Settlement ‘instructions’: Firms look to US for guidance as Europe braces for T+1

Halloween may be over, but a new threat has operations managers at European financial firms spooked. With six months until US and Canadian markets are due to make the switch to T+1 settlement, the specter of settlement compression is now knocking on Europe’s door.

The European Securities and Markets Authority (Esma) has published a call for evidence with the stated intention of assessing “the costs and benefits of a possible reduction of the settlement cycle in the European Union.” The timeframe is yet to be confirmed, but sources say that the initial proposal could see a one-day—or even same-day—settlement window introduced as early as Easter 2026.

This may sound like a long way off, particularly given that firms can already settle on T+0 in European central securities depositories—a regular occurrence among debt instruments. But Europe’s uniquely elaborate market structure, coupled with entrenched behavior, make the challenge of shortening settlement cycles a particularly tall order on the continent.

Motivated in part by the prospect of a re-run of the scramble for compliance currently underway in North America, the Association of Financial Markets in Europe (Afme) assembled a task force in early 2023 to discuss opportunities for improving settlement efficiency in Europe. When the group of post-trade professionals from a range of sell-side firms met in person for the first time, the top item on the agenda was to draw up a list of the frequent causes behind their settlement failures.

Peter Tomlinson, director of post trade at Afme, was in the room, listening to members’ discussions and writing up the final report with the support of Deloitte consultants. “The process was a bit of a group therapy session. Everyone put these issues out on the table and realized that they were common challenges across multiple firms,” Tomlinson says.

The most common pitfalls were identified and grouped into six categories: data quality, inventory problems, inefficiencies caused by counterparty behavior, workflow management, market standards and regulation, and market infrastructure limitations.

In its final report, Afme said that increasing settlement efficiency can reduce costs and risks for institutions. But it also noted that shorter cycles may be on the horizon as a consequence of push factors, and not just commercial incentives.

“Whilst there is no regulatory mandate for T+1 adoption in Europe, we believe it is prudent for the industry to consider this as a potential future state, and plan accordingly,” it read.

Europe un-settled

The precedent set by North America has rattled onlookers in Europe. The Securities and Exchange Commission gave market participants just 15 months to prepare for the transition to a one-day settlement window, catching both financial institutions and market infrastructure providers off guard. A recent study by Coalition Greenwich and Xceptor found that less than one-third of in-scope firms currently feel able to achieve T+1 settlement in every asset class.

Esma’s call for evidence recognized the need for a sufficient implementation period, but it also highlighted a particular difficulty in bringing shorter settlement cycles to Europe: the complexity of the EU post-trade landscape.

You've got a single regulator in the US. If they say, ‘We’re moving to T+1,’ everyone does it. But Europe’s fragmented market is a completely different animal

James Maxfield, Duco

With more than 25 different markets, multiple tax regimes, a host of local regulators, and a long custody chain, Europe’s market structure comes with an unwieldy settlement process. Unlike the US and Canada, which each have a single central securities depository (CSD), a single central counterparty (CCP) clearing house, and only a handful of exchanges, Europe’s market infrastructure layer hosts a plethora of competing CSDs, CCPs, and venues. Agreeing which CSD the transaction should settle at is therefore a crucial criterion for the matching process in Europe.

“If you draw a process diagram for the US, it's like a single motorway. The EU equivalent is more of a spaghetti junction,” Tomlinson says.

And unlike the US, where settlement can be achieved without CSD-level matching in certain circumstances, Europe requires that a match take place before securities are delivered.

Regulators have an array of tools at their disposal to help drive settlement efficiency, however. Europe took a significant step in 2022, when it introduced a Settlement Discipline Regime, handing out fines to market participants responsible for settlement fails. Monthly averages in penalties issued fell after the regime was brought in, suggesting that the penalty system is helping to reduce fails.

For its part, the SEC has announced a regulatory obligation that will come into force to facilitate the switch to T+1: every transaction must be affirmed by 9 p.m. ET in the evening on the day of the trade. Sources say that enforcing discipline in affirmations will reduce the likelihood of matching errors on settlement day.

But if Esma followed this example, it would rely on a network of local regulators to enforce the rule. James Maxfield, chief product officer at data automation company Duco, doubts the efficacy of such a system in Europe. “You've got a single regulator in the US. If they say 'we're moving to T+1,' everyone does it,” he says. But Europe’s fragmented market is “a completely different animal,” he says.

Lessons learned

While Esma ponders how best to facilitate a future transition, operations teams in Europe are looking to North America for inspiration on how to keep pace when the time comes.

“I think there will be some learnings from the US, which become immediately apparent from day one,” Afme’s Tomlinson says.

In particular, market participants will closely watch the impact of the mismatch between foreign exchange settlement on T+2 and other assets on a shorter settlement cycle. Exchange-traded funds based on overseas assets will also be strongly affected, as the settlement of fund shares may be out of sync with the settlement of the fund constituents.

Gabi Mantle, head of post trade at EquiLend, a securities lending trading platform, says that any detrimental impact on settlement efficiency rates in the North American market could help inform how Esma and European market participants implement a reduced settlement cycle in Europe.

“I think the market is all hopeful that there’ll be enough time so that if there is anything fundamental that comes out of the move in the US and Canada, there is time to change course if needed,” she says.

Securities financing is one area that will be heavily impacted by accelerated cycles. Borrowers holding short positions already have to pre-fund the lender. But with less time for lenders to instruct the release of collateral back to the borrower, Mantle says borrowers may have to hold additional buffers overnight so that they can be used at short notice on settlement date. This could have the unintended consequence of reducing liquidity, and would be a particularly acute problem in Europe, where non-cash collateral is more widespread.

