Looking for T+1 in the EU? Think 2028…at the Earliest

One of the FX themes of the transition to T+1 settlement in North American securities markets has been the attitude of the European authorities towards mirroring such a move. Officials in the EU have said such a move is “inevitable”, however a new report from the European Securities and Markets Authority (ESMA), makes clear that such a move remains years away.

In a feedback statement on its October 2023 call for evidence on shortening the settlement cycle, which sought stakeholders’ views as well as quantitative evidence to form a better understanding of the possibility for the EU to shorten the settlement cycle, ESMA says such a move will take place “no earlier” than 32 months after the financial industry is advised by the authorities of its decision to implement T+1. Given that the regulator plans another report on the issue to be published in Q4 2024, the likelihood is that the EU will not be in a position to transition until at least 2028.

ESMA observes that it requires “further assessment” of the issue and that any change will require “intensive cooperation between regulators and the industry” and that no specific body has been formed by the EU to coordinate the transition.

ESMA was seeking feedback on both T+1 and T+0, and a potential worry for markets could be the US in particular moving again to T+0, as has been suggested in come circles. Following the feedback, the European regulator says it will focus solely on T+1 as the majority of respondents indicated that whichever definition of T+0 is provided, the costs of such a move would largely outweigh the benefits.

The feedback suggested that the move to T+1 in the EU would be more difficult than in other regions of the world due to the complex and fragmented nature of EU financial markets. Respondents highlighted not only the high number of market infrastructures, but also other issues such as the unharmonized national securities laws.

Additionally a number of respondents indicated that T+1 might be challenging in situations where FX bookings are required, in particular for less liquid currencies (which ESMA cites as BGN, CZK and HUF) but also for investors in different time zones.

When talking about FX, inevitably CLS is a hot topic, ESMA says almost all respondents referred to CLS, with several arguing that missing the CLS cut-off of 00.00, midnight CET,

would result in increased settlement risk of the FX transaction. Some respondents, who may not have been paying close attention to the FX debate over the North American change,

highlighted that the CLS deadline will need to be changed in order to continue to channel

FX settlement through the mechanism. This is, of course, already under consideration and CLS has conducted a feedback survey on extending its settlement window.

As is the case with the North American move, respondents raised the need for pre-funding FX transactions as a side-effect of the mismatch between settlement cycles, with some highlighting that pre-funding based on estimated amounts of cross-border securities transactions might lead to “extremely high liquidity and funding costs”.

The net result of such a change, it was argued by some respondents, could be market participants executing FX transactions during periods of reduced liquidity, thereby increasing the cost.

Interestingly, ESMA says many replies noted that a decrease in use of CLS is “foreseeable”, however, “all the alternatives identified are more expensive”. It adds, “As a side-effect of the challenging cut-off times of CLS, market participants will shift to bilateral transactions adding settlement risks and costs.”

The feedback stressed the importance of aligning any work with the UK and Swiss authorities to ensure a coordinated move across the continent, all of which suggests that even 2028 could be optimistic for the final changeover. In this case, the FX industry probably needs to bed down its processes for calculating and processing FX hedges as soon as possible after the North American changeover – because this new way of doing business is likely to be here for some time.