‘T+1’ settlement ‘event risk’ looming as calls grow for coordinated European approach

The European T+1 Taskforce, which comprises representatives of various industry associations across buy-side, sell-side, and market infrastructures, made the recommendation ahead of a coordinated shift to next business day settlement requirements – a so-called ‘T+1’ model – in North America.

Subject to exceptions, that change means that most securities transactions in the US, Canada, and Mexico will need to settle within one business day of their transaction date. The change takes effect on 28 May 2024 and is being implemented at a time in which technological improvements are enabling financial trades to be executed and settled much faster than they used to. Despite this, a similar shift is not imminent in Europe, where a T+2 settlement model will continue to operate.

“Our shared ambition is for a low-cost, efficient, safe, resilient and integrated post-trade environment which supports globally competitive European securities markets, with high levels of automation and standardisation,” the European T+1 Taskforce said (5-page /282KB PDF). “We anticipate that alignment of dates will reduce the complexity of implementation projects for firms active across multiple jurisdictions, and minimise scoping issues related to instruments listed, traded and settled across geographical Europe.”

Recently, the UK government confirmed its support for a move to a T+1 model in the UK. It gave its full endorsement to a recommendation – made by a taskforce it set up in late 2022 – that the move should happen by no later than the end of 2027. The recommendation was contained in a report published by the Accelerated Settlement Taskforce (77-page / 544KB PDF), which the government had tasked with examining the case for trades to be settled more quickly in the UK.

For settlement in EU markets, Mairead McGuinness, EU financial services commissioner, has implied that a move to a T+1 model is inevitable, but there is as yet no clarity on whether, and if so when, such a change might be implemented. The European Securities and Markets Authority (ESMA) is under a statutory obligation to file a report on the issue with the European Commission by 17 January 2025. That report, among other things, will need to include ESMA’s assessment of the appropriateness of shortening the settlement cycle, the potential impact that change would have on market participants, and the costs and benefits of such a change.

To inform its report, ESMA opened a consultation on shortening the settlement cycle last October. The consultation closed on 15 December 2023. Last month, ESMA published a summary of the feedback it had received to the consultation. It cited a lack of consensus amongst stakeholders on the costs and the benefits of T+1 and further feedback that suggests major changes to the way in which markets operate are necessary if a T+1 model is to be achieved in the EU.

In Switzerland, the Asset Management Association in the country has said a shift to a T+1 model is needed “for competitiveness reasons”. It also believes it makes sense for Switzerland to coordinate with the UK and EU on such a move.

Mark Shaw of Pinsent Masons said: “The forthcoming shift to a T+1 model in North America poses immediate operational and regulatory challenges for asset managers in Europe, and raises longer term questions relating to whether, how, and when European markets follow suit.”

“On an operational level, a shorter settlement cycle increases the risk of trade failures. That risk can arise because the stock promised to the buyer is not always actually held by the seller – it is often held under stock loan arrangements and in multiple custody accounts, or because of complications associated with when stock is declared as dividend. It can also arise because of a failure to deliver cash, via the foreign exchange process, to settle equity trades. Smaller fund managers in Europe, who have to deal with the time difference and different trading hours, may not be able to afford an on-the-ground presence in the North American markets to ensure those processes complete in time,” he said.

According to Shaw, on 28 May 2024, the risk of trade failures will be heightened, since there is likely to be double the volume of trades in a single day – i.e. those to be settled under the old T+2 model and those to be settled in accordance with T+1.

“The ‘event’ risk and ongoing operational challenges thereafter are compounded by regulatory restrictions,” Shaw said. “Fund managers in Europe face challenges in achieving T+1 settlement in respect of their trading of US cash equities, in compliance with the rules in the US market, while continuing to fall within limits imposed under the EU UCITS rules, which restrict how much cash they can hold in reserve and how much they can borrow against the assets they hold. There is a 20% cash limit, as against the value of their whole portfolio of assets, and a 10% leverage limit too.”

“European fund managers can mitigate the event risks by minimising US equity trades over the change. Where this is unavoidable, for example where they are managing a US equities exchange traded fund (ETF) that is highly liquid, there is a risk that cash or leverage buffers could be triggered, or that some trades fail. Where there is a regulatory breach, this should be reported immediately, and the breach remediated as soon as possible,” he said.

In respect of the EU market, ESMA has already said that it won’t exercise regulatory forbearance in respect of the UCITS regime to account for the T+1 transition in North America, and national regulators across the EU have requested information from fund managers in their jurisdiction about what they are doing to prepare for the change coming.

“In the longer term, it seems inevitable that European markets will follow North America in transitioning to a T+1 settlement cycle,” Shaw said. “Fund managers would face additional complexities if the UK, EU and Switzerland moved at different paces in this regard, so they should take every opportunity to stress the importance of a coordinated approach to relevant policymakers and regulators.”