European firms prime for lopsided settlement in North America and at home

T+1 may seem like a new frontier, but the idea of settling transactions the day after a trade dates back 100 years. The New York Stock Exchange settled trades on T+1 as early as the 1920s, before backlogs of paperwork forced it to extend settlement cycles to T+5. Now, with the benefit of 21^st century technology, the US—along with Canada and Mexico—is having another go. And public authorities in Europe and the UK are discussing how to follow North America’s lead.

For firms with European operations, this has created the twin challenge of getting ready for the misalignment created by the North American transition while also laying the technological foundations for a future acceleration of settlement cycles closer to home.

Sachin Mohindra, executive director at Goldman Sachs, works on the firm’s T+1 strategy in the client and market solutions division. “We’ve been looking at this since Q1 2021, when the memestock events had just occurred, and the question of ‘Why does it take two days to settle a transaction when you could do it in one day?’ came up. It started off as an exploratory topic, and now, personally, I’d say it takes up 90% of my time. And that’s not just the US, because we’re involved directly in the EU and the UK conversations as well,” he says.

The European Securities and Markets Authority (Esma) issued a call for evidence on shortening settlement cycles in 2023, and will submit a report to the European Commission in Q4 2024. At a roundtable hosted by the European Commission in January, commissioner Mairead McGuinness told attendees, “When it comes to T+1, the question is no longer if, but how and when it will happen here in the EU.” And in a poll conducted by participants of the same roundtable, 65% of respondents said that they favored a transition in Europe as soon as 2027 or 2028.

Meanwhile, the UK government has also assembled an accelerated settlement task force with the aim of exploring a move to shorter settlement windows.

Come what May

North American markets are set to make the switch in late May, and market participants in the throes of preparing for the transition are trying to negotiate a host of complications thrown up by the move. 

For European players, sourcing foreign exchange for US securities purchases is one such difficulty. Matthew Coupe, director for cross-asset market structure at Barclays, explains that most European players currently do the FX leg of a trade on day two of the settlement cycle, allowing them to manage FX demand on the aggregate of their trading positions from the previous day, and settling on T+2.

“That becomes a little bit more challenged in a T+1 environment, because if you’re trying to do it all in one day, you’re having to estimate where you are from an FX perspective while you’re trading the securities. Whenever you compress cycles—whenever you are putting two processes in competition against each other—there will always be inefficiencies and potential mistakes that might come out of that,” he says.

There are different solutions out there; none of them are perfect. But these solutions will then help inform how we in Europe and the UK should approach it and what the big obstacles are

Sachin Mohindra, Goldman Sachs

The industry is assessing various options to negotiate the challenge of FX in a T+1 environment, Goldman Sachs’s Mohindra explains. “It could just be, ‘Trade on an estimated balance on T+0 and then do a true-up on T+1.’ We’re hearing some UK-based clients are moving trading and operations to the US. Others are saying ‘We’re just going to outsource everything to our custodian and get them to do FX on an automated basis.’ There are different solutions out there; none of them are perfect. But these solutions will then help inform how we in Europe and the UK should approach it and what the big obstacles are,” he says.

Asset managers in Europe are in a particularly challenging position with the North American shift. The European fund management industry is more exposed to US equities than to any other single market, so the switch to T+1 will create misalignments, not only in FX, but also in redemptions and investments within their own funds.

Fund managers outside the US receive new investments from customers as late as four days after they place their order, meaning that they will have to settle US transactions days before receiving the necessary funds. As a result, many European asset managers are currently grappling with the question of how to fund US trades once the settlement window shrinks in May, says Lynn Challenger, global head of trading at UBS Asset Management. 

“When we receive an order to buy a US stock, we buy it today, pay for it tomorrow, but our clients do not send us the money for two or perhaps three days. We either have to borrow the money from our custodian, allow an overdraft on the account or borrow money from the executing broker by extending settlement. All of those options are going to cost different levels of money and have different levels of availability depending on the size of the trade—but in the end, a client is likely to have to pay more to buy a US stock than they do today," he says.

Funding and post-trade difficulties as a consequence of the US transition are likely to disproportionately impact smaller asset managers with limited cash buffers and no existing operations in North America.

Challenger emphasizes that the US switch in May will not affect all market participants equally. “It’s not easy, it is not cheap, nor is it without risk. But we’re confident we have the processes, systems and teams to manage it. Other asset managers may not be so fortunate as I think a lot of Europe is just waking up to it now and trying to understand, ‘What this is going to mean?’ Many European asset managers don't have a large trading desk in the US and don't have a back office in the US. It is going to be much more complicated for them.”

Watch and learn

The transition in North America could provide a useful lesson for the UK and Europe. For market participants, it is likely to uncover the potential pitfalls and best practices in advance of any similar shift in their local markets.

