The European Union, the United Kingdom, and Switzerland are facing pressure to follow in the footsteps of Wall Street by accelerating share trading processes. However, this move may not prevent a disparity in market practices between the transatlantic regions, according to industry experts.
On Thursday, the European Securities and Markets Authority (ESMA), which oversees securities activities in the EU, requested input from the industry regarding reducing the time required to execute a share trade. Regulators argue that this step helps mitigate risks and reduces trading costs, especially during periods of market volatility.
Reducing the time it takes to settle trades could make things smoother, reduce the amount of collateral required, and “enhance the competitiveness and appeal of EU financial markets,” according to ESMA.
Currently, trades are settled within two days of the transaction, a system known as T+2. Moving to T+1, or settling within one day, would free up cash more quickly.
With Wall Street, which represents nearly half of the global equity market, set to make this change in May 2024, there’s mounting pressure on the European Union, the United Kingdom, and Switzerland to do the same. This is because financial markets operate globally, and it’s important for these regions to align with the U.S. transition to ensure smooth trading.
Foreign investors own a significant chunk, around 40%, of the total value of U.S. companies. In 2021, they bought a total of $30.6 trillion worth of U.S. shares, according to data from the Federal Reserve.
ESMA is now looking for input on the costs and benefits of moving to a settlement period of at least one day after a trade (T+1). Many experts believe this change is likely to happen because of technological advancements, regulatory demands, and the influence of Wall Street. ESMA plans to provide a report on this matter by the fourth quarter of the next year.
“Paving the way for T+1 settlement should involve not just ‘when’ but also ‘why’ and ‘how’,” stated Pete Tomlinson, who serves as the director for post-trade affairs at the Association for Financial Markets in Europe (AFME), an organization that represents banks and asset managers.
Transitioning to T+1 settlement in Europe may be more intricate compared to the United States due to the greater number of stock exchanges, clearinghouses, and settlement institutions in Europe.
The European Fund and Asset Management Association (EFAMA) has pointed out that the shift happening on Wall Street will necessitate adjustments to the current IT systems of European firms and American investors who engage in trading European stocks.
Concerns have arisen in Europe about the possibility of some operations and trading activity moving to the United States or Canada, as wealth and fund managers can’t simply disregard the U.S. market, as outlined in a paper for the SWIFT Institute back in May.
CLS, an organization that settles forex transactions used for share purchases, is exploring ways to accommodate fund managers operating outside of the United States. These managers follow a T+2 settlement cycle and now face the challenge of having less time to secure funds for finalizing U.S. trades.
Richard Knox, who serves as the director of financial services at the UK’s finance ministry, expressed the need for the UK to align with global advancements in faster settlement practices. He emphasized the importance of carefully assessing the impact on all market segments when considering such a transition.
However, determining a consensus within the industry regarding the commencement date for this transition might pose challenges. Charlie Geffen, who leads the UK taskforce on this matter, highlighted the complexities involved. He pointed out that significant investments in back-office operations and technology would be necessary for this shift.
Geffen further explained that while the costs of these changes would predominantly affect the buy-side, the sell-side would primarily reap the benefits. This dynamic presents a challenge in achieving industry-wide consensus.
Geffen is scheduled to release an interim report later this year, with the final recommendations expected by December 2024.
Cooperation Across Borders
According to a report from the SWIFT Institute, staff handling operations at wealth and fund management firms are less prepared for shorter settlement times compared to custodians and regulators.
There could be difficulties if the UK and the EU don’t make this change simultaneously. For instance, if exchange-traded funds transition to T+1, but the stocks they are based on remain on T+2, it could create confusion and complexity.
The euro bond market is heavily traded in London but settled in Brussels or Luxembourg within the EU. Varying speeds in adopting T+1 could lead to investors changing where they trade.
“It’s crucial for EU and UK authorities to consider the potential advantages of a coordinated shift to T+1 due to the strong interconnections between these markets,” explained AFME’s Tomlinson.
ESMA suggested that regulatory action might be necessary to ensure a unified transition for all participants in the market.
Switzerland is closely monitoring the actions of the EU and the UK, although its Madrid exchange division would need to align with the EU’s decisions.
There are other potential challenges that need consideration. For example, reducing the time available for settlement preparations, like arranging currency for payment, could increase the chances of “failed” settlements.
Additionally, the practice of lending stocks to short-sellers, including hedge funds, may become more complicated. Shares are often loaned out, and shifting to T+1 would leave less time for their recall.
Furthermore, there’s talk of moving beyond T+1 to achieve instant or simultaneous settlement. India’s market regulator, for instance, aims to achieve instant settlement of stock market trades by October 2024. Mainland China already has a T+0 system in place for certain securities.