Mantle believes that one consequence of shortening cycles will be more communication between the front, middle, and back offices. All the post-trade tools developed by EquiLend over the past 18 months include workflow handoff and communication functionalities to enable the different parts of a firm to collaborate on matching and settlement needs. “At any given time, no matter which step of the chain you’re in, you can look in the screens and see, ‘Actually, I need to take action here,’” Mantle says.

Although settlement has traditionally been seen as the purview of the back office, conversations about inventory management and available liquidity are driving home the fact that settlement functions are heavily dependent on upstream workflows.

“I can have a great platform that can process data intraday and settle really quickly, but if I'm reliant on the other components of that process (trade capture, reference data enrichment, SSI creation, data accuracy, instructing to the market, inventory management) and all of those processes stay on the old timeline, I’m never going to transition successfully,” says Duco’s Maxfield.

Katia Falina, head of post-trade product for Bloomberg’s buy-side order management system, AIM, agrees. She has firsthand experience of this process, having started out in the world of trade workflow through Bloomberg’s venue and execution management businesses.

“When I came over to post trade five years ago, I was thinking, 'Oh, my God, what do I know about post trade? And what are going to be the challenges?’ And once I dug into it a little bit with my team, it became apparent that the challenges are exactly the same as what we saw on the trading side of the process, except that post trade seems to be about five to 10 years behind the curve, at least in terms of adoption,” she says.

A tool like that can get a little bit overwhelming to adopt during peacetime, when there are no regulatory changes. Operations go, ‘Well, you know what, I like to see trades before I release them downstream. I like to have that manual control.’ Whereas now, with T+1 upcoming in the US, with the Esma consultation paper, with the UK's accelerated investigation into the same process, we hear a lot more of, ‘What was that automation solution that you spoke to me about a year and a half ago? How does that work again?’

Katia Falina, Bloomberg

The prospect of shortening settlement cycles is pushing market participants to look for parts of the trade lifecycle that can be automated. Bloomberg’s AIM has an automation engine that allows clients to handle post trade on an exception management basis using custom rules and parameters. For example, when a trade is executed in X asset class and in Y currency at Z settlement location, predetermined rules will auto-release it to matching, wait for the match successful state, auto-release it to settlement, wait for the successful settlement state, then send it to accounting. Users can achieve up to 85% automation using this tool.

Falina says operations professionals often take a more hands-on approach, but that the proximity of T+1 is driving some clients to consider how greater automation could save time in a shortening time window to perform processes.

“A tool like that can get a little bit overwhelming to adopt during peacetime, when there are no regulatory changes. Operations go, ‘Well, you know what, I like to see trades before I release them downstream. I like to have that manual control.’ Whereas now, with T+1 upcoming in the US, with the Esma consultation paper, with the UK's accelerated investigation into the same process, we hear a lot more of, ‘What was that automation solution that you spoke to me about a year and a half ago? How does that work again?’”

But while automation can cut down on both data deficiencies and headcount, it is not a panacea for European firms. The Afme paper on shortening settlement cycles found that counterparty behavior was ranked by both brokers and custodians as the most significant cause of transactions being unallocated on trade date and unmatched at the CSD the following day.

“Your process is only ever as good as the weakest link in the chain. It's that tail of customers everybody will be worrying about—because they're smaller, they don't have a lot of money, they don't invest in automation, and they don't spend money on consultancies,” says Duco’s Maxfield.

Rui Ferreira, product manager for settlements at post-trade processing services provider Torstone Technology, warns that a regional acceleration in settlement cycles cannot be achieved in isolation. Larger players may be more able to adapt and co-ordinate their infrastructure, technology, and operational processes. But that doesn't mean everyone will be able to do it.

“And if one party is left behind, unavoidably, you will end up having fails all at the same time. So it has to be a very well co-ordinated industry move. And doing so at a European scale, when there are so many different markets, so many different CSDs, CCPs, different players in the scenario, obviously, it's a much more challenging exercise,” Ferreira says.

The worry is that the less technologically adept tail of market participants will be unable to keep up with the accelerated pace and set off a chain reaction of fails, where the settlement of one transaction depends on the settlement of another failed trade upstream, so no participants are able to deliver securities to their counterparties. The Bank of England published a working paper on this network effect, and found that 80% of settlement fails in a subset of UK equities resulted from these gridlock scenarios.

Such known unknowns and potential unintended consequences are always front of mind for operations and compliance teams working on an incoming rule. But the marked difference of the EU’s settlements landscape from other jurisdictions that have made the leap to T+1 will make the prospect of this particular transition singularly daunting.

“Should we actually address and improve the settlement efficiency before moving to T+1?” asks Torstone’s Ferreira. “It has slowly been getting better over the last year, but there’s an underlying concern that shortening the settlement cycle will bring additional stress that may have a detrimental impact,” he adds.

Afme estimates that around 70% of transactions in Europe currently match at the CSD by the end of trade date. By the following day, that matching percentage is in the high nineties. For Tomlinson, these figures demonstrate how far Europe still needs to come before it can adjust to a cycle where matching should be completed on a T+0 basis.

“The difference between those two numbers is a proxy for the immediate potential drop-off in settlement efficiency if you were to move to T+1 tomorrow. We must aim to get that T+0 matching rate up to the high nineties before moving to T+1. That's the scale of the challenge ahead of us.”