What Are the Critical Due Diligence Questions a Buy-Side Firm Should Ask Its Custodians regarding T+1 Readiness?

Concept

The Temporal Compression Imperative

The transition to a T+1 settlement cycle represents a fundamental re-architecting of the temporal and operational relationship between a buy-side firm and its custodian. This shift compresses the intricate ballet of post-trade processes ▴ affirmation, allocation, and settlement ▴ into a dramatically shortened window, transforming what was once a multi-day workflow into a high-velocity, intra-day series of obligations. The core of this challenge lies in the radical reduction of slack within the system. For decades, the T+2 cycle afforded a buffer, a period for manual intervention, error correction, and communication across time zones.

That buffer is now being systematically dismantled. Consequently, the due diligence process for selecting or reaffirming a custodian moves beyond a simple assessment of service-level agreements and fee structures. It becomes a forensic examination of the custodian’s technological prowess, operational resilience, and capacity for real-time data exchange. The central question is no longer merely “Can you settle my trades?” but rather “Is your operational and technological architecture capable of functioning as a near-real-time extension of my own, under conditions of significant temporal stress?”

This paradigm shift elevates the custodian from a service provider to a critical infrastructure partner. Their systems are no longer adjacent to the buy-side firm’s; they are deeply integrated, with data flowing between them in a continuous, high-stakes dialogue. A delay in one system creates an immediate and cascading liability in the other. A failure to affirm a trade by the new, unforgiving deadlines on trade date is not a minor operational hiccup; it is a direct threat to settlement, carrying with it the potential for financial penalties, reputational damage, and significant counterparty risk.

The due diligence process, therefore, must be approached with the rigor of a systems integration project. The buy-side firm must probe the custodian’s internal workflows, their API capabilities, their exception management protocols, and their staffing models with a level of granularity previously reserved for internal audits. The integrity of the entire investment lifecycle now depends on the seamless, high-speed functioning of this interconnected system, and any weakness in the custodial link of the chain jeopardizes the whole.

The move to T+1 transforms custodial due diligence from a periodic review into a critical stress test of a deeply integrated infrastructure partnership.

Recalibrating the Architecture of Trust

Trust in a T+1 environment is no longer built solely on long-standing relationships or the custodian’s brand reputation. It is forged in the crucible of verifiable, systemic competence. The conversations must pivot from qualitative assurances to quantitative evidence. A buy-side firm must demand to see the data ▴ affirmation rates benchmarked against the industry, detailed analytics on exception resolution times, and transparent reporting on system uptime and processing speeds.

The due diligence questions must be designed to penetrate the marketing gloss and reveal the hard-coded realities of the custodian’s platform. This involves a deep inquiry into the very architecture of their systems. Are they built on modern, API-driven microservices that allow for flexible, real-time communication, or are they monolithic legacy platforms that rely on slow, batch-based processing?

This recalibration of trust also extends to the human element. While automation is paramount in a T+1 world, the role of the custodian’s operational staff becomes even more critical, albeit in a different capacity. The focus shifts from manual data entry to expert exception management. The due diligence process must therefore include a thorough evaluation of the custodian’s support model.

When an automated process fails, how quickly can a knowledgeable human intervene? Are the support teams organized in a way that provides 24/7 coverage, particularly for firms operating across multiple time zones? Are they empowered to make decisions and resolve issues quickly, or are they bound by bureaucratic escalation procedures? The buy-side firm needs to understand the custodian’s “follow-the-sun” support capabilities and assess whether they have the expertise and authority to handle the complex, time-sensitive problems that will inevitably arise in a compressed settlement cycle. The new model of trust is a hybrid ▴ it is built on the verifiable performance of automated systems and the proven expertise of the human teams who manage them when they falter.

Strategy

Pillars of Custodial Assessment in a T+1 Regime

A strategic framework for evaluating a custodian’s T+1 readiness must be built upon four foundational pillars ▴ Operational Automation, Technological Integration, Liquidity and Funding Access, and Proactive Risk Management. These pillars provide a structured approach to move beyond a simple checklist and develop a holistic understanding of a custodian’s ability to perform under the new temporal constraints. Each pillar represents a critical dimension of the custodian’s capabilities, and a weakness in any one area can create significant vulnerabilities for the buy-side firm.

