The US T+1 Transition - how will European Financial Firms be Impacted?
All eyes on T+1
The countdown to T+1 settlement is well and truly on. In fact, we make it 246 days exactly until the settlement period of all securities transactions in the US will shorten down to one business day from two business days. According to BNP Paribas, the main driver of the reduced trade settlement cycle in the US is to reduce the pre-settlement risk of counterparties not delivering on settlement date, which generally has positive knock-on effects for capital efficiency, margin requirements and the availability of liquidity. However, as you’ll see below, adapting to T+1 settlement won’t be easy for market participants, and may arguably create some new issues for capital markets.
The change in settlement time across the Atlantic has been met with optimism and uncertainty, with European (EU and UK-based) financial firms (including institutional investors, custodians and broker dealers) set to be heavily impacted. Inevitably, T+1 security settlement brings a need for European firms to adjust their operating models and technology infrastructures if they are to continue trading in US securities. European firms currently operate on a T+2 settlement cycle, so the switch to T+1 settlement in the US could create trading misalignment and operational risks and pressures for European financial firms. The expectation is that overseas firms will be more heavily impacted than domestic US firms in the transition to T+1 settlement.
Understandably, in order to keep formality, the pressure is heaping on EU and UK regulators to follow suit and implement T+1 security trade settlement systems right away. However, that is easier said than done. According to Symphony, Europe has significantly more complex security-trading infrastructures. With 14 currencies, 18 CCPs and 31 CSDs across Europe, security settlement is a far more complex procedure than in the US, which of course has one currency and only two major clearing houses. Although it is expected that Europe will switch to T+1 security trade settlement a year after the T+1 implementation in the US, European financial firms, for the time being at least, will have to prepare, and make necessary structural changes, so that they can continue to access the US market.
What then, could T+1 settlement mean for European financial firms, and how can they prepare for this change, if at all?
Intuitively, one might think that moving from T+2 to T+1 settlement would half the post-trade settlement time. However, bearing in mind time zone differences, the settlement timeline in Europe will be roughly seven or eight hours. Even worse, if you include the entire trading day, European firms will only be left with a two hour settlement window at market close, inevitably heaping pressure on post-trade divisions, and in particular, leaving less time to source and execute foreign exchange transactions. Cash management processes will also have to be compressed into a shorter period to ensure that correct funding is in place for settlement. Collectively, this could lead to processing errors and a more frenetic, unsettled workflow.
Additionally, some classes of securities could suffer more than others. For instance, ETF trading execution will likely become more difficult, with increased complexities associated with matching newly issued units with underlying constituents domiciled in several jurisdictions under greater time pressure.
Also, it is key to note that the adjustment to T+1 settlement cycle is not only an issue faced by post-trade divisions in firms, but rather, one faced by the entire firm. Other critical business areas will also be heavily impacted, such as the middle office, securities lending departments, fails management and trading desks. For instance, middle offices may have to re-paper client agreements and shift to e-contracts, while security lenders may have to implement new collateral management platforms. Additionally, trades may not settle in time (especially those made by smaller firms, given the disparities in the size of teams who will have to deal with tighter settlement deadlines) and trading desks may have to become more nimble and improve pre-trade communications and data handling.
So, how can European firms respond?
Generally speaking, European firms will need to quickly overhaul their technology systems and business processes, from the front to the back office. That could mean replacing legacy stacks with specific and potentially costly off-the-shelf vendor solutions, adopting more automated workflows, or even leveraging consultancy services to assist with transitional uncertainties. The Depository Trust and Clearing Corporation (DTCC) currently provides consultancy services through its subsidiaries.
In fact, DTCC’s subsidiaries, which include the NSCC and the NASDAQ exchange, are currently part of an ongoing industry T+1 testing phase in Europe. European firms can test prospective T+1 processes on industry infrastructures. Testing cycles will begin on the Monday of each week up until the T+1 implementation deadline, and reset at the start of each week. For more information, click here.
Other measures are also being taken in preparation for the US T+1 settlement transition. A report by the Financial Times found that several European asset managers are currently in the process of moving staff to the US, and weighing up changes to working hours of specific roles.
However, according to Barney Nelson from The ValueExchange, firms that aren’t currently preparing for T+1 settlement may have left it too late. In fact, Nelson points out that more than 40 percent of European firms still haven’t begun preparations for T+1, although this figure is now likely lower (the analysis was collated in February 2023). Under the European legislation of CSDR, this could leave European financial firms vulnerable to penalisation from regulators if they don’t settle their transactions in time.
Although the clock is ticking, there is arguably still hope. According to Vikas Srivastava, Chief Revenue Officer at Integral, “cloud-hosted trading technology solutions can be onboarded in more than enough time giving European firms the tech capabilities and agility they need to coordinate the equity and FX trades T+1.”
While the move to T+1 implementation in the US is designed to improve trade efficiencies, it could have significant implications for European financial firms. Navigating this new terrain over the coming months will likely bring uncertainties and confusion, while pointing to a structural makeover of not only post-trade settlement divisions, but the entire firm. The nuances involved in such a transformation may arguably leave the firm with no choice but to optimise or even automate their workflows, or otherwise risk no longer remaining relevant to the world’s largest capital market, which is the US market. That in itself could be a greater cost than not taking any action to meet T+1 settlement requirements at all.