Investment banks and brokers will have little choice but to step in to ensure their buy-side clients can cope with the introduction of T+2 on 6 October, according to industry experts.
Institutional investors, particularly those below the top tier, are being viewed as the “weak link” in the shift to a shorter settlement cycle across Europe, with many lacking the technology processes to be able to comply.
Commenting on the potential challenges for shortened settlement, Alan Cameron, head of relationship management, international banks and brokers, said, “it’s likely that institutional investors will be the most impacted by this. While the bigger players are already highly automated and able to cope with T+2, there is a tail end of mid-sized and small asset managers who still handle their settlement manually.”
The new standardised T+2 settlement cycle, which is introduced in almost all EU countries next month, will see an entire day taken out of the settlement process. While it might be possible to continue to handle some trades manually for those asset managers who trade relatively infrequently, problems are likely to arise around some specific issues, such as trading into Asia.
Cutting out a day of settlement, especially when dealing between areas where business days barely overlap, such as Asia and Europe for example, puts particular pressure on firms to turn around settlement instructions in a timely manner, potentially outside normal business hours. Automating the settlement process will mean required data can be quickly sent back and forth between organisations even while traders sleep.
However, initially at least, the industry expects the sell-side will have to step in, taking on an additional day of settlement risk, effectively enabling their buy-side clients to continue dealing with brokers on a T+3 basis.
Rules lack clarity
At present, the final regulatory technical standards for the EU’s Central Securities Depository Regulation (CSDR) have yet to be finalised, with the European Securities and Markets Authority due to publish them later this year. The initial political agreement that T+2 will not impact OTC trades has been interpreted by many to include those between an institutional investor and broker where the broker trades on the investor’s behalf, however this could be clarified in the final rules.
Cameron said that this would “go against the spirit of the rules”, though would likely be used by many as a stopgap to enable them to have more time to prepare for shorter settlement.
However, Scott Coey, head of broker dealer services EMEA at BNY Mellon Pershing, said it is not just buy-siders who will struggle with the technological challenge of introducing T+2.
“The buy-side have said to their banks and brokers that they are relying on them to make this transition to T+2 happen. Many investment banks are running 20+ systems that are impacted by this, so it’s no small task to ensure they can streamline their processes,” he said.
In the short term, the biggest challenge facing the industry is the so-called “double settlement day” on 8 October. On this day, settlement will need to be completed for trades on both 5 and 6 October, meaning post-trade staff across the buy-side, brokers and custodian banks are set to be extremely busy. For institutional investors, this will be an unprecedented event and many will expect their brokers to absorb the strain of the process.
Incentives for T+2
However, in the longer term, with fines set to be introduced for late settlement, it is hoped the tail end of investors will be incentivised to automate their post-trade systems to come fully into line with T+2 and gain the full benefits of reduced post-trade risk. Coey believes the buy-side will be able to get ready before the introduction of TARGET2-Securities (T2S), the centralised European central bank settlement platform, set to be rolled out from June 2015.
“There is this long grace period between the introduction of T+2 and the fines because there are were a lot of unknowns, but T2S will be the game changer and then firms will no longer be able to put this off,” added Coey.