T+1 is old news. Europe should move to T+0
With the U.S. and Canadian securities markets set to adopt a shorter settlement cycle in May 2024, European regulators are considering their own move to T+1, or even T+0, settlement.
With the U.S. and Canadian securities markets set to adopt a shorter settlement cycle in May 2024, European regulators are considering their own move to T+1, or even T+0, settlement.
Settlement cycles play a crucial role in ensuring efficient and secure transactions. The settlement cycle refers to the time it takes for a trade to be settled, with T+1 settlement indicating that the trade settles one day after execution.
However, recent discussions have emerged around the possibility of Europe bypassing T+1 settlement altogether and moving straight to T+0 settlement, where trades are settled on the same day.
The current standard in Europe is T+2 settlement, meaning trades are settled two days after execution. This timeframe allows for necessary processes such as trade confirmation, reconciliation, and the exchange of funds and securities.
However, as technological advancements continue to reshape the financial landscape and market expectations evolve, there is a growing interest in shortening settlement cycles. The rationale behind this is to reduce counterparty risk, improve capital efficiency, enhance market liquidity, and align with global best practices.
The move from T+2 to T+1 settlement has already gained traction in various regions. For instance, the US, Canada, and Mexico have announced plans to transition to T+1 settlement in May 2024. This significant shift will have a profound impact on global securities markets, given the dominance of the US market and its interconnectedness with other economies.
Europe, as a major player in the global financial landscape, must carefully consider its approach to settlement cycle reduction.
The European Securities and Markets Authority (ESMA) recognizes the need to align with international standards and is actively exploring the possibility of implementing T+1 settlement.
The concept of T+0 settlement, where trades are settled on the same day as execution, presents both opportunities and challenges for European market participants.
Proponents of T+0 settlement argue that it would revolutionize post-trade activities, streamline processes, and significantly reduce counterparty risk. Additionally, T+0 settlement would enable market participants to capitalize on intraday trading opportunities and enhance market liquidity.
However, implementing T+0 settlement poses several challenges. Technological upgrades would be essential to support real-time settlement, requiring robust infrastructure and secure systems.
Furthermore, T+0 settlement would necessitate a higher degree of global coordination across jurisdictions, accommodating different time zones and ensuring seamless cross-border transactions. Market participants would need to adapt their IT systems, business models, and risk management frameworks to meet the demands of near-instant settlement.
To gain insights into the feasibility and potential challenges of T+0 settlement, it is instructive to examine countries that have already made the transition to T+1 settlement. India, for instance, completed its shift to T+1 settlement in 2023, providing valuable learnings for other jurisdictions considering similar changes.
India’s phased approach to T+1 settlement aimed to acclimate market participants to the new settlement cycle gradually. The transition involved ranking stocks based on their market capitalization and introducing T+1 settlement for each group at different stages.
However, India’s experience also highlights some challenges that may arise during the transition. Late settlement rates increased as market participants adjusted to the new cycle, emphasizing the importance of thorough preparation and seamless coordination among market infrastructure firms, investment firms, and regulators.
Technological advancements will play a pivotal role in facilitating shorter settlement cycles. As settlement cycles become compressed, automation and digitization will be crucial to ensure efficient trade processing and seamless coordination among various market participants.
New technologies, such as distributed ledger technology (DLT) and blockchain, hold promise in enhancing transparency, reducing settlement times, and minimizing operational risks.
To fully leverage the benefits of shorter settlement cycles, market participants must invest in upgrading their IT infrastructure, embracing digital solutions, and adopting standardized protocols.
Automated systems for trade confirmation, reconciliation, and reporting will contribute to faster cycle times and improved accuracy. Additionally, real-time data and analytics tools will enable better risk management and decision-making.
Shortening settlement cycles requires a coordinated effort among market participants, regulators, and infrastructure providers.
While there is no legal or regulatory barrier preventing the industry from independently reducing settlement cycles, a harmonized approach is crucial to ensure a smooth transition and maintain market integrity.
ESMA’s consultation on reducing the securities settlement cycle reflects the regulator’s commitment to gathering input from various stakeholders. Market infrastructure firms, investment firms, issuers, and retail and institutional investors are invited to share their thoughts on the costs, benefits, and potential challenges associated with shorter settlement cycles.
Regulatory action may be necessary to implement a harmonized reduction in settlement cycles across the European Union (EU). E
SMA’s final report to the European Commission, scheduled for the fourth quarter of 2024, will provide recommendations on the way forward. The report will consider the feedback received during the consultation period and address any urgent issues that may arise from the North American market’s shift to T+1 settlement.
The transition to shorter settlement cycles in Europe, whether T+1 or T+0, will have a profound impact on market participants. While the potential benefits include reduced counterparty risk, increased capital efficiency, and enhanced market liquidity, market participants must prepare for the associated challenges.
Operational adjustments will be necessary to meet the demands of shorter settlement cycles. Market participants should evaluate their IT systems, workflow processes, and risk management frameworks to ensure seamless integration with the new settlement cycle.
Collaboration among market infrastructure firms, investment firms, and regulators will be essential in driving industry-wide readiness and addressing potential bottlenecks.
Additionally, market participants must consider the implications of shorter settlement cycles on liquidity management, collateral requirements, and funding arrangements. A comprehensive assessment of the financial and operational impact will enable market participants to develop robust strategies and adapt to the evolving landscape effectively.
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