The move to T+3 Brett Kotze. T+3 Project Market Communication CONTEXT Global best practice - shorter...

The move to T+3

Brett Kotze

T+3 Project

Market CommunicationCONTEXT

Global best practice - shorter settlement cycles have been around for decades

Original G30 Recommendations (1989)

Recommendation VII

“All markets should adopt a rolling settlement system. Final settlement should occur no later than T+3.”

IOSCO Recommendations (2001)

Recommendation 3 – Settlement Cycles

“Rolling settlement should be adopted in all securities markets. Final settlement should occur no later than T+3. The benefits and costs of a settlement cycle shorter that T+3 should be evaluated.”

USA/UK/Europe moving to a T+2 settlement cycle

T+3 Project


Events surrounding the 2008 crisis have increased the spotlight on inefficiencies and inherent risk in post-trade processing

• DTCC Boston 2012 group study – cost benefit analysis supporting the move to T2• Europe’s Central Securities Depository Regulation (CSDR) – T2 mandate, financial penalties for

trades that fail to settle on time (implementation 2015)

This culminated in a drive by policy makers to reduce risk and increase clearing efficiency through even shorter settlement cycles (SCC):

The Lehman failure highlighted the importance of counterparty risk exposure

2001 and 2003 Giovannini reports on barriers to settlement and clearing efficiency were used as a basis for the debate

T+3 Project


Prior to the crisis, many markets had already settled on T3 since 1995. The JSE’s settlement cycle is notably out of step with global precedent (including emerging markets)

CCPs / Exchanges Settlement Cycle

Tel Aviv Stock Exchange (TASE) Israel, Kuwait Stock Exchange, Saudi Stock Exchange

T+0

Eurex – Eurex Clearing, HKEx – Hong Kong Stock Exchange, Bulgarian Stock Exchange, Ljubljana Stock Exchange (Slovenia)

T+2

LCH – LCH Clearnet, DTCC – The Depository Trust & Clearing Corporation, ASX – Australian Stock Exchange, TSX – Toronto Stock Exchange, BM&F Bovespa – Brazil Stock Exchange, Mexico, Oman Stock Market (MSM), Nasdaq

T+3 (moving to T+2)

JSE T+5

According to Thomas Murray, fail rates for most exchanges are between 2 and 8 percent

Source: Stock Exchange websites, Chevreux/Credit Agricole Markets Trading Guide 2012; Thomas Murray Sept 2006

T+3 Project


Source: Extracted from Thomas Murray White Paper, October 2006; FSB license renewal letter Nov 2012

The move to T+3 has been on the cards for many years and is now an FSB mandate

Thomas Murray findings in 2006:

South Africa should move to a T+3 settlement cycle even if it results in “some” failed trades.Global benchmarks would improve by moving to T+3 even if there are failsIt is the only area where South Africa does not meet the FTSE requirements for an Advanced Emerging Market*

FSB mandate November 2012 license renewal letter:

‘ . . .concerns were raised by the Licensing Committee regarding the continued delay in the implementation of the T+3 settlement cycle for equities as well as the perceived lack of prioritising the shortening of the settlement cycle. We request that the JSE do whatever is necessary to ensure the successful completion of this project.’

T+3 Project


Source: BCG (Oct 2012)

Why is a shorter settlement cycle relevant?

1. Exposure:

‘Client-side transactions between buy-side and brokers represent significant uncollateralised, unguaranteed exposure

The amount of this market risk depends on time and volatility and thus increases with longer settlement cycles’

2. Capital

CSDPs are starting to hold capital for exposures. Longer cycles mean more capital

3. Systemic Risk

Systemic risk increases when the magnitude of outstanding transactions increases (risk is based on number of outstanding transactions and the concentration)

T+3 Project


Source: BCG

(Oct 2012)

What are the benefits of reducing the JSE’s settlement cycle?

• Align to global best practice – comply with the FSB mandate

• Harmonisation across international markets

• Increased liquidity – faster reinvestment of assets that are released from the settlement process quicker

• Margin will be called earlier in the cycle

• Reducing the number of outstanding unsettled trades will:• reduce settlement exposure / credit risk

• reduce systemic risk

• improve efficiencies by causing participants to adapt and modify behaviours

The FSB has mandated the JSE to move to T3 settlement cycle – T3 is now a licensing requirement

T+3 Project


Source: Omgeo

(May 2012)

Does a shorter settlement cycle mean more failed trades?

