NEW YORK/LONDON, March 21 (Reuters) - The looming

introduction of a shorter settlement cycle for U.S. securities

is causing headaches for international fund managers, who face

staffing problems, the prospect of holding more cash and raised

foreign exchange risk as they prepare to comply.

Introduced to lessen the risks of unsettled trades after

periods of volatility, the coming change will see securities

transactions settle one business day after the trade, or T+1,

rather than two.

The move, which came after the 2021 plunge in GameStop ( GME )

, is due to take place on May 28 in the U.S.

However, it places the country at odds with much of the rest

of the world where the typical cycle is T+2. As a result, market

participants have been rethinking their processes to avoid

transaction failures and higher trading expenses, according to

custodians, traders and consultants.

"(The transition) is not going to be without its costs,"

said Ben Springett, head of European electronic and program

trading at Jefferies.

"You'd ... expect there to be a requirement for a greater

amount of cash balances in funds to bridge any potential gaps,

and cash mismatches," said Springett. "So, that will come at a

detriment to fund performance."

The Depository Trust & Clearing Corporation (DTCC), which

provides securities clearing and settlement in U.S. financial

markets, has been working to prepare with industry bodies

including the Investment Company Institute (ICI).

Tom Price, managing director and head of technology,

operations and business continuity at Securities Industry and

Financial Markets Association said that while T+1 was a

"complicated and complex initiative" there were "risk reduction

and operational benefits" for the industry.

RJ Rondini, director of securities operations at ICI said

that for the U.S. securities market, "the overall reduction in

capital far outweighs the actual absolute value of the increases

in risk in all of these other areas."

DTCC declined comment. A paper it published on Feb. 28 said

market participants must accelerate their preparations.

TRADING HOURS

The shortened cycle could cause operational challenges such

as potential dislocation in FX trades. Foreign investors have to

buy dollars to fund U.S. securities transactions.

Nathan Vurgest, director of trading at Record Financial

Group said he is looking at whether FX costs would increase if

more trades are done in the late U.S. period should liquidity

move away from the London morning.

The European Funds and Asset Management Association (EFAMA)

said earlier this month that faster U.S. settlement posed a

"systemic risk" to Europe, noting the very limited window that

non-U.S. market participants will have to access to CLS, the

world's largest multi-currency settlement system for FX trades.

According to EFAMA, asset managers trading up to the U.S.

close have just two hours to confirm those trades and submit

them to CLS. EFAMA members polled said they expected to have to

settle $50-70 billion of daily FX trades outside the safety of

CLS, leading to calls to extend the CLS cut-off time.

Jefferies' Springett said some non-U.S. participants were

weighing contingencies including setting up outposts in the U.S.

or working U.S. hours.

Shortening the cycle could have other knock-on effects such

as increasing demand for short-term financing. Typically, some

investors must wait to receive cash from one market before they

can buy securities in another, but those who sell international

securities to buy into the U.S. may find themselves with a cash

shortfall for a day.

This could increase the use of the overnight repurchase

agreements but shift credit risk - the danger that a

counterparty cannot pay its obligations on time and in full -

onto banks in that space, said Adam Watson, head of commercial

product for custody services at BNY Mellon.

"That is going to force portfolio managers to start thinking

about 'do I go to the overnight repo market, or ... are my

custodians able to extend me the credit overnight?'" said

Watson.

Custodians, safekeepers of client assets, typically provide

clients with short-term credit in the form of intraday

liquidity, and on an exceptional basis overnight funding, to

help settle across different systems and time zones.

But this type of lending is usually limited to the

processing of clients' securities or payment transactions and is

not generally committed, and is therefore not a guaranteed

extension of credit, Watson said.

KNOCK-ON EFFECTS

There could be other consequences. Global index funds such

as exchange-traded funds with a significant mix of assets having

mismatched settlement could also face disruption, managers said.

Steve Fenty, head of currency management at State Street

Global Markets, said that when there is disharmony across a

fund's settlement cycle and its underlying assets, managers

might consider splitting up settlement cycles between funds that

have a high proportion of U.S. assets underlying versus more

diversified global funds.

The change could also reduce liquidity in equities markets,

said Josh Galper, managing principal at capital markets

consultancy Finadium, as a shortened time frame in the U.S.

could decrease the time to recall securities that were loaned to

short sellers.

"It is often overlooked how much liquidity short selling and

securities lending delivers to equity markets," Galper said.

"It's the type of thing that you know it when its gone."