European authorities must prioritise the transition to T+1 and address the underlying issues that could impede it, writes James Pike, interim CEO at Taskize, a Euroclear company, who explains some of the complexities the continent faces that differ from its US counterparts.

In the global and often highly unpredictable world of capital markets, adaptability to change may well be paramount, but not always possible to enact quickly. Recently, the European Securities and Markets Authority (ESMA) issued a “call for evidence” to consult on shortening the settlement cycle across equities, fixed income, and exchange-traded funds (ETFs). While seeking market feedback is commendable, the urgency of transitioning to a T+1 settlement cycle — a model where transactions are settled the next business day — is a tough proposition but ultimately a change that is inevitable. 

The fragmented nature of European equity markets means that a coordinated shift alone will not suffice to expedite this transition. The complexity and inherent challenges of implementing T+1 in Europe are significantly greater compared to the U.S which so far has seen a successful implementation of a shorter settlement cycle. As things stand, T+1 in Europe is much more likely to result in exceptions and increased trade disputes.

Unlike the relative uniformity of the US market, Europe consists of multiple exchanges and clearing houses, each with its own regulations and practices. This fragmentation complicates the implementation of a harmonised T+1 model across the region. It is not as if this is a new phenomenon. Way back in 2001, European think-thank the Giovannini Group,  filed a damming report on the copious inefficiencies that exists in the European clearing and settlement infrastructure.  

At the heart of this complexity over two decades on from this report is the absence of a single Central Securities Depository (CSD) in Europe. In contrast to the US, where the Depository Trust & Clearing Corporation (DTCC) serves as the single CSD. Europe has multiple CSDs across different countries, each operating under its own rules and systems. This lack of a unified CSD infrastructure means that harmonising the settlement cycle requires coordinating not just between market participants, but also between these various CSDs, adding another layer of complexity to the transition.

Additionally, the nature of cross-border trading in Europe further complicates a move anytime soon to T+1. Market participants often engage in trades where the seller and buyer operate in different countries with different CSDs, unlike in the US where all securities trades settle in the US market infrastructure (except where the realignment occurs between participants in Euroclear and Clearstream for European investors).  

Consider a scenario where one party sells their position at Euroclear in France, but the buyer wants to hold them in Brussels at a different CSD. Equities tend to settle where the liquidity is, which depends on where the exchange is located. If a market participant wants to buy BP shares, they typically trade on the London Stock Exchange (LSE) and then settle in Crest (EUI). Similarly, for a French stock traded on Euronext, settlement typically occurs at Euroclear in France. This cross-border trading adds another layer of complexity to the settlement process. 

Therefore, any misstep or delay in trade confirmation and matching in these scenarios is highly likely to lead to an increase in settlement failures and disputes. The shorter settlement cycle will certainly necessitate much faster and more accurate communication between counterparties. In a fragmented market like Europe, where different countries and exchanges operate under various systems, ensuring seamless communication will be challenging. 

This problem is exacerbated by the fact that many financial institutions are wedded to using phone and email to handle very high volumes of issues with their counterparties. While phone and email are ubiquitous, they are not efficient for resolving trade disputes. These methods are slow, prone to errors, and lack the immediacy required for the rapid resolution needed in a T+1 environment. 

To avoid further lagging behind the US, and to harbour any hopes of moving to T+1 within the next few years, European authorities must prioritise this transition and address the underlying issues that could impede it. Market participants can also do a lot to streamline the way trades are settled and exceptions resolved. This includes agreeing more of the post trade components at the point of trade, enhancing much faster dispute resolution mechanisms to ensure clearer communication channels between broker-dealers, asset managers and custodians. Only then can Europe hope to reap the benefits of T+1, such as increased liquidity, reduced risk, and improved global competitiveness.