Issuer Q&A with Vanguard

Patrick Hooper, Senior Capital Markets Specialist at Vanguard
Chris Baniewicz, ETF Capital Markets Specialist at Vanguard
Danielle Rutsky, Senior Product Manager, Nasdaq ETP Listings

What impact do you think the U.S.’s change to T+1 settlement will have on end investors?

Overall, we expect the move to T+1 will help improve market efficiencies that will positively impact end investors. Shortening settlement not only reduces the window for potential disruptions but also creates greater transparency and risk management for all parties involved. T+1 settlement aims to reduce counterparty risk, enhance liquidity, and improve capital efficiency within the market, all of which will contribute to better outcomes for investors.

How will the shift to T+1 affect different ETF asset classes?

The shift to T+1 in ETFs will occur simultaneously with other US securities. We expect the shift will streamline the settlement process for Equity and Fixed Income ETFs that have domestic holdings.

For US ETFs with international underlying securities, the shift can present challenges in the primary market as ETF settlement may not match the settlement of the underlying securities in other regions. This settlement mismatch can increase funding costs for APs which could be passed down to investors through slightly higher premium discount volatility or wider spreads for low volume products. While these costs can be impactful, it is important to understand that approximately 95% of all international ETF trading occurs in the secondary market and only a portion of ETF trading reaches the primary market where the additional costs could be present.

Although, the shift to T+1 could increase transaction costs for more thinly traded ETFs with international exposure, approximately three quarters of the trading volume in international ETFs are in the top 25 products which are unlikely to see a dramatic change in spread. So, on a volume-weighted basis, the increase in transaction costs for international ETFs is likely to be negligible.

How has Vanguard been working with the industry to try and solve for shortened settle in a T+1 world?

When the industry moves to T+1 the need for accelerated settlement will remain for certain ETF creation and redemption activity. Vanguard has been actively participating in industry working groups to prepare for this transition to minimize frictions for Authorized Participants (APs) and market makers that support ETF liquidity in hopes of reducing ETF transaction costs for end investors.

Currently, 10-15% of all activity leverages shortened settlement and we expect the same level of activity to continue when the industry shifts to T+1. We plan to offer T+0 settlement where feasible to provide flexibility for liquidity providers while protecting the interest of current investors in the fund.

Are there any other concerns that clients should be aware of?

Post-transition, clients should have minimal concerns but should have raised awareness. Some industry professionals argue that shortening the settlement cycle to T+1 could increase costs for investors dealing with US-based ETFs holding international assets, particularly due to the settlement mismatch between the ETF shares and the underlying portfolio assets. There is some validity to the idea that higher funding expenses, specifically as it relates to overnight collateral usage, can affect product spreads and premium/discount volatility. However, for investors transacting in the more liquid products, any additional costs should be negligible or non-existent. For clients transacting in less liquid products, some hurdles may exist but many of those can be mitigated by following ETF trading best practices and working with the issuer’s ETF Capital Markets desk.

For more information, please visit https://investor.vanguard.com/investment-products/etfs

This piece was published for use in the Nasdaq ETF Intel Newsletter. Subscribe here for more ETF content.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.