According to Omgeo (global standard for PTS efficiency):

“The world-wide shift towards shorter settlement cycles will increase the number of failed trades, unless post-trade operational practices are adapted to reduce the period between trade execution and settlement. The most important change required is that market participants should affirm trades on the day the trade is executed, enabling both timely and accurate settlement.”

Custodian banks and their clients cite inaccurate settlement and account instruction (SI) data as the most significant reason for failure, followed by the deliberate failure to settle by counterparties and mismatches between cash and securities cycles.

The shorter settlement cycle does introduce the potential for failed trades, as less time is available for the resolution of any operational issues that may occur

T+3 Project


How will the JSE keep failed trades low?

Plans to reduce fails:• Further automation from trade execution to settlement –this includes going to real-time trade

confirmation on T – part of Phase 2 release

• Further automation across the market for Corporate Actions – part of phase 1 release

• Removal of inefficiencies with share removals between global and local markets – this has been the cause of all of failed trades since go-live of electronic settlement. This will be compounded when moving to T+3 as the settlement cycles will be the same as the global markets

• Increase Securities Lending & Borrowing liquidity – make more shares available for lending & borrowing to ensure settlement

• Preparing the market for the move to T+3

Behavioural change and efficient operations are vital to the process

Timeline: All Phases

Phase 1: Regulatory and Automation

Go-live: Weekend 20-22 July 2013

Phase 3: ECS and BDA T+3 Settlement Cycle

Go-live: As soon after Phase 2 go-live as possible(Functional requirements due Quarter 3 2013 to confirm timeline)

Phase 2: ECS go-live on T+5 Settlement Cycle

Go-live: H2 2014(Include Parallel Phase – ECS Technology Upgrade)

Phase 3 Market Consultation

T+3 will be the JSE’s top

priority project

Functions per phase

Releases

Phase 1 (Regulatory and Automation) Phase 2 (ECS Go-live T+5)

• Split Brokers Prop and Controlled

• Client Pledge (electronic pledge to 3rd parties)

• SLB Automation to CSDP’s

• Corporate Actions Automation to CSDP’s

• ECS (First Phase – replacement of the equities clearing & settlement system)

• Deal Management

• Prime Broking

• Technology Roadmap Upgrade (ECS)

Phase 3 (T+3 Implementation) Running in Parallel

• ECS (Second Phase – functional migration to T+3)

• Change from T+5 to T+3 Settlement

• Fails Management Automation

• Portfolio Moves

• Account Transfers

• FTP Automation

T+3 Settlement Cycle

Reducing the timeframe in which to conduct the existing processes and activities will result in quicker settlement.

On-market activities current versus future

Action Current Timings – T+5 Future Timings – T+3

Settlement Orders – non-controlled clients

T - Batch T - Real-time after allocations

Client Affirmation to CSDP/Rejection to broker

T+2 (12h00) T+1 (18h00)

Deemed Affirmation Client T+2 (12h00) T+1 (18h00)

Broker re-allocation T+2 (16h00) T+1 (18h00)

Client affirmation of re-allocation T+2 (16h00) T+1 (18h00)

Brokers nets T+2 (EOD) T+1 (EOD)

On-market activities current versus future (cont.)

Action Current Timings – T+5 Future Timings – T+3

Non-controlled client breach T+3 (12h00) T+2 (12h00)

Principal Assumption T+4 (12h00) T+2 (16h00)

Margining T+3 (EOD) T+1 (EOD)

Broker borrowing on Principal Assumption

T+4 (12h00 to 14h00) T+2 (16h00 to 18h00)

Settlement Authority SLB T+4 (14h00 to 16h00) T+3 (08h00 to 10h00)

Failed Trade/Rolling Of Settlement T+4 (16h00 to 18h00) T+3 (10h00 to 12h00)

Settlement T+5 T+3

General Corporate Action cycle

Declaration Date

RD – 13or earlier

Finalisation Date

RD - 8

Last Day to Trade

LDT

RD - 3

First Day to Trade with New

Entitlement

LDT + 1

RD - 2

Record Date&

Election Deadline Date

LDT + 3

Payment Date

Withdrawal Date (if applicable)

RD + 1

1 Day

LDT + 2

14h00

1 Day

Strate to send Pre-Advice

Security Entitlements Posted B.O.D

Cash Entitlements paid on receipt of Cash

10h00 Broker submits elections to CSD Participants

13h00Elections submitted to Strate (Projected Holdings if settlement has not taken place)

10h00 Matched ready for Settlement for same dayreturns

12h00 Event Eligibility Calculated (where settlement has taken place)

Amended elections may be submitted (if affected

by JSE fail trade/reverse substitution procedures).

