The upcoming European and UK transition to a T+1 settlement cycle could see firms pushed to explore instantaneous settlement on some ETF trades, a process which could be wrought with operational challenges, The TRADE has learnt.
Jim Goldie
The move to T+1 settlement cycle across Europe’s markets in October 2027 means misalignment with the US with regards to ETFs trading will no longer be a problem, however there will still be divergence with other markets which remain on T+2.
Enter the Thursday conundrum 2.0 – an inverse of the similar style challenge from the US move in May 2024.
Given the difference between the settlement regimes in the US, and in the UK and Europe following the May 2024 transition, a drop off in ETF volumes was noted on a Thursday due to the fact that brokers would in some cases have to fund positions over the weekend and were therefore charging a premium for trading.
The TRADE’s coverage of the subject garnered a lot of industry attention as just one of the pain points created by divergent settlement regimes globally following the US’ decision to move to T+1 settlement last year.
Speaking at the CMX conference in 2024, Jim Goldie, EMEA head of capital markets, ETFs and indexed strategies, Invesco, said: “Additional funding over the weekend will manifest itself through wider spreads. A few bps matters. Brokers are pricing two different levels, one for T+1 settlement and one more expensive option for T+2 settlement. We’re in a suboptimal place with global misalignment.”
Global misalignment
Given that Europe and the UK have now confirmed they will be moving to T+1 settlement in October 2027 and aligning with the US, many thought that the end of two-tiered pricing and issues relating to volumes on a Thursday was nigh. However, the October transition is set to create a new pain point with other global markets when it comes to ETF trading.
After sitting down with Goldie earlier this month to unpack the UK and European roadmap to T+1, a process that he has been central to, The TRADE has learnt that an inversed version of the Thursday conundrum is set to take centre stage in ETFs trading thanks to a misalignment with other global markets that remain on T+2.
As opposed to buying ETFs tracking US securities at a premium on a Thursday, the industry could now see a dynamic where ETFs containing global T+2 securities are being sold at a discount.
The key issue relates to the primary trades on T-1 funds whereby firms take global ETF trade orders on a T-1 basis using the closing price from the previous day given that some markets will already be closed thanks to the time difference.
If a broker is trading a global ETF in a secondary market on a T+1 basis and they have to go to the primary market to place a creation to facilitate that settlement, that creation being done on a T-1 basis would mean that they would have to settle that creation trade T0 to match their settlement obligations for their secondary market trade on T+1.
“If we can’t offer T0 then it’s likely that those trades would automatically fail,” explains Goldie.
“The price effect on ETFs containing US securities will disappear, however, when Europe migrates to T+1 we will now have to try and settle T0 for primary trades on T-1 funds, which is something that we haven’t had to do before. That we can do, but there’s just certain operational considerations that we need to look at to be able to facilitate that.”
He adds: “The reason it’s more profound on a Thursday is because their creation trade with us or their hedge trade with the futures or the underlying stocks will settle Friday, but their trade with the client won’t settle until Monday. Over that weekend they have to fund that cash position. When interest rates are high, that cost is obviously going to be larger on a daily basis.”
“Rather than it be this pricing dynamic where on a Thursday you’re buying ETFs tracking US securities at a premium, what you’re going to see is a pricing dynamic on a Thursday for ETFs containing T+2 securities when you’re selling them at a discount.”