The majority of European securities markets will shorten their settlement cycles by one day from 6 October, moving from T+3 settlement to T+2. Germany already settles on T+2. In Spain the fixed income market will move on 6 October, but the equity market will not move to T+2 until November.
|The full list of countries migrating on 6 October is:
Austria, Belgium, Croatia, the Czech Republic, Cyprus, Denmark, Estonia, Finland, France, Greece, Hungary, Iceland, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Norway, Poland, Portugal, Romania, Slovakia, Sweden, Switzerland, and the UK.
The shortening of the cycle is triggered by the introduction of the new CSD Regulation (CSDR), which mandates T+2 settlement for trades on trading venues by 1 January 2015 at the latest. However, the decision has been taken by most markets to implement the change ahead of the deadline.
How it will work
The last day of trading for T+3 settlement will be Friday 3 October, which will settle on Wednesday 8 October. The first day of trading for T+2 settlement will be Monday 6 October, which will also settle on Wednesday 8 October, which will therefore see double settlement volumes.
Guidelines on best market practice during the migration have been issued by the T2S Harmonisation Steering Group, the Association for Financial Markets in Europe (AFME) and the International Capital Market Association (ICMA).
The main points of best practice are:
- Although the CSDR requirement only applies to trades on trading venues, it is recommended that over-the-counter (OTC) trades should also move to T+2 from 6 October.
- The market should avoid rebalancing indices and making portfolio transfers around the migration weekend.
- Issuers should avoid major new issues or corporate actions around the migration weekend.
- The timetable for processing corporate actions should in future be adjusted in line with the new settlement cycle.
- In future, pre-settlement matching should be completed on T+1. This will require investment in automation of post-trade confirmation and matching by any firms that have not already automated these operations.
- The settlement cycle for financing operations using repos will shorten from T+2 to T+1: since the positions to be financed will only be known at the close of trading on T, the repos will have to be agreed on T+1 for settlement next day, in order to provide financing for settlement on T+2.
Most trades on trading platforms are now netted and cleared through central counterparties (CCPs). There are two possible approaches to netting during the migration period: trade date netting or settlement date netting. LCH.Clearnet SA (in Paris) will adopt settlement date netting and net all trades due for settlement on 8 October (ie those traded on both 3 and 6 October), while LCH.Clearnet Ltd (in London) and EuroCCP will adopt trade date netting and net each trading date separately, resulting in two net settlements on 8 October.
Most investment banks and broker-dealers already have highly automated processes between trade and settlement in order to process very high volumes of trades. Although there will be a spike in settlement volumes on 8 October, given the high level of automation in major markets and the degree of netting that takes place through CCPs, it will be surprising if this causes significant problems.
The sectors most likely to feel increased pressure as a result of the shorter cycle are asset managers and custodian banks. For them there are several steps between trade and settlement: the asset manager has to receive trade confirmation from the broker and pass settlement instructions to the custodian, who then needs to match with the broker. These steps will need to be automated, as manual processing will not be able to cope with the shorter timetable.
This is particularly important for cross-border trading. Although some Asian markets already settle on T+2 (for example, Hong Kong) or are planning to move to T+2 (for example, Singapore), the issue for Asian investors trading in Europe is the compression in the time available for post-trade confirmation and matching because of the difference in time zones. In many cases, an Asian investor’s business day will have finished by the time a trade is executed in Europe, leaving them only one day to complete their processing and pass settlement instructions to their custodian for matching on T+1, with no margin for error. Automation therefore becomes particularly critical in Asian markets, as pointed out in a recent paper published by Omgeo, “Automation of Post Trade Processing in Asia Pacific”.
There are also implications for investors moving between markets, as the US market will continue to settle on T+3. Although DTCC issued a White Paper in April this year recommending a move to T+2, there is as yet no timetable for such a move. This means there will be timing differences for investors moving between markets: an investor selling US and buying European securities on the same day will need one day’s financing, as payment must be made for the European purchase one day before the proceeds from the US sale are received. (Of course, it works the other way round for selling in Europe and buying in the US.) There will also be a discrepancy in the settlement cycles of European stocks and the ADRs issued on them.
Old back-office wisdom has it that “Nothing good can happen between trade and settlement”. Shortening the settlement cycle makes a useful reduction in exposure to counterparty risk, provided it is not offset by an increase in exposure to operational risk. Automation and preparation are the keys to ensuring that the migration to T+2 goes smoothly.