15h00 Strate to send elections to TS

Corporate Actions activities

Action Current Timing - T+5 Future Timings - T+3

Declaration Date RD-15 RD-13 or earlier

Finalization Date RD-10 RD-8

LDT RD-5 RD-3

First day to trade new entitlement RD-4 RD-2

Election RD (13h00) RD (13h00)

RD RD RD

Payment Date RD+1 RD+1

Settlements for new entitlements RD+1 RD+1

Fails Management by JSE Settlement Authority

Primary

Securities Lending and Borrowing

Money Lending and Borrowing

Then

Rolling of Settlement:

If circumstances are correct

Then

Failed Trade:

Retransactions

Compensation

For Failed Trade procedures we need to find opposite transactions

Failed Trade procedures

Cycle Overview

T T+1 T+2 T+3

Settlement ordersNon-controlled

EOD T+1 Brokers and Controlled

clients nets

Voluntary Reverse Substitution

16h00 T+2 Compulsory Reverse Substitution

Fails Management

Status Updates

T T+1 T+2 T+3

Settlement ordersNon-controlled

EOD T+1 Brokers and Controlled

clients nets

Voluntary Reverse Substitution

16h00 T+2 Compulsory Reverse Substitution

Fails ManagementCommits by CSDP

Back-to-Back linksMT598-103 – same settlement cycleMT598-104 – future settlement cycle

Equities Clearing System (ECS)

Updates from Strate for links MT598-103: MT598-104

Failed Trade procedures Look for a terminating transaction:

Equal and opposite; then Highest to lowest

Look for a non-terminating transaction with least impact: Account transfers Portfolio move Collateral SLB return Off-market

Then Equal and opposite; then Highest to lowest

Fractions and Spreadsheets

Raised in 2009

CSDPs rejected

Recently approved at CSDP Forum

Investigating implementing before T+3 Phase III

Preferred option as previously agreed VWAP on LDT+1 less 10% (for market movements) used for fraction payment;

JSE to announce rate so everyone uses same rate; and

Surplus shares sold by participant / broker to cover pay out.

Spreadsheets will remain for IPO’s;

Excess Take Up; and

Dual listed companies where home Exchanges regulations prevail.

Migration

W T F C M T W T F M T

T T+1 T+2 O T+3 T+4 T+5

T T+1 N T+2 T+3 T+4 T+5

T V T+1 T+2 T+3 T+4 T+5

E T T+1 T+2 T+3 CA

R T T+1 T+2 T+3 CA

S T T+1 T+2 T+3

I T T+1 T+2 T+3

O T T+1 T+2

NLDT RD/RD PD/PD

Migration Assumptions

Limit amount of Corporate Actions (including IPO’s/private placements) if possible.

Move to a RD-3 LDT date – no LDT on Friday of conversion

Jobbing across settlement days – warn members about SLBs and funding for a

period of time

Resources will be available across the market for 2 weeks after go-live to manage

issues

Migration will not take place over a month end

Migration will not take place over a futures close out

Actions

Market education on conversion process and requirements

Securities Lending & Borrowing

Rolling Of Settlement

Off-market timelines may be moved to facilitate settlement with no penalties

T+3 Phase 3 Way forward

• Completion of the CSDPs / Strate / Clients impact analysis

• Alignment of the development timelines

• Alignment of the Testing timelines

• Achievement of the agreed project milestones, as agreed with the market

• Strate, CSDP, Fund Managers and member participation in testing

• Successful close-out of all planned testing cycles – including migration testing

• Successful close-out of the documented Issue list to T+3 migration

• Training and embedding of the revised processes

Overview of the proposed T+3 Education & Awareness Strategy

• It is proposed that the Education & Awareness effort for T+3 is focussed not only on driving an understanding of the T+3 project, but also on providing a broader explanation of the workings of the equities market

