The European Securities and Markets Authority (ESMA) published its Final Report providing the assessment of the shortening of the settlement cycle in the European Union (EU).
The report highlights that the increased efficiency and resilience of post-trade processes that should be prompted by a move to T+1 would facilitate achieving the objective of further promoting settlement efficiency in the EU, contributing to market integration and to the Savings and Investment Union objectives.
ESMA recommends that the migration to T+1 occurs simultaneously across all relevant instruments and that it is achieved in Q4 2027. Considering the different elements assessed by ESMA, in particular the difficulties linked to the go-live of such a big project in November and December, and the challenges linked to the first Monday of October (just after the end of a quarter), ESMA recommends 11 October 2027 as the optimal date for the transition to T+1 in the EU. ESMA also suggests following a coordinated approach with other jurisdictions in Europe.
Regarding the quantification of the costs and benefits, the elements assessed by ESMA suggest that the impact of T+1 in terms of risk reduction, margin savings and the reduction of costs stemming from the misalignment with other major jurisdictions globally, will represent important benefits for the EU capital markets.
However, this change will also imply some challenges, including amending the Central Securities Depositories Regulation (CSDR) and the settlement discipline framework, in order to have legal certainty and foster the necessary improvements in post-trading processes to move successfully to T+1.
Additionally, all actors of the financial system will need to work on harmonization, standardization, and modernization to improve settlement efficiency. This will require some level of investment. The complexity of a trading and post-trading environment such as the EU capital markets means that this project will require a specific governance to be put in place.
SFTs on T+1
Some of the concerns which had been raised by a number of respondents to ESMA’s call for evidence relate to the impact that the shortening of the settlement cycle could have on securities financing transactions, and in particular on securities lending and repo. Regarding securities lending, this impact can be briefly summarized as the potential increased pressure on the securities lending market from (1) the demand by market makers to obtain in a shorter timeframe securities that they would not have in their inventories but would need to continue providing liquidity for and (2) the potential decrease in the appetite for lending from traditional lenders (such as asset managers) if they fear that they could not call back in a reduced post-trade window securities that would have been lent out. All of this could result in lower activity, higher cost of borrowing (higher fees) and lower duration of loans.
In its analysis of the move to T+1 in the US, ESMA wrote that the overall number and value on loan of US securities remained stable around the move to T+1 and in the months immediately after. No sudden shifts were observed around the implementation date; the value of equity loans showed a slight decrease albeit with levels comparable to historical values.
In June 2024, outstanding values of equity loans increased compared to 1Q24 (+3%). The utilization rate, a complementary measure of activity in the securities lending markets, did not display relevant changes across asset classes, with the exception of ETFs. In terms of pricing, the average loan fees remained broadly stable and in line with historical levels in the initial phase following the T+1 implementation. Finally, no significant shortening of average loan duration was observed in the short term.
“Written confirmations and allocations of trades, matching, but also different adjacent processes for successful settlement, in particular those required to ensure that securities and cash are available for settlement (e.g. position alignments, securities lending, FX trading / settlement), should be further harmonised, automatised and become more efficient. Remaining manual processes must be phased out,” according to the report.