The objective is to assess not just the individual components of the custodian’s offering, but the systemic interplay between them. A highly automated trade processing system, for example, is of limited value if it is not seamlessly integrated with the buy-side firm’s own order management system, or if the custodian lacks the liquidity arrangements to manage settlement funding on a compressed timeline.

The assessment process under this framework is inherently comparative. It requires the buy-side firm to benchmark the custodian’s stated capabilities against both industry best practices and the firm’s own specific needs. A global macro fund with significant FX exposure will have a very different set of priorities than a domestic equity manager. The former will place a heavy emphasis on the custodian’s ability to handle cross-border settlements and manage currency-related funding requirements, while the latter may be more focused on the raw speed and efficiency of the domestic trade affirmation process.

The strategic framework allows for this customization, enabling the buy-side firm to assign different weights to each pillar based on its own unique operational footprint. The ultimate goal is to create a detailed, multi-dimensional scorecard for each custodian, providing a clear, data-driven basis for decision-making. This strategic approach elevates the due diligence process from a compliance exercise to a core component of the firm’s own risk management and operational strategy.

Operational Automation the Drive to Straight-Through Processing

The first pillar, Operational Automation, is the bedrock of T+1 readiness. The compression of the settlement cycle makes manual intervention a point of failure. A custodian’s commitment to Straight-Through Processing (STP) must be absolute and demonstrable. The due diligence process must dissect the custodian’s entire trade lifecycle, from trade capture to settlement, to identify any remaining pockets of manual processing.

This involves asking for detailed workflow diagrams, system process maps, and, most importantly, hard metrics. The buy-side firm should demand to see the custodian’s STP rates for each stage of the process, broken down by asset class and market. A custodian claiming to be “highly automated” should be able to substantiate that claim with data showing, for example, that 98% of its equity trade affirmations are processed without human intervention.

The inquiry must also extend to the custodian’s strategy for handling exceptions. In a T+1 environment, an exception is no longer a routine operational task; it is a critical incident that requires immediate attention. The due diligence should probe the custodian’s automated exception detection and routing capabilities. How quickly does the system identify a mismatch?

How is the exception routed to the correct team for resolution? What tools and analytics does the custodian provide to the buy-side firm to enable them to monitor and manage their own exceptions in real-time? The goal is to understand whether the custodian views exception management as a reactive, manual process or as a proactive, data-driven discipline. A truly T+1 ready custodian will have a sophisticated, automated workflow for managing exceptions, with clear escalation paths and a rich set of tools to provide transparency to its clients.

Technological Integration the API Economy Comes to Custody

The second pillar, Technological Integration, recognizes that the buy-side firm and the custodian are no longer separate entities operating at arm’s length. They are nodes in a single, interconnected network, and the quality of the connections between them is paramount. The due diligence process must therefore focus on the custodian’s Application Programming Interface (API) strategy. The era of relying on flat-file transfers and end-of-day batch reports is over.

In a T+1 world, the buy-side firm needs real-time, event-driven communication with its custodian. This means having access to a robust and well-documented set of APIs that allow for the seamless exchange of data on trade status, corporate actions, and cash projections.

The evaluation of a custodian’s API capabilities should be rigorous and technical. The buy-side firm’s technology team should be deeply involved in this part of the due diligence process. They should review the API documentation for clarity and completeness. They should assess the modernity of the technology stack.

Are the APIs based on modern RESTful principles, or are they legacy SOAP-based services? What are the authentication and security protocols? What are the stated performance metrics in terms of latency and uptime? The firm should also inquire about the custodian’s roadmap for future API development. A forward-thinking custodian will have a clear and ambitious plan for expanding its API offerings, reflecting a deep understanding that the future of custody is in open, programmable, and deeply integrated platforms.

