Shorter securities settlements cycles to be introduced in Europe
By Marianne Brown, Thomson Reuters Accelus contributor
LONDON, Dec. 19 (Thomson Reuters Accelus) – Earlier this year, the European Commission published its proposals for the regulation of central securities depositories (CSDs), the entities that operate settlement systems. The proposals, known as the Central Securities Depositories Regulation (CSDR), seek to improve settlement efficiency across European markets, and are currently working their way through the European Parliament and Council.
At the moment, markets across Europe settle on divergent cycles, contributing to high rates of trade failure, costs and operational risks, particularly for cross-border transactions. One of the measures contained in the draft CSDR relates to the shortening and harmonisation of securities settlement cycles across the European Union (EU). The European Commission has proposed that financial market participants should settle their securities transactions no later than two days after the date on which a trade is executed, referred to as a T+2 settlement cycle. The proposal also states that financial penalties will be imposed for trades that do not settle within the T+2 cycle.
Securities settlement is seen by policymakers as an important component of risk management since faster and more efficient settlement practices are expected to reduce counterparty risk. The implementation of T+2 is one part of the extensive reforms aimed at removing the barriers to efficiency in Europe’s clearing and settlement structure. In many ways, it could become one of the most tangible examples of how the industry and regulators have worked to reduce risk in the financial system since the global financial crisis.
Germany, Bulgaria and Slovenia already settle on T+2 and, as of the January 1, 2015 CSDR deadline, the remaining 26 EU member states will need to comply with the new shortened settlement cycle. T+2 is, however, a prerequisite for the completion of another initiative being led by the European Central Bank (ECB), Target2-Securities (T2S), which will create a single European platform for securities settlement. The T2S initiative is scheduled to go live by mid-2015 and so, although the CSDR regulation is not due to come into effect until January 1, 2015, market participants may need to have their systems ready for the move to T+2 by as early as mid-2014.
The industry has shown support for the shortening of settlement cycles in Europe. Recent research from Omgeo showed that over 70 percent of broker/dealer, custodian bank and investment manager survey respondents believed that shorter settlement cycles were beneficial for the industry. A reduction in counterparty risk was cited as the most important benefit of T+2, but there was also thought to be a strong business case for shorter settlement cycles because reducing the amount of time that assets were tied up in the settlement process would mean that market participants were able to reinvest faster, as well as manage their capital more efficiently.
Somewhat surprisingly, the majority of market participants were in favour of imposing financial penalties on counterparties that caused late or failed settlement. This was indicative of the sentiment, which borders on frustration, of those market participants whose counterparties are slow to deliver the instructions required for securities transactions to settle. The need for clients to submit trade details in a more timely fashion therefore ranked as the most important factor in preparing for shorter settlement cycles. The next stage in the regulatory process is likely to be the establishment of a taskforce to develop the specific rules around T+2, including further details on financial penalties for late settlement.
No significant upheaval
The move to T+2 should not require a significant upheaval in operational processes. The main barriers to non-compliance relate to behavioural practices or awareness issues. If they are to adhere to the T+2 deadline, however, participants will naturally have to complete the pre-settlement stages of the trade lifecycle more quickly. This will include verification of the trade (the process whereby counterparties agree the details of a transaction) on the same day the trade is executed, referred to as same day affirmation.
The middle office, where trades are matched, confirmed and settled, has become a higher priority for senior executives and board members as part of the overall drive to implement and demonstrate better risk management practices. That said, securities settlement has received rather less attention across the industry than the regulatory reforms relating to trade execution and clearing. This will need to change in the coming months to ensure that firms are on track to comply with the rules, once they have been finalised.
The impact of T+2 will not be confined to Europe. Market participants with clients or counterparties outside Europe will need to ensure that cross-border transactions are also settled on T+2. Moreover, discussions relating to shorter settlement cycles are now re-emerging in the U.S. as well. A recent cost-benefit analysis of a move to shorter settlement cycles carried out by the Boston Consulting Group has fuelled industry dialogue about the potential for the U.S. also to accelerate its current T+3 cycle. If settlement efficiency is to have an effect on systemic risk worldwide then, due to the increasing globalisation of trading and investment, the effort to improve settlement efficiency should be a global one.
(Marianne Brown is CEO and President of Omgeo, a global financial services technology company, serving over 6500 corporate customers in nearly 52 countries. The views expressed are her own.)
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