughout the trading day.
The allure of intraday FX swaps lies in their ability to enhance funding position management. Given the importance for banks to maintain the right level of funding in their nostro accounts right now, falling short can lead to expensive overdrafts. In addition, excessive holdings are wasteful, and can attract unwelcome attention from rule makers.
To address this challenge, market participants need the best possible visibility of their currency sources and obligations. Although even with visibility, positions fluctuate throughout the value date, requiring adjustments. Intraday FX swaps offer an attractive alternative to manage funding positions – instead of disrupting cash flows, banks can enter into a short-term arrangement to receive the currency they need, in exchange for one that they have in surplus and continue business as usual. Flexibility is key for bank treasury teams, and intraday FX swaps provide a valuable tool in their toolkit.
Traditionally, banks with a surplus or shortage in their nostro accounts tend to resort to overnight markets to borrow or lend funds. However, accessing overnight markets on short notice for intraday requirements can be inefficient or costly, particularly in the current interest rate environment. An intraday FX swap with a trading counterparty in the opposite position presents a straightforward solution.
As capital markets explore the creation of a marketplace for time-based intraday FX swaps, the requirement for fast, reliable and riskless settlement processes becomes an increasingly critical component. This is why firms should look to adopt more sophisticated settlement technology, that doesn’t require them to give up netting benefits, in order to overcome this issue. Market participants now have the opportunity to settle any currency pair at their chosen time, including immediate settlement, multiple times during the trading day so liquidity can be reused, all on a riskless Payment vs Payments (PvP) basis with legally enforceable settlement finality and full transparency.
Moreover, market participants, through the right platforms, can also extend the benefits of PvP settlement across any currency without limitation – allowing intraday swaps in less widely traded currencies or those with restricted liquidity to be settled with the same level of ease as the majors. Considering that the costs associated with overdrafts are higher for currencies that fall into the former category, and regulatory pressure to maintain appropriately funded nostro accounts is more pronounced, doing so offers clear advantages from an economic and compliance perspective.
The introduction of intraday FX swaps is certainly a significant step towards greater financial efficiency and risk management. At a time where consumers expect physical goods to arrive on their doorstep in a matter of hours, financial market participants are (quite understandably) increasingly demanding a similar level of immediacy. Intraday FX swaps are not just a new financial tool, they represent a reimagining for how market participants could more effectively manage currency risk and liquidity.
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