AFME Cautions on T+1 Settlement Move

The Association for Financial Markets in Europe (AFME) has published a paper discussing whether Europe should move to a one-day settlement cycle (T+1) from the current two days in fixed income and equities markets. The paper follows announcements by the US and other jurisdictions earlier this year of their intention to move to shorter settlement cycles.

The paper, T+1 Settlement in Europe: Potential Benefits and Challenges highlights the key benefits of moving to a shorter settlement cycle, including risk reduction from shorter settlement cycles; the “significant” cost reductions due to better capital and liquidity risk; and global harmonisation between Europe and other jurisdictions that move to T+1.

It also, however, highlights potential obstacles that it says needs to be overcome before such a migration can take place. AFME argues there would be significantly fewer hours between trading and the beginning of the settlement cycle for post-trade operational processes to take place. “While it might be assumed that moving from two days to one day would reduce the available post-trade processing time by 50%, AFME actually estimates market participants will be moving from having 12 hours to 2 hours of post-trade operations time, an 83% reduction,” the association states.

The migration could also lead to an increase in the number of settlement fails in the market, which will incur cash penalties under Central Securities Depositories Regulation (CSDR) rules, as well as having capital impacts under Basel III requirements.

AFME also observes that time zone differences will impact the possibility of same-day matching processes for investors from outside Europe, vastly reducing the time available to communicate and resolve any breaks or exceptions. This impact would be particularly significant on cross-currency transactions which have an FX component,’ it adds.

Moving to a T+1 settlement cycle also compresses the timeline to identify and recall securities, it argues, which could lead to breaks in the process, resulting in an increase in settlement fails and cash penalties unless there is a modification to existing processes, technology and overall behavioural changes.

Finally, AFME argues that due to the global composition of many ETFs, which contain underlying securities from several jurisdictions, this can often lead to settlement delays in a T+2 environment, due to time zone differences, market holidays and cross-border settlement complexity. “These challenges would be even more pronounced in a T+1 environment,” it states. “Challenges will also exist for securities-based derivatives with further assessment required to identify impacts to the swap lifecycle, such as margining calculation and collection.”

A rushed or uncoordinated approach is likely to result in increased risks, costs and inefficiencies, particularly given the unique nature of European markets which have multiple different market infrastructures and legal frameworks

While not ruling out a move in Europe to T+1, AFME’s paper “strongly recommends” that further cross-industry discussion is required to identify and quantify the benefits and challenges of any change. It also cautions that a successful migration will require coordinated industry effort, from an initial impact assessment through to the development of a detailed implementation plan.

“An industry move to T+1 would follow the historic trend towards shorter settlement cycles, and could result in reduced market risk and associated costs,” says Pete Tomlinson, director of post trade at AFME. “However, a move to T+1 could be the most challenging migration yet because it would remove the only business day between trading and settlement, creating significant pressure on post-trade operations, particularly for global participants.

“The barriers to timely settlement in the current model need to be fully understood and addressed before Europe can move to T+1,” he continues. “A rushed or uncoordinated approach is likely to result in increased risks, costs and inefficiencies, particularly given the unique nature of European markets which have multiple different market infrastructures and legal frameworks.

“For this reason, AFME is calling for an industry task force to be set up to conduct a detailed assessment of the benefits, costs and challenges of T+1 adoption,” he concludes.