T+2: Progress But Not Out of the Woods Yet

I have been talking about T+2 implementation for as long as I can remember and therefore to finally see the first stage of implementation on 6 October 2014 was a significant milestone in the move to shortened settlement cycles in Europe.

For many of us who have long been educating the industry on the need to prepare for the impending arrival of T+2, the European Central Securities Depository Association’s (ECSDA) announcement that the initial implementation of T+2 in 29 EU countries had been smooth was both expected and welcome. Well in advance of the 6 October deadline, much time had been invested in educating market participants – both buy-side and sell-side – about what middle office processes are required to enable the harmonisation of settlement cycles to two days in Europe.

The results were impressive. According to ECSDA, using settlement data collected from 17 central securities depositories (CSDs), on 8, 9, and 10 October the number of failed instructions in 11 out of 17 markets was lower than the week prior to T+2 implementation based on the proportion of the total value of settled instructions. In five of the European markets, there were no failed trades during the transitional phase while there was only one market which experienced an increase in the number of failed instructions on 8 October, which was in the normal range according to ECSDA.

Statistics from Omgeo CTM, based on data from more than 1000 clients, also prove that the market was well prepared for the implementation of T+2. Pre-T+2 implementation, 14% of clients were settling equities trades on trade date plus two, while 83% were settling on T+3. Post 6 October, the figures changed dramatically, with 91% of equities trades settled at T+2 and 6.7% settled at T+3.

While the first phase of T+2 implementation has gone smoothly, we are not out of the woods yet. In early December, the next chapter in the T+2 story will begin when the European Securities and Markets Authority (ESMA) announces the level of penalties to be assigned to failed trades which will be implemented in the CSD Regulation. This means that given the average trade failure rate 3-4%, there will be an additional bill for market participants when the CSD Regulation is implemented in 2015. This will provide even more of an incentive for market participants to implement IT processes, which are robust enough to ensure compliance with T+2 while also minimising the rate of trade failures.

The threat of the Settlement Discipline Regime becomes even more concerning if you consider the forthcoming impact of Target 2 Securities (T2S) to be implemented in 2015. This is because T2S will further reduce settlement time frames due to the standard settlement window operating from 7:30pm on T+1. A buy-side firm in Los Angeles, for example, investing in European equities or fixed income will likely face an EU trade instruction deadline from its custodian by 8:30am on T+1. The corollary of this is that the identification of mismatches and the resolution of problems, which today routinely occur on the morning of T+1, will have to be carried out on trade date. And for those trades, which fail in Europe, the financial penalties as set out in the Settlement Discipline Regime will be enforced.

There was much nervous anticipation around the implementation of T+2 and rightly so given the scale of the task; however the intensive education programme carried out by market infrastructure providers ahead of the deadline played a large part in preparing the industry for the change and implementation thus far has been relatively smooth. That said, the next year will bring further change, with more detail expected on the Settlement Discipline Regime and the forthcoming implementation of T2S in June 2015. We are not out of the woods just yet.