The fragmented nature of the European market combined with the Central Securities Depositary Regime (CSDR) makes T+1 settlement a daunting prospect for the ETF industry.
Last year, US regulators announced plans to transition to T+1 settlement from T+2 which is currently in place across the majority of jurisdictions including Europe, Latin America and Asia.
The proposed move is designed to drive more efficient use of capital across markets by reducing credit, market and liquidity risks.
As Adrian Whelan, global head of market intelligence at Brown Brothers Harriman, explained: “The more risk, the greater the amount of margin and collateral that is required to be deposited with the clearing house to mitigate the potential failed securities trade.
“It then follows that a reduced settlement time equates to a reduction in risk, as well as margin and collateral requirements.”
The proposals suit the US market which operates with a single currency and effectively a single market. The same cannot be said for Europe which is a continent of 35 exchanges, 31 central securities depositaries (CSDs) and 14 local currencies.
“Europe is not the United States of Europe,” Whelan toldETF Stream. “Within each financial market, local nuances still exist regardless of thedesire for harmonisation.”
For the European ETF market, the issue is particularly pertinent as settlement failures are already above market averages, according to the Association for Financial Markets in Europe (AFME).
“This is in part due to the global composition of many ETFs, which contain underlying securities from several jurisdictions,” the AFME said.
“Because settlement of newly created units is contingent on the settlement of the underlying constituents, this can often lead to settlement delays in a T+2 environment, due to time zone differences, market holidays and cross-border settlement complexity.
“These challenges would be even more pronounced in a T+1 environment.”
Furthermore, the introduction of CSDR in February 2022 means the proposed move comes at a time when Europe is still addressing the challenges posed by this regime.
While the European Commission has postponed the introduction of mandatory buy-ins until November 2025, fines are still issued for liquidity providers that fail to settle trades on time meaning a move to T+1 would only increase the pressure on these firms.
This could lead to unintended consequences such as widening spreads as market makers are forced to pay a premium for liquidity in order to settle on time.
“This will of course impact CSDR that came into force last year and is currently under review,” Jim Goldie, head of ETF capital markets and indexed strategies, EMEA, at Invesco, told ETF Stream.
“The aim of the regulation was to improve settlement discipline in Europe, not only for ETFs, but also for equities and bonds and it will be interesting to see how this develops in 2023.”
Finally, a move to T+1 settlement should be a global effort. If one jurisdiction forges ahead, Whelan said this would create “operational inefficiencies”.
“The perfect scenario is all or nothing. Either everyone stays on T+2 or moves to T+1,” he continued. “If there is a disconnect, it creates operational risk.”
Echoing his thoughts, Goldie added: “In the scenario where some countries adopt this shortened settlement cycle and others do not, it can lead to settlement cycle mismatches between underlying markets or the ETF wrapper itself.”
Overall, the European market has major challenges to address if it is to follow the US in migrating to T+1 settlement. As the AFME said, “concerted” industry effort will be required if this is to be achieved.