T+1 – The First Report Card Comes Out

First formally proposed by the US Securities and Exchange Commission (SEC) in February 2022 following the now infamous meme stock trading episode, T+1 finally went live in the US (and also Argentina, Canada, Jamaica and Mexico) in late May.

So far, the industry appears to have handled this initial transition reasonably well. In the week after T+1’s launch, affirmation rates were above 91%, while fail rates were broadly within their T+2 parameters.

Although it was reported there was a marginal jump in the trade fail figures on days three and four following an MSCI rebalancing and a double settlement day whereby T+1 and T+2 trades settled concurrently, it highlighted rates subsequently normalized.1

Whether T+1 can be judged a success or not will only become obvious in the months ahead as more detailed data comes in, particularly around securities lending and corporate actions, a point made by multiple speakers during TNF.

T+1 Takes Shape in Europe

With T+1 now up and running in North America,  the debate about shorter settlements is now pivoting towards Europe. 

Despite the European Securities and Markets Authority (ESMA) having yet to carry out any cost benefit analysis on T+1, Jesús Benito, Head of Domestic Custody and Trade Repository Operations at SIX, said the EU is expected to introduce T+1 within the next five years. “This might sound like a long time away, but it really is not,” he added.

A number of T+1 risks have been flagged by various European industry experts. 
Although proponents argue that shortening the trade settlement cycle will help free up trapped capital (i.e. less settlement duration risk during the trading lifecycle allows for margin optimization, facilitating greater liquidity), one speaker at TNF said early indications from North America suggest that firms are having to borrow large amounts of cash at vast expense to meet their FX funding requirements under T+1.

In an ESMA consultation, several industry associations also warned that shorter settlement cycles will mean firms have less time to perform their post-trade functions.

According to the Association for Financial Markets in Europe (AFME), the time available for post-trade processes in a T+1 environment could be reduced by 82%, from 12 hours to two hours, although another industry body puts that figure at 92%  (from 26 hours to two hours).1

Should fails increase as a result, then firms could face penalties under the EU’s Central Securities Depositories Regulation (CSDR).

“The impact of T+1 on securities lending could also be significant. Equally, there will be challenges for dual listed securities in T+1 and T+2 markets, and exchange traded funds (ETFs) which are made up of baskets of securities from T+1 and T+2 markets,” commented Benito.

Laurent Lefèvre, Head Delivery Capabilities, SIX

Testing is an absolute must if financial institutions in the EU are to manage T+1. Firms need to be prepared well in advance of any T+1 deadlines.

Jesús Benito, Head of Domestic Custody and Trade Repository Operations, SIX

Learning from North America

Although T+1 will present its own unique challenges for the EU, they are not insurmountable.

One way to reduce disruption would be to ensure that the EU introduces T+1 in lockstep with other major European markets, namely the UK and Switzerland, to avoid fragmentation, said Benito.

The EU should also look to North America for guidance on T+1.
“Understanding what the problems and pain points were during North America’s introduction of T+1 will be critical to ensuring a successful T+1 implementation in the EU,” Benito explained.

One reason the US transition has been quite seamless (at least so far) was because the industry repeatedly tested its systems in the Depository Trust & Clearing Corporation’s (DTCC) testing environment in the nine months leading up to the T+1 go-live date.

“This is a lesson the EU should certainly take on board. Testing is an absolute must if financial institutions in the EU are to manage T+1. Firms need to be prepared well in advance of any T+1 deadlines,” concluded Benito. 

Centralized Clearing Undergoes a Transformation

The merits of central counterparty clearing house (CCP) interoperability, the growing trend towards FMI consolidation, and the decision by some CCPs to clear a more diverse range of asset classes, were among some of the main talking points during TNF. 

Interoperability and Consolidation Come back into the Fold

CCP interoperability could help accelerate the adoption of the EU’s Capital Markets Union (CMU) programme.

“Within the framework of the CMU, CCP interoperability could play a major role in driving flows towards capital markets. Interoperability has created a lot of value as it has driven down prices at CCPs and facilitated easier cross-border clearing,” said Laura Bayley, Head Clearing Services at SIX.

She continued: “If the EU is serious about building a resilient and competitive CMU, then there needs to be more of a push from regulators about the benefits of interoperability or at least open access under the Markets in Financial Instruments Regulation (MiFIR).”

Although interoperability offers plenty of cost synergies, it is facing mounting competition from the preferred clearing model, a set-up where both counterparties to a transaction must select their preferred CCP. However,  in markets where interoperability is not available, CCPs – such as SIX x-clear– will sometimes offer the preferred CCP model to their clearing members. 
“We recently went live with Euronext markets as a preferred CCP, for example” said Bayley.

The debate about FMI consolidation in Europe shows no sign of letting up either, especially as regulators move ahead with the CMU program, according to speakers at TNF.

Bayley continued: “One of the ideas being circulated is that Europe has too many FMIs relative to the US, a market widely considered to be more attractive for investors than Europe. One theory is that the sheer number of FMIs in Europe makes it harder for people to invest. A question is also being asked about whether we need further consolidation of CCPs in Europe, where there are currently 20 CCPs operating. However, this is something I believe will happen organically in the European CCP market.” 

Moving into More Asset Classes

In order to diversify their revenues, CCPs are increasingly clearing a wider mix of asset classes.

In the case of SIX, Bayley noted: “The CCP is now clearing interest rate swaps, repos, and crypto exchange traded products (ETPs). SIX is also moving into new markets. In 2023, SIX announced it would provide clearing services to ARTEX, a multilateral trading facility that allows investors to access the fine art market.”

The Year Ahead….

With the dust settling from T+1’s introduction in North America, the EU is likely to begin its planning for shorter settlements.  Although the impact of T+1 is still being analyzed, the EU will look to learn from what happened during its implementation in North America.

On clearing, the market is undergoing a massive transformation, as CCPs look to clear new investment products while the CMU is forcing vendors to consider interoperability and M&A -  trends that are likely  to continue in 2024. 

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