EU Must Accelerate Transition to T+1 Settlement to Remain Competitive

The recent shift by the United States and Canada to a T+1 settlement cycle in May has set a new benchmark in global financial markets. Moving from settling securities transactions two days after a trade (T+2) to just one day (T+1) has proven to be a resounding success, leading to greater efficiency, increased liquidity, and enhanced risk mitigation. As the UK plans to transition by the end of 2027 and Switzerland expresses intent to coordinate with both the UK and the EU, it's imperative for the EU to commit firmly to adopting T+1 to maintain its competitive edge.

The Impact of T+1 in North America

Under the new T+1 regime in the US, 95% of transactions are affirmed on the trade date itself, a significant improvement from the 73% rate recorded in January 2024. The settlement fail rate remains steady at just 2%, consistent with figures under T+2. Moreover, margin posted in the clearing fund has decreased by $3 billion daily—a 23% drop from previous averages—freeing up approximately $750 billion annually for broker-dealers to allocate elsewhere. These figures underscore how a shorter settlement cycle fosters a more efficient and resilient market.

Benefits of Adopting T+1 for the EU

1. Reduced Counterparty Risk: The current two-day gap between trade execution and settlement exposes parties to the risk of counterparty default. T+1 settlement reduces this exposure by 50%, offering better protection for investors, especially during periods of market volatility.

2. Enhanced Capital Efficiency: Lowering the need for collateral releases billions of euros tied up in margin requirements. This capital can be reinvested into new opportunities, stimulating market activity and potentially boosting returns for investors.

3. Increased Liquidity: Faster settlement cycles mean investors can reinvest their funds more quickly, increasing market liquidity and improving price discovery. This can lead to lower transaction costs and a more dynamic marketplace.

4. Global Harmonisation: With North American markets already on T+1 and the UK soon to follow, the EU risks falling behind. Aligning settlement cycles reduces cross-border inefficiencies, particularly for EU-listed ETFs with exposure to US securities, which currently face settlement mismatches.

Challenges and the Path Forward

Transitioning to T+1 is a significant undertaking that requires modernisation of market infrastructure, technology, and back-office operations. In the US, a collaborative effort between buy-side participants, broker-dealers, and central clearing parties resulted in a detailed playbook that facilitated the transition. A similar approach is necessary in the EU, given its 41 trading exchanges and 30 central securities depositories under various supervisory authorities.

To ensure a smooth transition, European policymakers must:

• Commit to a Clear Timeline: Announce a firm commitment to adopt T+1 by the end of 2027, aligning with the UK's schedule. This provides certainty for market participants to plan and invest accordingly.

• Amend Regulatory Frameworks: Make necessary legal and regulatory changes, including amendments to the EU’s Central Securities Depositories Regulation, to facilitate the transition.

• Support Industry Investment: Encourage and perhaps subsidise the significant investment required by the industry to modernise systems and processes.

MY ANALYSIS

In my opinion, the EU's hesitation to commit to T+1 could have long-term repercussions on its capital markets. The benefits of reduced counterparty risk, improved capital efficiency, and increased liquidity are too significant to ignore. Moreover, failing to align with global markets may deter foreign investment and hinder the competitiveness of EU financial institutions.

The transition to T+1 also presents an opportunity for the EU to modernise its financial infrastructure, potentially leading to innovations in fintech and more integrated capital markets within Europe. While the challenges are non-trivial, the cost of inaction is higher. Delays could result in the EU falling behind not just in settlement efficiency but in overall market attractiveness.

Conclusion

The EU stands at a crossroads. To maintain its position as a leading global financial centre, it must act decisively and commit to transitioning to a T+1 settlement cycle. This move will not only align the EU with other major markets but also deliver tangible benefits to investors and market participants. Policymakers must recognise that delay is not just costly but could lead to irrelevance in an increasingly fast-paced and interconnected global financial landscape.