Is everybody ready for T+2?
2014 is almost certainly the year of financial services regulation regulatory. And it will be also remembered as a year full of acronyms.
After EMIR and MiFID II haunted the dreams of a vast range of financial services workers, it’s now the turn of T+2 – not a mysterious chemical formula but one of the most significant operational challenges that Europe’s securities markets have yet to face.
On 6th October, the Central Securities Depository Regulation (CSDR) adopted T+2 settlement changes for the majority of securities across 27 European countries. As of now, trades in transferable securities executed on multilateral trading facilities (MTFs) must be settled within two business days, a change from the current three days used in most European markets. Presently, Germany, Bulgaria and Slovenia are the only markets in the EU that settle on a T+2 cycle.
The shorter settlement period is part of the broader EU programme to reform and harmonise post-trade processes across the region, including the European Central Bank’s Target2-Securities, or “T2S”, project and the Central Securities Depositories Regulation. T2S will create a central, pan-European platform that settles securities using central bank money.
What does this mean for participants? Basically, the settlement date (which refers to the date on which the ownership of the security is actually transferred and money is exchanged between buyer and seller) will come earlier, leaving less time for the exchange of securities and cash following a trade. This may sound like a minor change that only impacts the post-trade process, but it will, in fact, bring challenges for various market participants, including the buy-side, banks, custodians and central securities depositories – all owners and holders of relevant securities. In particular for OTC markets, this is a much bigger operational challenge than any other previous change in the settlement cycle, and for those that do not settle trades automatically on the same day.
Are firms really ready for this transition? As seen with many other regulatory deadlines, the concerns are concentrated around the participants’ internal resource to cope with potential issues and constraints, and maintain a good level of efficiency. A big question mark is also the automation of processes in the middle office: if we simply consider that, as Omgeo’s executive director Tony Freeman, highlighted, between 20% and 25% of buy side firms across Europe may still be using faxes, emails and spreadsheets for trade allocation and confirmation, this tells us a lot about the current state of readines. Ultimately, problems may arise from the time difference between Europe and other global markets (for example, Asia-based firms trading European securities).
With inadequate post-trade processes for T+2 settlement, fallout may be bigger and impact the trading operation: because of trade processing issues and inefficiencies, the front office might be unable to trade, losing business or suffering from reduced productivity and effectiveness due to the time spent addressing post-trade processing issues. Also, participants might come across fines, unplanned operational costs, remediation costs, or unplanned fees. In general, it is expected that the reduction from T+3 to T+2 is likely to increase settlement failures in the short term as the industry becomes familiar with the new rules.
What about the future? Experts see T+2 as the potential catalyst that will move the industry to achieve same-day and potentially real-time trade agreement and settlement instruction, delivering significant cost, risk management and service benefits.