The road to T+1

Javier Hernani, head securities services at SIX, provides a CSD perspective on moves to T+1 in Europe.
By Editors

Like a slowly ticking clock, global markets are moving towards a time when trade date and settlement date will be synonymous, but how close are we today? In the US, with GameStop still relatively fresh in regulators’ minds and the idea of ‘meme stocks’ still current, the impetus to move to T+1 is well advanced and a further reduction to T+0 is a subject of live discussion and debate.

Will Europe follow suit? A recent paper by AFME on the move to T+1 in Europe suggests people are waiting and expecting movement in this direction and urges conversations to begin. 

However, the movement to T+1 in Europe will be much more complicated in Europe than in the States. The US market is a huge domestic market with one legislative rule book and a smaller number of different market infrastructures compared to Europe. 

Additionally, Europe has to cope with trading cross-border in different currencies in one single market. As long as FX markets settle on T+2, this may create a setback for even the most enthusiastic proponents of reduction in settlement timeframes. It would seem a necessary accompanying step that FX settlement also move to T+1 to harmonise with T+1 in securities settlement.

Challenges of T+1

Even were that to happen, other challenges for a pan-European move to T+1 remain. The broadly accepted benefits of a reduction in settlement time frame include among others a clear reduction in counterparty and market risks, and consequently a significant decrease in margins.

These benefits, however, need to be set in the context of how much they will cost to achieve. Such costs include updating infrastructure to make T+1 both feasible and reliable. Outside of the infrastructures themselves, necessary changes to some post-trading processes to enable the move imply significant costs.

Even if the requisite technology is implemented, a T+1 settlement environment could be particularly demanding for certain investment products. If we take the example of ETFs, T+2 is already difficult in some circumstances, given that such structures involve underlying securities from a range of time zones and currencies.

Without giving these factors serious consideration, there is a clear risk of increasing settlement failures as an unintended consequence of reducing settlement timeframes. This could be problematic for market participants, not least because of the penalties for failed trades in the EU resulting from the implementation of the Settlement Discipline Regime under CSDR. 

Were fails to increase, this could significantly reduce the benefits of T+1, while securities lending to cover short positions could also be affected due to time pressures, increasing even further the risks of settlement failures.

CSDs themselves are obviously already ready to settle on T+1 or even T+0 as T2S is able to settle from T to T+n. However, CSDs do not operate in a vacuum. To achieve T+1, it is essential to improve procedures from the moment the trade is executed until the settlement instruction is introduced in the CSD. The increased use of partial settlement in the CSD may be, in the short term, an attractive option. As a result, any move to shorten the settlement cycle in Europe will need to correspond with regulation – especially CSDR – and market practices, and be comprehensively reviewed to ensure the different regulatory and market initiatives do not cancel each other out or work against the stated goals of each regulation.

Finally, we need to consider the impact of settlement reduction on an area of activity that the industry as a whole has been struggling to automate effectively, at least relative to other post trade processes and that is corporate events. Today we have Ex Date, Record Date and Payment Date. In the current environment, these three are consecutive. In a T+1 environment, Ex-Date and Record Date would both need to be on trade date. We need to consider seriously the implications this might have for the efficient handling of corporate events. IPOs, already under pressure in some respects, might also be affected.

Are there solutions to address the notes of caution sounded above? As already suggested, new technologies and enhanced post-trade infrastructure will be essential to facilitate a relatively smooth transition to T+1. For those pointing to distributed ledger technology (DLT), although the potential is great, it is not yet a solution for this particular initiative, though it may be more instrumental in a subsequent move to T+0 or T+n.  

A huge amount of work from all stakeholders is needed to create greater harmonisation in Europe before moving to T+1, to avoid undermining efforts to improve settlement practices. A potential review of operating hours might be necessary, and not only in the post-trade area of our industry (possibly moving the main workload to late in the afternoon), but also as far as trading is concerned. Shortening trading hours by anticipating the closure of the markets may give post-trading procedures more time to cope with a T+1 environment. In short, there are no insurmountable barriers to reducing the settlement frame to T+1, but we should not gloss over the scale of work that needs to precede such a move.