The AFME paper goes on to lay out the primary pros and cons of moving to a shorter settlement cycle. The benefits are similar to those highlighted in the U.S. Depository Trust & Clearing Corporation’s U.S. study, including reduced counterparty, market, and credit risks, decreased costs and margin requirements, and helping broader global alignment with many markets beginning to coalesce around the T+1 cycle.
This will help Europe practically but also keep Europe competitive and not considered to be trailing behind global peers in terms of speed and efficiency.
However, the barriers to the change are far more numerous and challenging in the European context because of the natural market fragmentation described above. The AFME paper outlines some of those hefty barriers to overcome before such a migration can take place across the region.
No One Said This Was Going to be Easy
A BBH article sets out the main process areas in the securities trade lifecycle that will be impacted by a shorter settlement cycle in the U.S. These affect everybody globally, but AFME covers five main areas most likely to engage European focus:
1. Shorter Time Frames
There would be significantly fewer hours between trading and the beginning of the settlement cycle for post-trade operational processes and interventions to happen. Interestingly, AFME calculate an 83%, not 50%, reduction in available time in practice for available post-trade processing which will leave 2 hours rather than 12 hours operation time by removing a day between trade and settlement date.
2. Increased Settlement Fails
The migration could also lead to an increase in the number of settlement fails in the market, which in turn could be affected by some existing European rules such as incurring cash penalties under Central Securities Depositories Regulation (CSDR) rules or having capital impacts under Basel III requirements.
3. Greater Global Complexity
International time zone differences will impact the possibility of same-day matching processes for investors from outside Europe, vastly reducing the time available to communicate and resolve any breaks or exceptions. This impact would be particularly significant on cross-currency transactions which have a foreign exchange (FX) component.
4. Securities Lending
The shift to a T+1 settlement cycle compresses the timeline to identify and recall securities. The compression again could lead to breaks which might subsequently result in CSDR settlement fails and cash penalties, unless there is a modification to existing processes.
5. Exchange-Traded Funds (ETFs)
The global composition of ETFs, many of which contain underlying securities from several jurisdictions, can often lead to settlement delays in a T+2 environment, due to time zone differences, market holidays and cross-border settlement complexity. These challenges would be even more pronounced in a T+1 environment.
The scale of securities in scope married to the amount of fragmentation and local nuance that still exists across the European trading landscape mean that there will need to be a high degree of industry coordination across all stakeholders. This would help ensure all impacts are identified and mitigated and the formation of a detailed implementation plan and timeline is undertaken.
For more information on how BBH can help optimize process areas for shorter cycles and to join industry advocacy group discussions, contact your BBH representative and follow BBH Market Insights on LinkedIn where we will be sharing further learnings on this topic in the coming months.