In the T+1 regime, the quality of a custodian’s API is a direct proxy for its operational competence and future viability.

The following table provides a comparative analysis of custodial characteristics in a T+2 versus a T+1 environment, highlighting the strategic shifts required across the four pillars of assessment.

This strategic lens reveals that T+1 is not an incremental change. It is a catalyst that forces a complete rethinking of the custodial relationship, elevating it from a simple service provision to a deeply enmeshed technological and operational partnership. The due diligence process must evolve accordingly, becoming a more rigorous, data-driven, and strategically vital function for every buy-side institution.

Execution

The Operational Playbook

The execution of a T+1 due diligence strategy requires a granular, forensic examination of the custodian’s operational capabilities. This is not a high-level conversation; it is a deep dive into the specific workflows, deadlines, and exception handling procedures that form the backbone of the settlement process. The following questions are designed to serve as an operational playbook, providing a structured and comprehensive guide for buy-side firms to assess a custodian’s true state of readiness.

The questions are organized by functional area, reflecting the sequential nature of the trade lifecycle. A custodian’s inability to provide clear, detailed, and data-supported answers to these questions should be considered a significant red flag.

Trade Processing Affirmation and Allocation

The battle for T+1 is won or lost on trade date. The ability to affirm and allocate trades accurately and efficiently before the end of T+0 is the single most critical factor in ensuring a smooth settlement. This requires a seamless flow of information between the buy-side firm, the executing broker, and the custodian, facilitated by industry utilities like the DTCC’s CTM. The due diligence in this area must focus on the custodian’s level of integration with these utilities, their internal processing deadlines, and their ability to provide real-time transparency into the status of each trade.

• Central Trade Matching ▴ What is your level of integration with the DTCC’s CTM platform? Do you support real-time, API-based communication with CTM, or do you rely on batch file processing? What is your current CTM auto-affirmation rate, and how do you measure and report on it?
• Internal Deadlines ▴ What are your hard cutoff times for receiving affirmed trade details for different asset classes and markets? How are these deadlines enforced within your systems? What is the escalation process if a trade is not affirmed by your internal deadline?
• Exception Handling ▴ Describe your workflow for handling CTM exceptions (e.g. mismatched settlement instructions, incorrect quantities). Is this process automated? What tools do you provide for us to view, manage, and resolve exceptions in real-time? What is your average resolution time for common exception types?
• Transparency and Reporting ▴ What reporting and analytics do you provide on our trade affirmation and allocation performance? Can we see our affirmation rates by broker, by asset class, and by time of day? Are these reports available on-demand through a portal or API, or are they end-of-day reports?

Settlement and Clearing

Once a trade is affirmed, the focus shifts to the mechanics of settlement. In a T+1 environment, there is no room for error or delay in this process. The due diligence must scrutinize the custodian’s settlement infrastructure, their connectivity to market depositories, and their procedures for managing settlement fails. The buy-side firm needs to understand the custodian’s ability to not only process routine settlements but also to manage the complexities of partial settlements, corporate actions, and cross-border transactions in a compressed timeframe.

1. Settlement Infrastructure ▴ Describe your direct connectivity to the major central securities depositories (CSDs) like the DTCC. For international securities, do you use a network of sub-custodians? If so, how have you assessed their T+1 readiness?
2. Fail Management ▴ What is your current settlement fail rate? What are the primary causes of fails, and what steps are you taking to reduce them? Describe your process for notifying us of a potential or actual settlement fail. How do you support the resolution of fails, including the sourcing of securities for buy-ins?
3. Advanced Settlement Functionality ▴ Do your systems support functionalities like “Hold and Release” to give us more control over the timing of settlement? Do you support partial settlements? If so, how is this managed and reported?
4. Corporate Actions ▴ How has the move to T+1 impacted your processing of corporate actions, particularly those with ex-dates and record dates close to the trade date? Describe your process for identifying and communicating corporate action events on trades that have not yet settled.

