While the potential benefits are undeniable, the unique complexities of the European market landscape demand a thoughtful, collaborative, and well-planned approach.
(This article first appeared on Best Execution, a Markets Media Group publication.)
Valérie Noël, head of trading at Syz Group, explores ‘the next frontier’ in securities trade efficiency, exclusively for BEST EXECUTION.
The move towards faster, more efficient settlement of securities transactions has become a global trend. Recently, the USA and several other jurisdictions announced their intention to move to a T+1 settlement cycle, reducing the time between trade execution and settlement from two business days to just one.
This transition will lead to greater post-trade efficiency and reduced systemic risk. With these global changes underway, a pressing question arises: should Europe, including the European Economic Area (EEA), the UK, and Switzerland, also adopt the T+1 model?
The appeal of T+1 settlement
By narrowing the gap between trade execution and settlement, counterparty, market, and credit risks across the settlement ecosystem would be reduced, particularly during phases of market volatility. Thanks to the potential reduction in margin requirements, companies can manage their capital and liquidity risks more effectively. Studies, such as those by The Depository Trust and Clearing Corporation (DTCC), suggest that a T+1 model could reduce the volatility component of central clearing counterparties (CCPs) in Europe margin requirements by a substantial 41%.
The democratisation of exchanges, enabled by technological progress, requires traditional markets to evolve. T+1 settlement is part of this transformation, promoting post-trade efficiency and making traditional markets more attractive. In addition, the emergence of real-time transactional assets, such as cryptocurrencies, has set new standards. Moreover, the implementation of T+1 in Europe would require the entire industry to focus on automating manual processes, setting standards, and optimizing inventory management, thus ensuring the continued relevance of traditional markets. As capital markets become increasingly interconnected, the consistency of settlement cycles on primary markets is essential to ensure the smooth running of transactions on a global scale.
Challenges
The potential benefits of post-trade efficiency and reduced systemic risk are at the heart of the potential transition to T+1 model by the EU, Switzerland, and the UK. However, the unique structure and diversity of the European market pose particular challenges.
The mosaic of European markets, each with its own regulatory, tax and legal framework, will complicate the transition to T+1. The diversity of European market infrastructures, comprising 35 stock exchanges, 41 commercial exchanges, and 31 central securities depositories (CSDs), further amplifies this complexity. Unlike unified markets such as those in the USA, Canada or India, Europe comprises several national markets, each with its own legal, tax, and regulatory environment. As settlement teams have a limited number of hours for post-trading processes, change could prove operationally difficult. Certain asset classes, such as ETFs with a global component, could experience amplified settlement delays, exacerbated by the shortened cycle. While the core systems of most market players can handle T+1 settlements, the transition requires more than just technological preparation. It requires industry-wide consultations, identification of potential challenges and in-depth cost-benefit analyses.
Shorter trading hours could be one solution, offering additional operational time, improving liquidity, boosting market efficiency and fostering a more diversified industry culture.
Final words
There is a global trend in shrinking settlement periods and as global markets are tightly linked, alignment in the settlement cycle between the major markets is expected to take place.
Let’s recall the historical context: Europe’s previous transition from a T+3 to a T+2 settlement cycle in October 2014 demonstrated the importance of industry-wide planning, coordination and cooperation. The US made a similar transition three years later, in 2017.
Europe’s potential move to a T+1 settlement cycle represents a turning point for the markets. While the potential benefits, from risk reduction to cost savings, are undeniable, the unique complexities of the European market landscape demand a thoughtful, collaborative, and well-planned approach. As Europe contemplates this change, ESMA’s recent “call for evidence” underlines the importance of gathering the views and reactions of industry players.
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