‘When, not if’: EU plots course for T+1 transition

If there was ever any doubt that the EU would follow North America’s lead on shortening settlement cycles, it has been put to bed for good. A roundtable held by the European Commission last Thursday saw widespread agreement from industry associations, market participants, and authorities that Europe must move to T+1—and sooner rather than later.

Mairead McGuinness, the EU commissioner responsible for financial services, set the tone in the opening speech, telling attendees, “I think we all know a clear trend is emerging for shorter settlement cycles. When it comes to T+1, the question is no longer if, but how and when it will happen here in the EU.”

With North American markets due to make the transition to T+1 settlement (the day after trades are executed) in late May this year, Europe is now under pressure to follow suit. Many EU investors are heavily exposed to US equities, so a misalignment in the settlement period will create funding problems as firms have to put down cash for US transactions before the necessary liquidity is freed up by asset sales or fund purchases in the EU.

Beyond logistical concerns, there was also a sense that a move to T+1 is necessary to keep EU markets competitive. In a poll, 65% of roundtable attendees said the EU cannot maintain its attractiveness in the long term without improving settlement efficiency. Speakers noted that the geographical location of the EU could play to its advantage in a shorter settlement cycle environment, allowing European market participants to provide liquidity between Asian clients and a fast-paced US market, for example.

It was encouraging to hear from Commissioner McGuinness that it’s a question of ‘when’ and not ‘if,’ but you may not want to read a substantial chunk of the responses that we received to the call for evidence.

Carsten Ostermann, Esma’s head of market and digital innovation

Attendees urged European authorities to focus on realizing these potential benefits as they draw up plans for implementing T+1. While a future shift was seen by most as a predominantly defensive one—keeping Europe in step with US markets—market participants said it would still present new opportunities for them to exploit if the move is carefully executed.

Stephan Leithner, a member of the board of Deutsche Börse Group, which has business lines across the trading, clearing, and settlement chains, said a move to T+1 is technically feasible, and warned against dragging out the process. He encouraged the Commission to set out a fast timeline for the move.

“Let’s not make this the next seven years’ distraction for the industry. It’s necessary, it’s unavoidable—let’s get it done,” he said.

Watch and learn

If the US move has given impetus to EU considerations of a shift to T+1, it also serves as a useful template and a warning against hasty implementation. With the Memorial Day deadline fast approaching, roundtable participants said markets are hard-pressed to keep pace.

Susan Yavari, senior regulatory policy advisor for the European Fund and Asset Management Association (Efama), said T+1 took up only 20% of her time early last year. Now, she says, it’s more like 80%. “There are days when I wake up and I think that the US move feels like a train hurtling at a very fast speed on the tracks. And I feel like we’re standing on the sidelines saying, ‘There’s a boulder over here, [and] there’s something a little further down, too.’ And we need help. We need help from the regulators,” Yavari told roundtable participants.

The shift from T+2 to T+1 is seen as more challenging than the transition from T+3 to T+2—which the EU made in 2014. In a T+2 environment, firms had 12 business hours between the end of the trading window and the start of the settlement window. In T+1, the available post-trade processing window would shrink by around 83%, according to research by the Association for Financial Markets in Europe (Afme), leaving settlement teams with just two core business hours between market close and the first overnight settlement runs.

Not only are we losing a business day between trading and settlement, we’re losing the only business day between trading and settlement. That’s pretty significant.

Sachin Mohindra, Goldman Sachs

Sachin Mohindra, executive director at Goldman Sachs, said this compression would have knock-on effects for overnight batches, overnight price feeds, and a host of risk management processes. “Not only are we losing a business day between trading and settlement, we’re losing the only business day between trading and settlement. That’s pretty significant,” he told the Commission’s roundtable.

Around half of trades in Europe are currently processed in overnight batches before markets open on the intended settlement date, according to data from European settlements platform Target2-Securities. For this method to remain viable in a T+1 environment, firms must allocate and match settlement instructions on trade date. The difficulties of inventory management under such circumstances would be compounded by the complexity of Europe’s post-trade infrastructure layer, where holdings in the same instrument could be spread across multiple central securities depositories (CSDs).