Quantitative Modeling and Data Analysis

Qualitative answers are insufficient for T+1 due diligence. A buy-side firm must demand quantitative evidence of a custodian’s capabilities. This involves analyzing performance data, modeling the financial impact of potential failures, and establishing a baseline of key performance indicators (KPIs) against which the custodian will be measured.

A T+1 ready custodian should be able to provide this data readily and transparently. Their willingness and ability to engage in a data-driven conversation is, in itself, a critical due diligence signal.

Custodian Performance KPIs

The following table outlines a set of critical KPIs that a buy-side firm should use to evaluate a custodian’s T+1 readiness. The firm should request historical data for these KPIs and establish clear service-level agreement (SLA) targets for them going forward. The “Formula” column provides a clear definition for how each KPI is calculated, ensuring an objective and consistent basis for evaluation.

Modeling the Cost of Failure

To fully appreciate the importance of these KPIs, it is essential to model the financial impact of a settlement fail in a T+1 environment. A settlement fail is no longer a minor inconvenience; it is a direct cost to the firm. The costs can include overdraft fees, the cost of borrowing securities to cover the fail, and, in some cases, penalties imposed by regulators or counterparties.

The buy-side firm should work with the custodian to model these costs based on the custodian’s historical fail rates and the firm’s own trading patterns. This exercise will highlight the tangible economic value of a high-performing custodian and provide a strong justification for investing in the resources needed to conduct a thorough due diligence process.

Predictive Scenario Analysis

To bring the due diligence process to life, it is useful to conduct a predictive scenario analysis. This involves creating a detailed, narrative case study that walks through a realistic application of the due diligence questions. The following scenario involves a hypothetical buy-side firm, “Alpha Horizon Capital,” conducting a final round of due diligence on two competing custodians, “Apex Custody Services” and “Zenith Trust.”

The setting is a video conference. On one side is Sarah Jenkins, the COO of Alpha Horizon, and her head of operations, David Chen. On the other side are the relationship manager and the head of T+1 transition from Apex. Sarah begins, “Thank you for your time.

We’ve reviewed your proposal and your high-level presentation. Now we need to get into the specifics of your operational workflow. Let’s start with affirmation. Our prime broker matches the majority of our trades in CTM. Can you walk me through, in detail, what happens once a matched trade enters your system?”

The Apex team describes a highly automated process, emphasizing their real-time API connection to CTM. David Chen interjects, “You say it’s real-time. Can you quantify that? What’s the average latency from the moment a trade is affirmed in CTM to the moment it is reflected as ‘affirmed’ in your client portal?” The Apex team hesitates, promising to get back to him with the exact number.

David makes a note. “Let’s talk about exceptions,” he continues. “Last month, we had an issue where a block trade was allocated incorrectly by one of our brokers. It was a simple fat-finger error, but it took us nearly four hours to get it resolved with our current custodian.

In a T+1 world, that’s a settlement fail. Describe your exception management workflow for that exact scenario.”

The Apex team outlines a process that involves an automated alert being sent to their exceptions team. “And what does that team do?” Sarah asks. “Do they call us? Do they call the broker?

What are their hours? We have a significant trading operation in Singapore. If an exception happens on one of their trades at 4:00 PM Singapore time, who at Apex is working to resolve it?” The Apex team assures her they have a “follow-the-sun” model, but when pressed for details on the size and experience of their Asia-based team, their answers are vague.

Vague assurances about ‘follow-the-sun’ support are a critical red flag; true readiness is demonstrated by detailing the specific headcount, expertise, and authority of global operational teams.

The next day, Sarah and David have the same meeting with Zenith Trust. When David asks about API latency, the Zenith team pulls up a live dashboard showing their current average latency is under 500 milliseconds. When he presents the same incorrect allocation scenario, the Zenith representative says, “That’s a great question. Let me show you our exceptions portal.” She shares her screen and walks them through a user interface that clearly shows the mismatched trade, highlights the specific field that is incorrect, and provides direct communication tools to message both the Zenith operations team and the counterparty broker within the platform.

