T+1 settlement has the potential to cause further friction within the European ETF market as the directive risks driving wider ETF spreads and a spike in fails.
T+1 settlementhas been a keen area of focus for the European Union after US regulators announced plans to move to one-day settlement by May 2024.
The proposed move is designed to drive more efficient use of capital across markets by reducing credit, market and liquidity risks.
However, while the US market benefits from a single currency and effectively a single market, Europe is an entirely different beast with 35 exchanges, 31 central securities depositories (CSDs) and 14 local currencies.
As a result, a move to T+1 settlement creates inefficiencies risks, especially for the ETF market which is already suffering from settlement delays due to the Central Securities Depositary Regime (CSDR) which came into effect in February 2022.
In response to these issues, the Association for Financial Markets in Europe (AFME) has created an industry taskforce to assess the T+1 settlement issues facing the European market.
The AFME taskforce will identify the potential impact on the current post-trade environment in Europe and agree on actions required to deliver those changes.
In a previous research paper, the AFME stressed: “Current settlement rates for transactions in ETFs are below market averages. This is in part due to the global composition of many ETFs, which contain underlying securities from several jurisdictions.
“Because settlement of newly created units is contingent on the settlement of the underlying constituents, this can often lead to settlement delays in a T+2 environment due to time zone differences, market holidays and cross-border settlement complexity. These challenges would be even more pronounced in a T+1 environment.”
The European ETF market has already been impacted by the introduction of CSDR in February which is leading to wider spreads in response to the fines implemented by the regulator.
The initial rollout of the directive has been extremely challenging with issues surrounding the enforcement and reporting of penalties leading to months of delays to ensure they were allocated correctly.
“Ultimately, further automation and harmonisation in the settlement models across Europe can help with timely settlement of trades and lead to a reduction in settlement fails,” Ciarán Fitzpatrick, head of ETF servicing for Europe at State Street, said.
“Any move in Europe to move to T+1 – similar to the US approach – may lead to a bigger increase in fails, given the impact of a shortened settlement cycle.”
Understanding the nuances of the European ETF market is essential if regulators decide to move to T+1 settlement. Any move could further impact the market and end investors, in particular.
