Debate on shorter settlement cycles

I recently had the pleasure of being joined by a panel of clearing and settlement experts to discuss the impending move to a T+2 settlement cycle in Europe, as proposed in the European Commission’s regulation for central security depositories and for improving settlement efficiency (CSDR).

After years of discussion around the shortening of settlement cycles, there is currently little debate over whether, in principle, the move to T+2 is a good or bad thing. Put very simply and astutely by one panellist, a shorter settlement cycle is a mechanism through which the industry can reduce risk in an obvious and clear way. Another panellist pointed out that T+2 has become one of the most palpable pieces of regulation since the global financial crisis. Compared to the complexities of the European Markets Infrastructure Regulation (EMIR)--and the significant upheaval that is anticipated as a result of the move to central clearing of OTC derivatives--T+2 is relatively easy to comprehend and implement.

There was consensus, too, over the broader benefits of moving to T+2. The panellists agreed that not only will participants--including asset managers, broker/dealers and custodian banks--benefit from a reduction in counterparty risk, they will also be able to reduce the amount of assets tied up in a transaction, meaning that these assets can  be reinvested faster, which in turn will increase liquidity.

So, the economic and political drivers for T+2 in Europe are generally, widely accepted. Where the apprehension surrounding shorter settlement cycles became apparent was in relation to discussions around the readiness of market participants’ internal operational processes. The question raised was--if internal systems are not robust or sophisticated enough to cope with faster settlement, would a decrease in counterparty risk be offset by an increase in operational risk? While a valid concern, this cannot be used as grounds for contesting an industry-wide move to shorter and harmonised settlement cycles, and nor will regulators allow it to be so. 

The system changes required for a move to T+2 are not insurmountable, particularly for larger firms that already have in place automated middle office processes. That said, two important factors that need to be addressed by all market participants were highlighted by the panel. The first is the need for counterparties to submit the economic details of a trade as soon as possible. The second, is the requirement for counterparties to verify trades on the day they are executed (known as same day affirmation or SDA). While it was pointed out that the latest draft of the CSD Regulation does not include a requirement for SDA, one panellist stated that it would be one of the biggest by-products of T+2, and a very positive one. Another panellist agreed, saying that in order to meet the T+2 deadline, SDA will be a necessity, particularly when settling trades with clients operating outside of Europe.

The panel went on to discuss the consequences for late settlement which, according to the CSDR, will incur financial penalties and a naming and shaming regime. Again, there was a broad level of support for this approach. The panel felt that in order for the industry to realise the benefits of T+2, it is necessary to have a strict settlement regime with mandated requirements--including incentives to settle trades on time.

Finally, the panellists shared the opinion that increasing the industry’s awareness of the move to T+2 is a critical factor in facilitating a smooth transition. My own view is that this is by far the most important factor, and one that is needed so that market participants can begin to prepare.

Joining Tony Freeman, executive director of industry relations at Omgeo, on the panel discussion, “The Truth about T+2” was Alan Cameron, Head of client segment – broker dealers and investment banks, at BNP Baribas, Ben Parker, Head of EMEA clearing and settlement at UBS Investment Bank and Robert Fair, Senior Business Development Manager at Euroclear. The video can be viewed here: https://www.finextra.com/video/video.aspx?videoid=271&topic=pto

The event was moderated by Virginie O’Shea analyst at Aite Group.