“Our system automatically identifies the mismatch and flags it to all three parties simultaneously,” she explains. “Our operations team is empowered to reach out to the broker directly to confirm the correction, and you can see the entire audit trail of that communication right here. For your Singapore team, our Hong Kong operations hub would handle this. They are a team of 15, and their MTTR for allocation errors in the last quarter was 27 minutes.”

After the meeting, Sarah turns to David. “The difference is night and day,” she says. “Apex talked about automation. Zenith showed it to us.

They have thought through the entire workflow from our perspective. They understand that in a T+1 world, we don’t just need a custodian; we need a partner with a shared-screen, real-time problem-solving capability.” The scenario analysis made the choice clear. The firm that could provide transparent, verifiable, and actionable data, combined with a well-defined and empowered human support model, was the only viable partner for the new T+1 regime.

System Integration and Technological Architecture

The technological underpinnings of a custodian’s T+1 readiness are as important as their operational workflows. A modern, flexible, and resilient technology stack is a prerequisite for success. The due diligence process must include a deep dive into the custodian’s system architecture, their data management practices, and their cybersecurity protocols. This is another area where the buy-side firm’s technology team must be deeply engaged, as they are best equipped to assess the quality and modernity of the custodian’s technical infrastructure.

The conversation should focus on the specifics of integration. How will the buy-side firm’s systems communicate with the custodian’s? What data formats and communication protocols are supported?

What is the custodian’s approach to data security and disaster recovery? The goal is to build a complete picture of the technological partnership and to identify any potential points of friction or risk.

• API and Connectivity ▴ Beyond simply having APIs, what specific data points and functionalities are exposed through your API library? Do you have APIs for initiating cash transfers, querying settlement status, and retrieving corporate action details? What are your API performance and uptime SLAs? Do you support industry-standard messaging formats like ISO 20022?
• Data Management ▴ Where is our data stored, and what are your data residency and governance policies? How do you ensure the accuracy and integrity of the data you provide to us? What is your data retention policy?
• Cybersecurity ▴ Describe your cybersecurity program. What are your protocols for preventing, detecting, and responding to cyber threats? Have you conducted third-party penetration testing of your systems? Can you share the results of those tests?
• Disaster Recovery and Business Continuity ▴ What is your disaster recovery plan? What is your Recovery Time Objective (RTO) and Recovery Point Objective (RPO)? Have you tested your DR plan recently? Can you provide us with the results of that test?

A truly T+1 ready custodian will welcome this level of technical scrutiny. They will have a well-documented and modern technology platform, and they will be eager to demonstrate its capabilities. A custodian who is evasive or unable to provide detailed answers to these questions is likely running on legacy technology that is ill-suited to the demands of a compressed settlement cycle. In the T+1 world, technology is not just an enabler; it is the foundation upon which the entire system is built.

Reflection

Beyond the Checklist a Systemic Recalibration

The exhaustive questioning and quantitative analysis required for T+1 due diligence serve a purpose far greater than simply selecting a vendor. This process is a mirror. It compels a buy-side firm to look inward, to dissect its own operational workflows, technological capabilities, and risk tolerances with the same rigor it applies to its external partners.

A custodian’s inability to answer a question about real-time exception management is not just an indictment of their systems; it is a critical signal to the buy-side firm about a potential vulnerability in its own post-trade process. The knowledge gained through this intensive due diligence becomes a catalyst for internal transformation.

Ultimately, the transition to T+1 is not a one-time project but a permanent shift to a new operational state. The due diligence playbook, therefore, should not be a document that is completed and filed away. It should become a living framework for the ongoing management of the custodial relationship. The KPIs established during the selection process should become the basis for monthly performance reviews.

The scenarios analyzed should be regularly updated and re-evaluated. The technological integration points should be subject to continuous testing and improvement. In this new regime, the quality of a firm’s operational architecture is a direct determinant of its ability to compete. The intense scrutiny applied to the custodian is merely the first step in a necessary and continuous process of systemic optimization, a recalibration that positions the firm not just to survive the transition, but to achieve a lasting operational advantage within it.