Measures must be taken to improve settlement inefficiencies for ETFs ahead of Europe’s planned move to a T+1 settlement cycle, according to the European Securities and Market Authority’s (ESMA) advisory board.
Responding to ESMA’s consultation on the Central Securities Depositary Regime (CSDR), the Securities Market and Stakeholder Group (SMSG) said a move to a T+1 settlement cycle on the continent risks exacerbating settlement inefficiencies for the wrapper.
It also recommended ESMA considers special “attenuation measures”, such as the ability to temporarily suspend the penalty mechanism and to “avoid making significant changes to current penalty rates or methodology” ahead of the transition.
The ETF industry strongly opposed the introduction of progressive cash penalties for ETFs under an updated CSDR, outlined in ESMA’s consultation, noting the introduction could damage the region’s competitiveness.
It comes as ETFs in Europe are already being impacted by the US’s move to T+1 in May, creating a misalignment leading to “wider spreads, ETFs trading at premiums to their fair value and volumes being determined by the day of the week”, according to the report.
The board also highlighted issues around different prices for T+1 versus T+2 settling in the same ETF and potential underperformance in UCITS due to the funding gap caused by misaligned settlement.
“An exacerbation of these trends can be anticipated as more and more countries migrate to T+1,” the report said.
“From this standpoint, when ETF primary and secondary settlement cycles do align on T+1 across the board following a European migration, settlement quality could be expected to improve.”
Other inefficiencies include the “burdensome” creation-redemption process for authorised participants, as they are required to transact on securities located in different time zones and manage their positions across multiple central securities depositories (CSDs).
“Without additional measures to improve settlement efficiency, moving to T+1 could make the process more difficult to operate. The SMSG calls on ESMA to ensure that these operational challenges do not harm investors and market integrity,” it said.
A recent ESMA report found settlement fail rates for ETFs remained at “high levels” in the first half of 2024.
It comes as the controversial mandatory buy-in regime – which contractually requires authorised participants (APs) to source securities elsewhere in the event of a settlement failure – continues to loom over the industry.
