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With ESMA recently reiterating the importance of harmonisation of shortening settlement cycles across Europe, it in effect signalled an appetite to move in sequence with the UK (provisionally end of December 2027 per task force recommendations) and Switzerland.
While nothing has been set in stone, these signals will trigger strategic and tactical planning across the post trade ecosystem in Europe, looking at readiness for just over two years’ time. While that may seem like a long time, the reality is most will need to be thinking about budgets and timelines immediately.
The impact of the recent T+1 shift in North America and the lessons learned from it were a key theme at the recent AFME OPTIC conference in London. What Europe and the UK should look to do differently in terms of preparation was a key focus. There was a lot of good discussion across the different participants but here are the top 5 things the industry needs to be thinking about.
1. Cash continues to be king
Much has been made of the margin benefit that both sell-side and custodians took from the shift to T+1, with a 30% reduction in clearing margin. However, this has come at the expense of funding inefficiency for the rest of the market, with much of the buy-side noting an increase in funding costs as a result of the reduced settlement window.
SWIFT was one of the panellists at AFME OPTIC, and noted that while buy-side FX payment volumes have gone up as a result of the move to T+1, the average size has decreased. This indicates a loss of efficiency in cash management overall as a result of more frequent trading in smaller sizes.
The cost and operating model considerations of expanding the scope of T+1 to a wider universe of currencies and assets shouldn’t be underestimated. This creates both a challenge for the industry and also an opportunity for service providers to play a more global role in insulating participants from this effect.
Custodians and service providers bringing together settlement processing, cash management and funding into a 24/7 model will become increasingly attractive. But they will need to show value – operationally, commercially and from a client service perspective – which hasn’t always been the case and has led to the current fragmented processes.
2. Affirmation, affirmation, affirmation
The role of the affirmation process has undoubtedly contributed significantly to the lack of market disruption from the move in the US. This was a relatively new concept for many outside of the US, but its value in driving settlement discipline has been clear to see.
Driving adoption as part of the march to T+1 however will be much harder within the UK and the rest of Europe, as it will require regulators and the industry to agree on the right framework that incentivises take up (and dis-incentivises non-compliance). This is easy to say, but much harder to do in practice, and locking effective affirmation processes into the migration timeline will require intensive collaboration.
3. Securities lending is a game of moving parts
The relative lack of automation, allied to the global nature of liquidity pools within securities lending, created a major cause for concern with the move to T+1 in the US. While the key metrics – fail rates as an example – would imply there hasn’t been much market impact, the reality is that liquidity has reduced as a result of the need to maintain higher inventory buffers and a general risk reduction across trading desks. 50% of the industry are now citing securities lending as the single biggest impact of the move to T+1, which has increased from 33% 12 months ago. (Citi Securities Services Evolution 2024)
The marketplace across the UK and Europe is much more complex than the US – different taxation regimes, business models like synthetic prime brokerage, ETF complexity, investor behaviour – and securities lending is a critical component of efficient market practice.
The role of collateral mobility, both to support trading activity as well as margin and funding, is critical to enabling these businesses. But though the growth of tri-party providers and automation solutions has increased over the last decade, the market is still heavily reliant on people and legacy processes to make it function.
It is hard to imagine that an equivalent reaction in terms of liquidity and risk appetite won’t fundamentally alter the economics of doing business. So being able to efficiently mobilise collateral across a wide spectrum of uses, locations, clients and business units will become a critical piece of the puzzle.
4. Automation everywhere (or not actually)
While the role of the affirmation process in driving smooth implementation in the US has been well publicised, what is less obvious is how participants have actually achieved dealing with compressed timelines.
The perception that the industry was in part ‘throwing people at the problem’ vs re-engineering systems and processes has been borne out by some of the recent industry feedback. 31% of the industry confirmed they had achieved compliance by simply adding people to their operations teams, which compared to only 18% 12 months ago. And anecdotally, this number increases to > 50% in some of the larger brokers and custodians, many of whom have been reported to have added significant headcount. (Citi Securities Services Evolution 2024)
This would potentially imply two things:
- The industry underestimated the challenge and impact to their operating models and had to invest more in people as the deadline neared.
- Organisations left it too late to get mobilised, leaving insufficient time for automation and ultimately compensating with people to plug the gaps.
This latter point would also imply there is an element of catch up within investment cycles going into 2025 and beyond – which is going to create capacity challenges as organisations balance investment in remediation vs planning for 2027 and beyond. Organisations in the UK and EU would do well to apply the lessons their US counterparts learned, particularly into investment thinking. But, as we’ve seen in the past, the industry frequently talks a good game and then reverts to tactical compliance to hit the dates.
One panellist at AFME shared an excellent analogy from a recent post trade conference, stating that “the industry is currently very focused on the shiny T+1 penthouse but is ignoring the fact that the foundations are cracking”. This underlines the challenges that many organisations face: they are unable to mobilise effectively to unpick what are extremely complex legacy architecture and process challenges so paper over the cracks instead.
Focused on the ‘penthouse’
These are not simple challenges to solve (otherwise they would have been solved already) but warrant serious attention as the industry considers its next steps. Adding headcount to deal with a relatively simple set of market infrastructure practices (in the US) vs trying to replicate that approach across a region with almost 40 financial market infrastructures (FMIs) is clearly not realistic.
The positive adoption of AI and other trade process automation tools has shown in part what can be achieved through leveraging the types of innovation that were not present 10 years ago. But technology in itself is not going to deliver automation, it is merely an enabler and the industry will need to mobilise quickly if it is to learn from the global experience of T+1 to figure out operating model optimisation.
5. Governance is not sexy, but it’s necessary
What the North American regulators did well was communicate clearly and often, creating momentum and also certainty (the slipped milestones that characterised Dodd Frank and other regimes in the past weren’t going to happen here). This energy pushed the whole industry towards the end goal, with working groups mobilised and being visibly active around decision making on key points of contention.
Replicating this across multiple jurisdictions is going to be much, much harder and regulators, FMI’s and the industry working groups that guide them need to be highly focused on mandating the right structures and behaviours to lead the industry forward.
The US experience has shown a blueprint, but it doesn’t have to be adopted – there is a much greater degree of complexity across the UK and Europe, which can’t be ignored in attempting to globalise T+1. The industry shouldn’t be blind to this and has to balance pragmatism with market impact – for no other reason than the sheer scale and complexity of cross-border flows across the region.
Looking ahead to 2027
The experience of the T+1 shift globally has shown some positive signs, but that doesn’t mean one-size fits all in terms of implementation. The costs of compliance will be significant and the economic benefit of the change has not been equally distributed across all market participants. Individual firms should not be reliant on moving with the herd, as the nuances of systems and process, business mix, investor and client mix and geographical reach, will all ensure that no one firm’s challenges (and opportunities) are the same.
The US experience has signposted what the future could look like in terms of market efficiency and standardisation, but this should not be viewed as a ‘cut and paste’ around what will work elsewhere. Bringing similar value will require collaboration and consensus across a fragmented post trade landscape across the European region, which is not in itself a trivial exercise.
James Maxfield is Chief Product Officer at Duco
