A Detailed Impact Assessment of T+1 Settlement for the European and UK Markets

Introduction

The financial industry is globally transitioning to T+1 settlement. This article examines the comprehensive effects of implementing a T+1 settlement cycle in European and UK markets.

Impact on Risk

T+1 is expected to significantly reduce counterparty risk. By shortening the settlement cycle, the time a trade is exposed to risk is reduced. This benefits investors and market stability, particularly during volatile periods.

• Reduced Margin Requirements: Moving to T+1 could also lead to a reduction in margin requirements for market participants, freeing up capital for other investment activities.

However, shifting to a shorter settlement cycle could introduce new risks:

• Operational Risk: A compressed timeframe for post-trade processes increases the chances of errors and settlement failures, potentially leading to penalties and increased costs. Firms need to enhance their operational efficiency and adopt robust risk management practices.
• Increased Settlement Fails: A tighter timeline for trade processing, alongside reduced opportunities for securities lending to cover short positions, could result in a rise in settlement fails, leading to financial penalties under regulations like CSDR and impacting risk-weighted assets under Basel III requirements.

Impact on Liquidity

A shorter settlement cycle can improve market liquidity. With T+1, investors receive their funds more quickly, allowing them to reinvest sooner. This faster capital turnover can lead to a more dynamic market environment and potentially improve pricing for investors.

Impact on Operational Efficiency

A move to T+1 necessitates significant operational changes:

• Process Automation: The reduced timeframe requires firms to automate their post-trade processes. Manual processes struggle to meet the accelerated deadlines, making automation crucial for tasks like trade allocation, confirmation, affirmation, and reconciliation. The adoption of solutions like robotic process automation (RPA) and artificial intelligence (AI) can significantly enhance efficiency and accuracy.
• Technology and Infrastructure Upgrades: Firms need to evaluate and potentially upgrade their technology and infrastructure to handle the faster processing speeds and increased data volume associated with T+1. This might include new settlement platforms, enhanced existing systems, or cloud-based solutions.

While the transition involves upfront investments, it leads to long-term efficiency:

• Cost Savings: Automating processes and optimising workflows can ultimately result in cost savings for firms.
• Reduced Manual Intervention: Automation reduces the need for manual intervention, minimising the risk of human error and freeing up staff for more complex tasks.
• Improved Transaction Processing Speeds: Technology upgrades and process streamlining improve overall transaction processing speeds, leading to a faster and more efficient market.

Impact on Different Market Participants

The transition to T+1 affects all market participants:

• Investors: T+1 benefits investors with reduced risk and increased liquidity. However, they need awareness of the changes in settlement procedures and timelines.
• Brokers: Brokers must upgrade systems and processes for timely trade execution and confirmation in the accelerated settlement cycle.
• Custodians: Custodians play a critical role, needing efficient asset servicing and settlement processes to accommodate T+1.
• Global Participants: A shortened settlement cycle creates complexities for global participants, particularly those in different time zones. For instance, Asian investors trading in European securities could effectively be operating on a T+0 basis, requiring significant adjustments and pre-funding arrangements.

Impact on Cross-Border Transactions

Europe's diverse regulatory landscape presents a challenge for cross-border transactions:

• Harmonising settlement periods across jurisdictions is crucial for seamless cross-border trading. The UK, while no longer part of the EU, has close ties with European markets, necessitating alignment to avoid operational challenges.
• The multiplicity of currencies and market infrastructures within Europe further adds to the complexity. A fragmented implementation could lead to inefficiencies and increased costs, particularly for cross-currency transactions that involve FX components.

Impact on Market Infrastructure and Regulation

T+1 implementation necessitates changes in market infrastructure and regulations:

• CSDs and CCPs: Central Securities Depositories (CSDs) and Central Counterparty Clearing Houses (CCPs) need to adjust their operating hours and procedures to accommodate the shorter settlement cycle.
• Regulatory Changes: Amendments to regulations, like the Central Securities Depositories Regulation (CSDR) in the EU, may be required to accommodate T+1. These could include modifications to rules related to allocation, confirmation, partial settlement, and the provision of real-time gross settlement facilities.

Lessons from Other Markets

The experiences of other markets that have already implemented T+1 offer valuable lessons:

• US, Canada, and India: Their successful transitions highlight the importance of early planning, comprehensive testing, and industry-wide collaboration.
• Increased Automation Rates: Firms in these markets have reported significant increases in automation rates in response to T+1, particularly in areas like trade matching and settlement instructions, indicating the importance of embracing technology.

Conclusion

The move to T+1 presents both opportunities and challenges for European and UK markets. By proactively addressing the potential impacts on various stakeholders, investing in technology, and adopting robust risk management practices, these markets can leverage the benefits of T+1. A successful implementation will require a coordinated effort between market participants, infrastructure providers, and regulators, ultimately contributing to a more efficient, resilient, and globally aligned financial market.