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T+1 Settlement in Europe - Potential Benefits and Challenges

  • Antonis Hadjicostas
  • May 14, 2024
  • 3 min read

Updated: Mar 9


Introduction


In the ever-evolving landscape of financial markets, the concept of T+1 settlement has gained significant traction, particularly in Europe. T+1 settlement refers to the shortened timeframe between the execution of a trade and the settlement of the transaction, reducing it from the traditional T+2 (trade date plus two days) settlement cycle to just one day.

This transition holds the promise of various benefits for market participants, but it also presents its fair share of challenges.


ESMA “Call for evidence”


The European Securities and Markets Authority (ESMA) issued a "Call for Evidence" regarding the settlement cycle for securities in the European Union. This call aimed to gather information and stakeholders' views on the potential benefits and challenges associated with shortening the settlement cycle from T+2 to T+1 or even same-day settlement.


Overall, the ESMA Call for Evidence likely provided a comprehensive overview of the potential benefits and challenges associated with shortening the settlement cycle in Europe, aiming to gather input from stakeholders to inform future policy decisions and regulatory initiatives in this area.




Benefits


  • Reduced Counterparty Risk: With transactions settling faster, the exposure to counterparty risk diminishes, enhancing overall market stability. This reduction in risk can lead to improved investor confidence and potentially lower costs associated with risk management.

  • Liquidity Enhancement: Shortening the settlement cycle frees up capital and liquidity sooner, enabling investors to deploy these resources more efficiently. This liquidity enhancement can foster increased trading activity and improve market liquidity overall.

  • Operational Efficiency: T+1 settlement necessitates more streamlined and efficient post-trade processes. Market participants are compelled to adopt robust infrastructure and automated systems, leading to lower operational costs and fewer errors in transaction processing.

  • Alignment with Global Standards: Many international markets have already migrated to T+1 or even same-day settlement cycles. By adopting T+1 settlement, European markets can harmonize their practices with global standards, facilitating cross-border trading and enhancing market integration.


Challenges


  • Infrastructure Readiness: Transitioning to T+1 settlement requires significant upgrades to market infrastructure, including trading platforms, clearing systems, and settlement processes. Ensuring the readiness of such infrastructure poses a considerable challenge, especially for smaller market participants with limited resources.

  • Cost Implications: While T+1 settlement offers long-term cost savings through enhanced efficiency, the initial implementation costs can be substantial. Market participants must invest in upgrading their technology and operational capabilities, which could strain budgets, particularly for smaller firms.

  • Operational Risks: The compressed settlement timeframe leaves little room for error in trade processing. Any operational glitches or delays can have more significant consequences, potentially leading to failed trades or financial losses. Market participants need to strengthen their operational resilience to mitigate such risks effectively.

  • Regulatory Compliance: Regulatory frameworks must adapt to accommodate the shift to T+1 settlement. Regulatory bodies need to ensure that market participants comply with the new settlement cycle while maintaining market integrity and investor protection. Navigating these regulatory changes poses a complex challenge for market stakeholders.




Conclusion


T+1 settlement holds immense potential to transform European financial markets by enhancing efficiency, reducing risk, and aligning with global standards. However, realizing these benefits requires concerted efforts from market participants, regulators, and infrastructure providers to overcome the challenges posed by the transition.


While the journey towards T+1 settlement may be fraught with obstacles, the end goal of a more resilient, liquid, and integrated market ecosystem makes it a worthy endeavor. By addressing the challenges head-on and capitalizing on the benefits, European financial markets can pave the way for a more dynamic and competitive future.




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