EU's D-Day: Anticipated Turning Point

The European financial markets are gearing up for a significant shift as they prepare to transition to next business day settlement, or T+1, by October 11, 2027. This move, driven by the push to reduce market risk and margin requirements, aims to strengthen the harmonization of global markets and enhance the global competitiveness of European markets.

The European Market and Supervisory Agency (ESMA) has been at the forefront of this transformation. In a bid to reduce counterparty risk and improve settlement efficiency, ESMA proposes aligning the EU currency market with the UK and Switzerland's T+1 settlement model.

The benefits of this transition are manifold. According to ESMA, a move to T+1 will increase the efficiency and resilience of post-trade processes. Deutsche Bank's David McNally, Head of Transformation, Securities Services, acknowledges this, but also notes significant implementation costs for European market participants. The need to improve and enhance post-trade processes and automation capabilities to meet T+1 requirements may require substantial investment in areas including technology, systems and controls, staff training, and compliance.

The European T+1 Industry Task Force, comprising 21 trade associations involved in the European capital markets, has published a Roadmap for Adoption of T+1 in EU Securities Markets. This roadmap outlines the steps necessary for a smooth transition, including the consideration of a time-limited suspension of cash penalties by the European Commission to alleviate potential increases due to the shift to T+1.

However, the transition is not without its challenges. Smaller firms may find the transition more challenging, while larger, global organizations might be better placed due to existing processes and infrastructure. Market participants will need to examine their readiness for T+1, ensuring they are well-prepared for this significant change.

The rollout of T+1 in the EU carries logistical challenges due to the simultaneous transition of 27 member countries. To address this, ESMA has recommended a three-phase approach to its operationalisation.

The Swift Institute, a global financial messaging cooperative, has estimated that bankers and brokers will have roughly 80% less time to manage cross-border settlements under T+1 due to time-zone and foreign exchange challenges. This underscores the importance of collaboration and coordination among market participants to ensure a seamless transition.

Respondents to ESMA's October 2023 Call for Evidence on Shortening the Settlement Cycle encourage ESMA to engage with APAC stakeholders and study lessons learned from North America's adoption of T+1. This global dialogue is crucial in ensuring a successful transition and setting the stage for a more efficient, harmonized global financial market.

The move to T+1 in Europe is part of a larger global trend. The US, Canada, and Mexico transitioned to T+1 at the end of May 2024, following similar moves in Asia and other regions. The EU, UK, and Switzerland have been using a 'T+2' post-trade settlement model since 2014.

The Swift Institute's paper, "Breaking the settlement failure chain", published in June 2023, identifies settlement compression as a risk factor for trade failures. The move to T+1 is a step towards addressing this risk, contributing to a more resilient and efficient financial system.

In conclusion, the move to T+1 in Europe represents a significant step towards a more efficient, harmonized global financial market. While the transition will pose challenges, the benefits in terms of reduced market risk, improved settlement efficiency, and enhanced global competitiveness make it a worthwhile endeavour.