T+3 Education Focus

T+3 Education focus – A review of the AS-IS vs. TO-BE trade life-cycle

REVIEW OF THE VARIOUS ROLE-PLAYERS IN THE SETTLEMENT PROCESS (and their respective responsibilities)

REVIEW OF SPECIFIC CONTENT AREAS APPLICABLE TO THE TRADE LIFE-CYCLE

REVISITATION OF THE AS-IS TRADE LIFE-CYCLE (with specific focus on the settlement process)

Explanation of the T+3

impact

T+3 Education focus – explanation of specific content areas





impact

Themes Settlement Phase

Content Areas to be

revisited

Dematerialisation Pre-tradePre-Allocation Pre-tradeEncourage more lending Pre-trade

Borrowers must make their intentions known to the lender before borrowing Pre-trade

JSE Rules: pre-trade Requirement Pre-tradeThe process of removals and the impact on settlement Pre-tradeUpdate of JSE listings requirements Pre-tradeChanges to off- market transactions & dependencies to on-market Pre-trade / Post trade

Changes to timelines for settlement, activities and their involvement Post trade

JSE as lender of last resort Post tradeMessage standards deployed in S.A Pre-trade / post-trade / post settlementCorporate Actions events, procedures & processes Pre-trade / post-trade / post settlement

Corporate Actions entitlement Pre-trade / post-trade / post settlement

Updated JSE and Strate rules and directives All

T+3 Education focus – role players involved in the settlement process





impact

DIRECT MARKET

PARTICIPANTSWhat do they contribute to

the settlement cycle?Post

SettlementWho owns the

relationship with the participant?

How are they impacted by the

move to T+3?

Topics of interest to them as part of their

roleMechanism for

message distribution

CSDPs

1) Custody of clients assets:- Non-controlled clients- Brokers nominee- Broker accounts proprietary2) Commit to transactions3) Finality of commit4) Settlement at account level5) Beneficial ownership for non-controlled clients

Corporate Action

processing

Strate and JSE 1) Shortened Settlement cycle2) Shortened Corporate Action cycle3) Automation4) Process

1) Shortened Settlement cycle2) Shortened Corporate Action cycle3) Automation4) Process

1) Workshops2) BRS and FRS

Brokers

1) Execution of trades2) Deal management - allocations and trade confirmations3) Settlement obligation4) Custody of assets:- Controlled Clients- Proprietary holdings5) Borrowers of securities6) Fails management7) Owns relationship with clients - non-controlled and controlled - from a trading perspective

Corporate Action

processing

JSE 1) Shortened Settlement cycle2) Shortened Corporate Action cycle3) Automation4) Process

1) Shortened Settlement cycle2) Shortened Corporate Action cycle3) Automation4) Process

1) Workshops2) BRS and FRS

T+3 Education focus – role players involved in the settlement process (cont.)

Agreed actions

• Securities Lending Association of South Africa (SASLA):

• Creating paraphernalia for Securities lending and borrowing in South Africa

• Creating paraphernalia for Corporate Action impacts on securities lending and borrowing

• Creating paraphernalia for Dividend Withholding Tax on securities lending and borrowing

• Workshops (global and local) with existing and potentially new lenders:

o To encourage more lenders

o To educate on above – corporate actions, etc.

• Workshops for foreign clients:

o Discuss removals and borrowing shares to ensure settlement

Agreed actions (cont.)

• Transfer Secretaries:

• Document the removal process per country

• Consider further automation around the removals

• Workshops / meetings with foreign Transfer Secretaries :

o Educate on the move to T+3 – explain what the impact would be if there are delays with the removals

o Automation around the removals

• Issuers :

• Discussions with regards to freezing of registers

• Educate issuers (local and global) on the move to T+3

• Updates on changes to JSE Listing Requirements

• Updates on changes to Strate’s Rules and Directives relating to Issuers

Agreed actions (cont.)

• National Markets Practice Group (NMPG):

• Document the local ISO 15022 standards on SMPG

• Encourage more automation using ISO 15022 / 20022

• Strate:

• Provide an overview of changes to Strate’s Rules and Directives

• Document all Corporate Actions processes for South Africa :

o Retail - a dummies guide

o Institutional – ISO15022 automation

• JSE:

• Provide an overview of changes to the JSE’s Rules and Directives

• Provide an overview of changes to the JSE’s Listing Requirements

• Document Settlement Obligations for clients and members

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