US T+1 Implementation in Europe: The Liquidity Crunch
7 Key Points on what we learnt at the #FIXFRANCE Trading Conference 2023
The final rule from the SEC to shorten the securities transaction settlement cycle is not only a significant shift for the US but also creates considerable challenges for European and APAC firms. ?
Noting the benefits in promoting operational and capital efficiency in resolving margin issues such as Gamestop[1] , the reality for European firms is that shortening the settlement cycle from T+2 to T+1 represents a transfer of risk from the market to greater settlement risk for themselves.?
Timelines potentially will be reduced to five hours for the buy-side, even down to possibly just two hours for those with clients based in Asia, to ensure the cash is in the right location and currency to settle a trade.? Together with the disconnect between market settlement (T+1) and fund subscriptions and redemptions in Europe (often T+3 or T+4) the cost to trade will become increasingly expensive and exclusive. Greater automation in workflows is desirable but as yet does not solve all the issues, and for some is still unworkable in practice.? The sheer market complexity of 29 CSDs in Europe versus two in the United States, 16 CCPs in Europe versus a single CCP in the US with euro and non-euro zones to contend with mean the benefits from the US move to T+1 for European firms is far from clear.? The risks for those firms unable to meet these challenges have the potential to be severe, even preventing access to US securities as an investment option.
On the panel at #FIXFRANCE 2023 we discussed just how prepared Europe was for the changes in May 2024; what progress has been made in resolving the issues and where do the pain points remain – here’s what we learnt:
1.????? Industry inequality is likely to increase.
Larger asset managers with a global footprint will have the advantage of leveraging local resources.? Local European asset managers will be limited to:
a.????? extending back-office hours to manage the shortened settlement time – not ideal for staff morale or recruitment.
b.????? Holding currency in the fund to manage cash management requirements, risking fund performance drag in a competitive environment.
c.????? Changing investment strategies to either derivative assets or non-US securities which may require repapering.
d.????? Utilizing third-party services which, with less direct control for operations departments in firms, may or may not be desirable.
2.????? Current industry technology solutions do?not solve all issues.
a.????? DTCC Match to Instruct will require firms to self-affirm, adding additional settlement risk in house that was previously with the custodian.
b.????? Without CLS extending cut-off times, the percentage of FX transactions settling will push more activity back to gross bilateral settlement, losing the ability to net off FX positions and increasing settlement risk which some firms’ operations teams are not currently set up to handle.?
c.????? Most back-office technology system upgrades are multi-year installations leaving insufficient time to address.
3.????? Managing the mismatch in settlement cycles incurs additional expense and risk of regulatory breaches.
EU asset managers have multiple fund set-ups with subscription and redemption cycles between T2 and T4 in the main.? These fund set-ups are also often attached to national law, so firms not only have to manage differences between US and EU regulatory frameworks but also under different member state national law.? For example:
a.??????? breaching cash holdings in UCITS funds to manage your FX requirements in advance is seen as a passive breach in Ireland and therefore a possibility for firms, but an active breach in Luxembourg which would lead to non-compliance.?
b.?????? Establishing credit lines is likely to be more expensive due to higher interest rates and again will put larger firms at an advantage over smaller peers in obtaining funding.
c.??????? Use of overdrafts may require changes in fund structure and repapering.?
d.?????? If brokers provide these services, questions remain as to whether this is an inducement to trade and whether the regulator will accept systematically settling on an alternative settlement date.
领英推荐
4.????? Unknown impacts for liquidity flows, particularly for FX
While the impact on liquidity formation remains theoretical, there was discussion on the likelihood of reliance on the 4pm London Fix having to change.? Given current FX flows at the US close, the compressed settlement timeline is likely to lead to changes in FX flows and spreads across all currencies, G20 & EM, or EM, impacting banks forward flows as well as asset managers.? Current options for firms include:
a.????? Trading local hours in the US or APAC provided there is sufficient liquidity;
b.????? Trading with estimated FX calculations on a non-confirmed basis;
c.????? Greater real-time batch FX trading intraday, limiting the ability to net off all positions.
5.????? Custodian Responses
b.????? Buy-side firms are also struggling to manage these different custodian solutions given it is the underlying clients who select the custodian, limiting their ability to respond.
6.????? Changes in working practices.
a.????? An automatic increase in the cost of trading for funds and ETFs to make up for the funding gap associated with T+2 settlement for funds, and T+1 settlement for US securities is likely to impact liquidity provision. ELP’s will need to align their strategies to cope with the mismatch in settlement cycles for creation and redemption.
b.????? Securities Lending is becoming less attractive to mitigate against settlement fails when faced with shorter recall periods, and a resultant performance drag on funds.? Some firms no longer offering out stock due to the laborious process involved in resolving settlement fines and CDSR. German funds require immediate compensation for any fails even if it represents a minimal amount.
c.????? Managing holiday periods in non-US jurisdictions will make it very difficult to comply with T+1 settlement without employing staff to work public holidays – adding additional expense to those firms unable to employ staff locally.
?
7.????? Debating the EU move
a.????? Understanding the European perspective on potential regulatory breaches, Best Execution, and the concept of inducement to trade is crucial for business practice and compliant workflows.
b.????? ESMA noted that one of the alternatives to consider is to move directly to T+0 given that most firms will have to shorten their processes to T+0 to address the US move before they are able to get to T+1.? They invited firms to respond directly to the Call for Evidence (https://www.esma.europa.eu/press-news/consultations/call-evidence-shortening-settlement-cycle ). ESMA noted that this is an important issue given the potential for the UK also to move (estimated April 2026). ESMA also indicated that some stakeholders were of the view that a misalignment between the EU and the UK would sharply increase the level of complexity.
c.????? All panellists highlighted the need to move in tandem with one suggestion being moving asset classes across to T+1 gradually, equities first.? Though with the level of multi-asset interconnected global trading today, others felt this would add to the complexity, rather than resolve the issue.
d.????? Also noted was the need for central banks to change their settlement cycles.
There remains an argument that the move to a shortened settlement cycle is inevitable, given the rise in interest in crypto and other asset classes that have the potential to settle instantly.? The industry will find solutions to the issues outstanding and this may involve hedging using tokenised assets to trade out of positions.? What is clear is that business practices that may now become obsolete will need to change.? But change takes time and with the US implementation supposedly just six months away, industry engagement in how to solve the challenges is crucial – whether at the custodian, broker, asset manager or even regulatory level.?
At FIX we are working hard to engage all levels of industry to find solutions in better working practices and automated workflows such as stock loan recall – for more details on how you can get involved please contact the FIX Program Office.
For more detail on the issues involved please see the Thought Leadership Paper from the Plato Partnership from early 2023 - https://bit.ly/T1-LookingattheBiggerPicture