By Scott Gold, Head of Sales, Americas at BidFX (an SGX company)

The impending shortening of the settlement cycle for US equities and bonds has sparked considerable concern among asset managers worldwide. As the May 2024 deadline looms closer, the focus on linking FX trading to equities during the critical 4pm to 6pm US trading session has intensified. This presents major challenges for asset managers around the globe but particularly ones with no US trading desk (mainly located throughout the Asia Pacific region).

The first hurdle involves executing FX trades during the 4pm to 6pm window. While the notion of executing estimated FX exposures during liquid hours seems feasible, it can realistically only account for around 80% of the required trading and will incur additional costs. The remaining 20%, commonly referred to as true-ups present a significant challenge. The period between 4pm and 6pm NY is particularly problematic, with liquidity constraints impacting spreads and depth of book, in turn creating a tough environment for traders. There are very few markets open during these hours and the restart of investment banks’ FX pricing engines at 5pm creates a liquidity gap, making trading during this timeframe less attractive and more costly.

One of the main challenges will arise from the unpredictability of FX exposures, particularly for asset managers with non-USD funds scattered across Asia. These firms will have to consider pre-funding – which involves setting aside cash to cover FX trades, primarily during liquid hours when spreads are tighter. However, this also poses its own set of challenges and costs as asset managers will be forced to trade FX one day prior to their equity trades in order to pre-fund their accounts. This hampers effective decision-making and requires traders to work night shifts or take immediate action upon arriving at the office in the NY morning.

As the industry grapples with these challenges, trying to find possible solutions is imperative given that T+1 is just around the corner. One approach involves automating overnight FX exposures through the establishment of pre-trade rules, from Order Management Systems (OMS) through to Execution Management Systems (EMS) and ultimately to the market for execution. This ensures that trades are executed during liquid time horizons and minimizes the need for manual intervention. Asset managers can then focus on refining trading strategies and analyzing data to optimize their automation.

However this presents an issue in that legacy execution management systems often lack the necessary automation capabilities, hindering asset managers from efficiently navigating the new settlement landscape. This is why asset managers are increasingly looking for quicker ways to check their overnight orders. Mobile applications for instance, when configured for view only purposes, can provide asset managers with peace of mind without the need for midnight logins.

In addition, a reliable composite data feed, based only on tradeable prices is essential for creating a fair market benchmark. This benchmark aids asset managers in assessing spreads during the critical 4pm to 6pm window, offering insights into the potential impact on FX costs. Liquidity Provision Analytics, commonly referred to as LPA, becomes paramount in answering questions about currency pair spreads and identifying optimal times for pre-funding, especially in emerging market countries where it is critical to understand your liquidity profile to reduce costs.

The shift to T+1 settlement for US equities and bonds unquestionably introduces complex FX challenges for asset managers, particularly those in the Asia Pacific region without US-based desks. Navigating the 4pm to 6pm trading window and addressing issues related to pre-funding requires new thinking, and likely new technology partners. How investment managers ultimately use available and new technology tools for greater automation, rules-based trading, and more comprehensive data analysis will be key. As the deadline approaches, the industry must embrace a new way of thinking to ensure a smooth transition and maintain effective FX trading strategies.