By James Pike, ex- EMEA client operations chief at Morgan Stanley, now head of business development at Taskize (a Euroclear company)
In the global and highly unpredictable world of capital markets, adaptability to change is of paramount importance. Earlier this month, the European Securities and Markets Authority (ESMA) issued a “call for evidence” to consult on shortening the settlement cycle across equities, fixed income and exchange traded funds (ETFs). Europe’s regulator seeking market feedback is all well and good, but when it comes to moving to T+1, the train has left the station and there needs to be a common approach across the different markets. The trouble is that continuous consultations followed by endless reviews, while important, can all too often lead to unnecessary delays. Remember how long it took for MiFID II to come into force?
These are delays that, frankly speaking, European equity and bond markets cannot afford right now. Liquidity is fleeing Europe for the US, and if the current state of affairs remains unchanged, this trend will likely continue. According to research from AFME earlier this year, the European Union’s (EU’s) market capitalisation (or the total market value of shares for listed companies) was only €10.4tn at the end of 2022, compared to €38tn in the US – in other words, it was less than one-third of US market capitalisation. Furthermore, turnover of EU shares (a measure of liquidity) remained completely flat from 2016 to 2022, while this measure increased by 40% in the US over the same period. These are, frankly, eye watering findings for any investor on the continent.
The harsh reality of Europe’s current liquidity woes is that if Europe does not replicate the US’s shift to T+1 post next May, the flow of investment will continue to move from the continent into US equities. There is no escaping the fact that the high growth companies are listed in the US. One only need look at a standard pension plan – 80% is likely to be in US stocks. While traditional US equities have always performed better in terms of returns (driven in large part by a thriving technology sector), a slow shift to T+1 – or worse, no shift at all – will only serve to worsen liquidity conditions across Europe.
For instance, the current T+2 settlement cycle requires traders to set aside capital to cover their trades for two days after execution. Unfortunately, this tie-up of capital limits the funds available for other trading opportunities which, by definition, doesn’t exactly help with liquidity. A shorter settlement cycle can also heavily influence the market for securities lending and borrowing. Market participants may find it less attractive to lend or borrow securities when settlement occurs more quickly, potentially affecting short-selling strategies and overall market liquidity. If this was not enough, shorter settlement cycles can make a region much more attractive to traders and investors. As a result, failure to adopt T+1 quickly could leave European markets lagging behind the US even further.
All this reinforces the importance of financial institutions ensuring they have more than one eye on a European move to T+1 while working through preparations for the US switch. This starts by addressing longstanding administrative and operational niggles that have led to increased errors, slower processes, and ultimately costs under T+2. The shortening of the settlement cycle means there is even less wriggle room for resolving trade disputes, for example. When disputes inevitably arise, it is crucial to initiate immediate contact with the right counterparty or relevant intermediaries as quickly as possible to ensure all trade details are accurately documented, including the trade date, asset, quantity, and price.
Europe has a history of dynamic and innovative financial markets. A delay to moving to T+1 could potentially impede the competitiveness of these markets, undermining their ability to keep pace with rapidly evolving global trading landscapes.
In this age of rapid tech advancement, European markets cannot remain bound by outdated settlement cycles. The benefits of transitioning to T+1 are clear: increased liquidity, reduced risk, and enhanced global competitiveness. By swiftly following in the footsteps of the US, Europe can not only take a significant leap toward shaping the future of market infrastructure across the continent, but also preserve its place on the global capital markets stage.
