Jens Schmidt at EY Luxembourg is among some who say t+1 could hinder deeper changes that are needed in capital markets. Nicholas Pratt talks to Schmidt and others as the EU comes under settlement pressure from the US.
When the US decided to shorten its securities settlement cycle from two days to one, it presented the European market with a dilemma – does it align with the US and move from t+2 to t+1 despite the absence of any clear economic benefit? The European Securities and Markets Authority (Esma) is currently canvassing stakeholders for their views on the issue so neither a roadmap nor deadline for the move have been set. In December, the European Fund and Asset Managers Association (Efama) submitted its response to Esma. The association’s response centred on three points: Could the move(s) to t+1 and t+0 be considered separately rather than as one? Can the industry wait and see how the US migration goes first? And is it worth doing it all?
“From where we sit in Europe, I’m not sure there is any real benefit in terms of reducing cost,” says Susan Yavari, senior regulatory policy advisor, capital markets, at Efama. “It is more the case that the us is moving so we will have to move too.” While the US and the EU are on separate settlement cycles, there will be a funding gap when dealing with US securities or if US investors redeem their fund holdings. There would also have to be changes to trading processes. For example, the current cut-off period for FX settlement on Continuous Linked Settlement (CLS) – a cross-border payment system – would mean that around a third of daily FX trades with US dollars would have to settle outside of CLS and be transacted on a bilateral basis. There may also be issues with cash holdings within a Ucits fund involving a US-based counterparty/investor.
There are some potential benefits, says Yavari. For example, it will increase the level of automation and STP with more intra-day batches of processing. And it could lead to more consolidation in terms of market infrastructure. However, it could also lead to more consolidation in the asset management sector as a result of the systems upgrades required as well as the need to staff a 24/7 operation for round-the-clock coverage, which would result in less competition. There would also be less securities lending activity because of the added clearing and settlement cost, creating a less liquid market. “There is a lot of performance drag involved,” says Yavari.
“THE MOVE TO T+1 MAY LOOK REALLY GOOD FOR THE US BUT I DON’T THINK THERE HAS BEEN ENOUGH CONSIDERATION OF THE IMPACT IT WILL HAVE ON OTHER MARKETS.”
– Susan Yavari, senior regulatory policy advisor, capital markets, Efama
“No demand seen”
But while there is cost for asset managers, asset servicers and clearing and settlement providers, is there any benefit to the end investor? “I have never seen a demand from end investors for a shorter settlement cycle,” says Yavari. “Where we sit today, it is not possible to quantify the performance drag. The only real benefit is that we match the US.”
When it was put to the vote, Efama came out slightly in favour of T+1. However, the feedback from ESMA and the European Council has been mixed, says Yavari. Added to that is the UK which has stated that it will move to T+1. And while the UK has pledged to coordinate this move alongside the EU, there can be no guarantee.
“The biggest issue is the uncertainty of the US move,” says Savari. “We can make forecasts and estimates as to the cost but we will only find that out once the US has completed its move and that could take three to four years at least. The move to T+1 may look really good for the US but I don’t think there has been enough consideration of the impact it will have on other markets.”
According to Daniel Pascaud, global head of operations, banking and custody solutions at asset servicer Caceis, it is not the settlement process itself that needs to be compressed as it is already a reasonably fast transaction. Rather, it is the many interlinked processes in which buyers, sellers and intermediaries, collect, exchange and verify information before the transaction is settled.
“A major driver of the move to T+1 is to pressure the entire chain involved in the settlement community,” says Pascaud. The settlement space faces a complex web of technical challenges, but aside from these solvable technical aspects, other potential market impacts should be carefully considered, including those on FX and the provision of liquidity for repos and securities lending.
“Although straight-through processing is a desirable goal and largely a reality, manual processes are and will remain a necessary part of the settlement cycle,” says Pascaud. “For many players, a change in settlement discipline is required, such as extending business
hours to cover new cut-offs, broader uptake of automated systems, and outsourcing to third-party specialist services providers.”
Collectively in Europe, there is a very high STP rate and imitating the US initiative will further raise this rate, he adds. That is positive, because what generates the majority of the workload at the level of the custodians is everything related to settlement failures.
A comprehensive cost-benefit impact analysis should be conducted before any decision is taken, says Pascaud. “A reduction in counterparty risk and collateral requirements are expected benefits and alignment with other international market practices may also be an attractive proposition. This needs to be documented and clearly understood within the overall operating model of the European securities markets in terms of safety and efficiency and the constant goal of greater harmonisation.
“However, in all of this, what remains unclear is whether investors stand to benefit from a move to T+1, since they are currently largely shielded from any potential risks and difficulties by robust regulation and a solid custody chain,” he says.
In his view, the US initiative is worth considering, but paying attention to unintended side effects that may affect not so much the custodians but the investors and brokers who would have to work in one day rather than two.
“WHAT REMAINS UNCLEAR IS WHETHER INVESTORS STAND TO BENEFIT FROM A MOVE TO T+1, SINCE THEY ARE CURRENTLY LARGELY SHIELDED FROM ANY POTENTIAL RISKS AND DIFFICULTIES BY ROBUST REGULATION AND A SOLID CUSTODY CHAIN.”
– Daniel Pascaud, global head of operations, banking and custody solutions, Caceis
Europe will adapt
Whatever decision is taken, Pascaud is confident that the European market will adapt given its track record with undertaking major changes, such as the introduction of the euro, T2S, T+2 in 2017, and CSDR.
The timing of the move to T+1 is also an issue, says Jens Schmidt, a regional wealth and asset management consulting partner at EY Luxembourg. “The asset servicing and funds industries are at an inflection point in terms of tokenisation of traditional assets and digital assets.” However, if any market participant is considering committing to tokenisation and adapting their infrastructure accordingly, they also have to consider that the majority of the market will be busy upgrading their existing legacy systems to cater for the move to T+1.
For Schmidt, it is another example of the industry engaging in a costly short-term fix rather than investing in a more radical, long-term change – such as a DLT-based infrastructure that will be suitable for tokenisation of traditional assets and digital assets. This could solve, among other things, the settlement timing issue. “We can agree that a move to T+1 would be good in terms of reducing operational risk and giving institutional investors greater ability to react to market movements and to commit capital much more quickly,” says Schmidt.
“THE INDUSTRY NEEDS TO TAKE A STEP BACK AND LOOK AT THE WIDER PICTURE. THE BIGGEST RISK OF THE MOVE TO T+1 IS THAT THE BIGGER PICTURE GETS NEGLECTED.”
– Jens Schmidt, a regional wealth and asset management consulting partner, EY Luxembourg
“However, the benefit for retail investors will be minimal. And there is always the prospect that asset servicers will simply pass the cost of the T+1 migration on to the asset managers who then pass it on to their investors.” With the US committed to the move to T+1, there is no avoiding the fact that the EU will have to make the same move. Therefore, says Schmidt, there needs to be more attention paid to the practical issues, like holidays across the EU and the cash penalties introduced by CSDR. “The industry will need some new guardrails and timelines for settlement rules while also appreciating the operational issues involved.”
Distractions, distractions
Sadly, says Schmidt, this will be a distraction from the more important task – a fundamental redesign of the industry’s infrastructure fit for the long-term, suggests Schmidt. “The industry needs to take a step back and look at the wider picture. The biggest risk of the move to T+1 is that the bigger picture gets neglected. The long-term incentives are missing and that means not enough is done to make fundamental changes. If there is a massive increase in demand for tokenisation from both institutional and retail investors, then this might change.”