This means that in the EU, even more than in North America, a switch to T+1 would require the integration, automation, and modernization of firms’ tech and data processes.

Roundtable attendees said improved straight-through processing is a prerequisite for any settlement cycle compression. Some suggested that settlement instructions be included in the confirmation process for transactions, so that traders agree at the point of trade how and where settlement takes place.

Participants also raised the concern that electronic messaging still has not permeated markets. Some smaller firms, especially fund and asset managers, continue to use email and fax to communicate with one another and with the CSD, which risks slowing down the settlement process further.

Deutsche Börse Group’s Leithner emphasized that the biggest costs would be associated with the process of automation, and that this would affect smaller players most of all. “It will lead to automation because it will force market participants to really develop a consolidated image of where individual stakes are lying, where the cash is. Because that’s what they struggle with. That’s why we have settlement fails,” he said.

Settlement skeptics

Not everyone is on board with the idea of an expedited transition in the EU. The European Securities and Markets Authority (Esma) issued a call for evidence late last year, and it’s currently drafting a report on whether it is even possible to shorten the settlement cycle in the EU.

Esma’s head of market and digital innovation, Carsten Ostermann, told the roundtable that the regulator received very mixed feedback on the desirability of switching to T+1.

“It was encouraging to hear from Commissioner McGuinness this morning that it’s a question of ‘when’ and not ‘if,’ but you may not want to read a substantial chunk of the responses that we received to the call for evidence,” he said.

Some respondents to Esma’s call for evidence said the operational hurdles thrown up by a transition to T+1 would wreak havoc on markets and impose significant costs on firms. 

In a comment letter, Croatian bank Zagrebacka banka estimated that a switch to T+1 would see an 80% increase in settlement fails in the short term, remaining as high as 40% in the long term. Another bank, Romania's BRD Groupe Societe Generale, wrote, “I see costs far exceeding the benefits in the current circumstances.”

Roundtable audience member Matthew Coupe, director for cross-asset market structure at Barclays, said there had not been enough discussion of the impact that a future shift would have on risk management. “I think it’s very telling that we have no traders speaking about the impact of risk sitting on this panel. And I think, to be honest, what we’re probably doing is confusing the political willpower to migrate to T+1, rather than the practical benefits,” he said.

Smaller fund and asset managers are likely to be hit hardest by the transition, and several roundtable participants warned that the higher tech costs required to keep pace would lead to consolidation.

Emiliano Di Giammatteo, COO for asset and wealth management at Generali, which manages more than €500 billion (~$540bn) of assets, said firms could improve their operations by integrating smart automation, analytics software, and AI, but warned that this would entail a transfer of risk and costs onto asset managers.

“How can we minimize implementation and running costs? First of all, by leveraging more technology—primarily a higher degree of smart automation and artificial intelligence integrated into the existing processes. Trying to optimize existing processes with robotic process automations (RPAs) instead of fully migrating the operating platforms toward the new system, therefore adopting more of a continuous improvement approach, rather than a full migration,” he said.

In Generali’s case, Di Giammatteo added: “One area that we are going to look at in the coming months is automatic solutions for the update of standard settlement instructions into our master data management systems. But this is not going to be enough, and we also need some industry answers. For example, we believe that there is room for improvement in the automatic resolution of central trade matching (CTM) mismatches on the standardization of the matching process that would envisage, for example, the pre-matching of the standard settlement instructions (SSIs) at the CTMs.”

To help market participants make the switch, other roundtable attendees called on authorities to waive settlement failure penalties for a period immediately following implementation and to consider market structure changes, such as setting up a central database where all market participants store SSIs.

The elephant in the room was the question of a move to T+0, which Esma included in its call for feedback last year. Precious little mention was made of the idea, with most attendees exclusively focused on T+1. At the end of the roundtable, Sean Berrigan, director general of the European Commission’s financial services unit, appeared to rule out an imminent switch to T+0: “We will walk before we run.”