With the recent announcement that the U.S. will shorten the standard securities settlement cycle from “trade plus 2” (T+2) to “trade plus 1” (T+1), planning is underway for a coordinated Canadian transition. Given the integration of the Canadian and U.S. equities markets and cross-listing of large Canadian issuers, alignment of the settlement cycle for equities and debt securities is essential.
On the other hand, the need to align settlement cycles for trades in Canadian and U.S. investment funds requires further consideration.
As with the move to T+2 in 2017, the transition is being led by the Canadian Capital Markets Association (CCMA) with a proposed implementation date that will align with the U.S.’s effective date to move to T+1. The effective date in the U.S. was initially projected to be Q2 2024 but will potentially be Q3 2024 (Labour Day weekend). This remains uncertain until the SEC completes a review of its proposed rule amendment consultation. The Investment Funds Institute of Canada (IFIC) has supported this initiative through involvement in CCMA working committees.
U.S. mutual funds are not sold in Canada, and Canadian mutual funds are not sold in the U.S. The U.S. securities markets are much more liquid than Canada’s, which is why the U.S. mutual fund industry already settles on T+1. The U.S. has other factors that help funds meet liquidity needs, such as higher borrowing limits, advance notice of major mutual fund orders and inter-fund borrowing.
While the move to T+2 in 2017 seemed relatively straightforward, there were investment fund liquidity concerns. Funds with significant continued exposure to T+3 jurisdictions argued they would have trouble raising cash to satisfy redemptions by T+2. The CSA noted this concern and responded by providing appropriate exemptive relief. Due to the small exposure of the Canadian fund industry to T+3 securities of foreign jurisdictions, the number of funds that required exemptive relief was limited.
The move to T+1 would not be as straightforward because, unlike T+2, the European Union (EU) and the United Kingdom (U.K.) are not moving to T+1.
It should be noted that ETFs entail different considerations than mutual funds because, while their units typically trade intraday on exchanges, the funds also need to create and redeem baskets of portfolio securities from time to time.
To give a sense of the assets of Canadian mutual funds that will not be moving to T+1 along with Canada and the U.S., IFIC undertook an analysis of Canadian mutual fund assets. Our analysis* showed that there are 1,539 funds with greater than 10% exposure to jurisdictions that will not be moving to T+1. This is a staggering 46.3% of all Canadian funds. In terms of assets under management (AUM), with fund of funds double counting removed, $364.5 billion in AUM held by Canadian mutual fund managers or 19.2% of the total Canadian mutual fund AUM will be impacted.
The settlement cycle mismatch between the settlement of trades in portfolio securities and the settlement cycle of mutual fund orders that exists in the T+2 settlement cycle will be exacerbated by the move to T+1 for funds exposed to non-domestic and non-U.S. securities. Mandating a T+1 settlement cycle will require regulators to provide significant exemptive relief to address the liquidity problem.
On the other hand, some funds may wish to move to settle on T+1 instead of T+2, so that purchase proceeds can be received and invested more quickly. Also, do investment fund managers want different settlement cycles for different types of investment funds?
For dealers, the move to T+1 for funds holding Canadian or U.S. securities would reduce settlement risk and provide investors with increased investing opportunities.
There are no easy answers. Mandating a T+1 settlement cycle for investment funds would create consistency and reduce confusion for investors.
Still, given the absence of an overriding need to align Canadian and U.S. investment funds markets, allowing greater flexibility would permit funds to move to T+1 if and when the EU and the U.K. move to T+1 also. Perhaps a market-based solution for investment funds is the most viable option for the Canadian market.
Paul Bourque is president and CEO of the Investment Funds Institute of Canada.
* IFIC data analysis based on May 2022 data from IFIC, Investor Economics and Morningstar.