With the increasing pace of transactions in global securities markets, Chris Elms, interim CEO of Euroclear UK and international, examines the implications of T+1 settlement in the UK, after the release of the Accelerated Settlement Taskforce’s findings and the expected market transition by the conclusion of 2027
The Chancellor of the Exchequer, Jeremy Hunt MP, announced the ‘Edinburgh reforms’ in December 2022, aiming to boost the government’s ambition for the UK to be the world’s most innovative and competitive global financial centre. An instrumental part of these reforms was the establishment of an Accelerated Settlement Taskforce and the appointment of an esteemed former corporate lawyer, Charlie Geffen, to chair industry discussions. The role of the Taskforce was to look at the best approach for the UK to speed up the time it takes to settle trades to increase the efficiency of UK financial markets.
Meanwhile, the US is already planning to shorten its securities settlement cycle from trade date plus two days (‘T+2’ in industry jargon) to T+1 on 28 May 2024.
Indeed, the SEC’s decision for the US to move has led policymakers, regulators, brokers and infrastructure providers on this side of the Atlantic to think about the potential opportunities and risks for capital markets in Europe. In the EU, authorities are consulting on T+1, with a report expected in the second half of 2024, while India is already trading on T+1 and its Securities and Exchange Board has already consulted on adding options for T+0 and even instant settlement.
Speeding up settlement times
At present, the most common standard is settlement on ‘T+2’ – which has been prevalent in Europe since 2014. In the move from T+3 to T+2, the US followed the EU, with American markets migrating in 2017.
Although there are some exceptions. The settlement of UK Government bonds known as ‘Gilts’ already takes place on T+1, while the settlement of the remaining physical certificates in circulation follows a different process to electronic securities—and typically requires a longer settlement cycle. Primary issues such as IPOs, rights issues and syndicated bond issues follow a separate regime, and funds subscription and redemption cycles range between T+1 and T+4, with most settling on T+3 or T+4.
As the report from Geffen outlines, ‘Those who are not familiar with how securities trade are surprised by the T+2 settlement cycle. Today, consumers can buy and receive an airline or train ticket on their phone within a matter of minutes. They can make payments through their banks and exchange currency almost instantaneously. Yet it takes two days to settle a trade in securities.’
There are good reasons why market convention does not leap towards instantaneous settlement. One of these has to do with market participants arranging financing. A lag between trading and settlement means that ‘pre-funding’ trades is not necessary. Market participants have a period of time in which to find cash to pay for the securities they have purchased—for example, by entering into a repurchase agreement or drawing down on a credit facility.
Participants in the current environment do not need large amounts of cash set aside in advance of each order they place, affording them the possibility to enter the marketplace more often—in aggregate, this facilitates greater market liquidity, and keener prices for investors. However, the settlement cycle gives rise to its own risks—including so-called ‘counterparty credit risk’—which are diminished as the settlement cycle is reduced.
Before the electronification of UK securities and the creation of CREST as the UK’s securities settlement system, settlement took place on a fortnightly, account-based cycle. Clunky telex machines were used for a lot of post-trade processing in the absence of centralised infrastructure, such as a clearinghouse. The cycle later changed to ten business days, then T+5 and T+3 shortly thereafter. At first, these reductions were driven by changes in technological capability, and more recently the settlement cycle has been set out in regulation.
Not least considering the number of business hours available to settle a trade, a move from T+2 to T+1 will involve considerably more change than the move from T+3 to T+2 did in 2014, given the deadlines for intermediate processes like confirmations and affirmations.
Obstacles to market migration
As the Accelerated Settlement Taskforce highlights, ‘one of the challenges for the capital markets sector is the diverse range of actors. Whilst larger firms stand to benefit significantly from the investment in extensive automation, it takes smaller participants a lot longer to recoup those costs.’
The wide array of impacts for different types of securities, and different varieties of financial institutions, makes a transition more complex than might be immediately apparent. As Geffen outlines, ‘No one will invest to upgrade their technology to enable T+1 unless the whole market does so at the same time. So for the system to improve, everybody must invest in a coordinated way. And that will only happen when mandated by regulators and government.’
There are anticipated to be difficulties for Asia-Pacific financial centres as those to the West move to a shorter cycle, particularly when market participants need to execute foreign exchange trades to settle their securities transactions.
However, it is clear that with the direction of travel in international markets, Europe cannot remain on T+2 indefinitely. A recent survey by Citi found that 89 per cent of global market participants expect their jurisdictions to move to T+1 (or T+0) within five years.
Geffen has suggested the UK shift its settlement cycle by the end of 2027, and the industry is eager for this to be done in coordination with the EU and Switzerland to reduce friction costs.
So there is work ahead. Reducing settlement times effectively means reducing the number of steps between trade and settlement.
This will require significant investment in upgrading back-office technology and more automation to improve processing efficiency. The industry in the UK is now coming together in technical working groups to explore new ways of working, and to draw lessons from the US move later this year. Proponents of accelerated settlement expect that over the long term a shorter settlement cycle will mean counterparties enjoy reductions in processing costs, together with lower capital requirements and reduced risk exposure.
Where does the CSD stand?
As the Central Securities Depository (CSD) in the UK, Euroclear UK and International (EUI) are committed to bolstering market integrity and client satisfaction. Our robust CREST settlement system is poised to embrace accelerated settlement procedures as soon as the UK advances. Timing and seamless coordination are imperative. While there’s a sense of momentum towards expediting trade settlements, especially with the US forging ahead, transitioning from T+2 to T+1 will substantially compress the settlement window for shares, marking a pivotal shift.
Failing to execute this transition optimally could incur avoidable expenses and operational hazards, potentially eroding confidence in the reform initiative and market credibility. To achieve the benefits of shortening the settlement cycle, such as mitigating counterparty and market risks, the UK must meticulously consider the steps to implementation. Failing to execute this transition optimally could incur avoidable expenses and operational hazards, potentially eroding confidence in the reform initiative and market credibility.
Euroclear is a pan-European market infrastructure, catering to a diverse clientele ranging from large corporations to niche players operating across domestic, European, and global spheres. We are aligned with financial institutions determined to effect a transition that minimises expenses and risks while optimising cross-border financial efficiencies.
Efficient securities markets are essential for fostering prosperity among companies, governments and investors — the very essence of the financial sector’s purpose. As a linchpin infrastructure within this ecosystem, we are committed to collaborating with all stakeholders towards a synchronised transition in the UK, harmonised with EU and Switzerland, thus modernising our markets to meet evolving global practices.