Daniel Miller, senior managing director for outsourced middle-office services at investor services provider IQ-EQ, says COOs are currently grappling with the need to improve infrastructure in time for the transition in North America.

Many European asset managers don't have a large trading desk in the US and don't have a back office in the US. It is going to be much more complicated for them

Lynn Challenger, UBS Asset Management

“Adding resources to a manual process likely isn’t going to meet the mark of the shortened settlement cycle. We’re encouraging managers to partner with trade matching engines; some sort of software solution is going to be required.” Miller adds that it is important not to leave decisions on new technology until the eleventh hour. “In a typical month, before T+1, some vendors might have had half a dozen to a dozen new onboardings in the course of a month. If everyone waits until April, you're looking at hundreds, if not thousands of onboardings in a single month,” he says.

Goldman Sachs’s Mohindra adds that investment in straight-through processing should be a priority in Europe, where there are often more intermediaries and more messages in the chain between allocation and settlement than in the US.

“We’re starting to see golden source solutions which say, ‘We’ve matched between the buyer and the seller in the trade matching system. Why don’t we take that as the golden match, enrich it with common reference data points, and then send it directly to the CSD? Rather than churning back to the buyer’s and seller’s own systems and the instructions somehow getting misinterpreted and leading to mismatches,’” he says.

The US example will also be watched carefully by public authorities in the EU and the UK as they weigh the advantages of a similar move. Mohindra says that clients are increasingly bullish about the benefits of alignment between the three markets, but cautions that the process will require a careful evaluation of the settlement process.

“If you try to run a marathon when you’ve got an existing injury, all you’re going to do is create more damage. And so trade discrepancies, settlement instructions, reference data and timeliness of instructions, and moving away from batches to real time are all very key,” he says.

Mohindra adds that planning for a future transition should also be an opportunity to discuss the introduction of more netting and clearing in Europe. This would require technical solutions like matching platforms that allow the buy side and sell side to come together, or clearinghouses facilitating clearing for trades done off-exchange.

Other sources called for regulators to examine the possibility of including some standard settlement instructions in the trading process so that counterparties agree on some settlement details during the trade itself.

UBS Asset Management’s Challenger says that, with time on its side, Europe could go one step further. “In Europe, I think it’s worth pausing and thinking about, ‘Can we, as an industry, make a step change on how we settle? Do we really need to go to T+1, or should we make the investment to go straight to T+0? Assuming from a political standpoint that we have a six-year runway, can we work together to come up with a plan to get us to a better state, which would be same-day settlement or even instantaneous settlement?’”

Case in point

Italy-based Generali Asset Management, which manages more than €500 billion ($540 billion) of assets, launched a smart automation program in 2021 to optimize operations. At the time, this involved conducting internal interviews to identify processes that could be automated, defining a use case, and then asking an external system integrator to implement a robot.

Emiliano Di Giammatteo, COO for Generali, explains that the intention of the program was not initially to boost the firm’s settlement capabilities, but it soon became apparent that this was a major benefit. In 2021, two of his colleagues came up with the idea of a citizen developer program. 

“They said, ‘Why not empower a certain number of our colleagues—most of them not from IT, but all of them have an interest in technology—to optimize their own processes? Let’s teach them how to build a robot, a smart automation process, and let them figure out what they can optimize by themselves,’” he says.

Erica Peduto, the firm’s head of smart automation, was one of those two people. She explains that one major use case is automating requests that Generali received from clients daily to manage contribution withdrawals. The problem was that every client used to send a specific template, or even several different templates, for the same type of withdrawal request.

“We have automated the process using robotic process automation and optical character recognition, so the metadata required to book this kind of transaction in our official book-keeping system are extracted from the request template (often in Excel, PDF, and so on),” she says.

In 2023, this automated system inserted almost 4,000 transactions into book-keeping platform SimCorp Dimension with a 99% accuracy rate.

Generali now hopes to scale up the program using a more accessible software that enables even employees who are less familiar with coding to automate aspects of their jobs. Di Giammatteo believes that this has the potential to further enhance the rate and efficiency of settlement at the firm.

“One area where we want to develop a robot is how we manage standard settlement instructions in our master data management. This step is not automated, there is no standard format. We are developing some capabilities in reading unstructured information that may come from various sources, so as to automate the matching process and to be a bit more precise when we insert those SSIs into our system,” he says.

As it stands, Generali is able to close around 5% of trades in Europe on T+1. “When we need to close at T+1, we give a bit more attention to the trade—we anticipate some tasks, and so on. That means that you can easily solve the problem if you add more capacity. But we can’t really increase the headcounts. That’s where automation comes in,” Di Giammatteo says.

With T+1 on the horizon in Europe, Di Giammatteo aims to get 15–20% of trades to T+1 by 2025, and 50% by 2026, in order to be ready for 2027.