Attended by more than 160 people, the SIX Post Trade Forum took place in London on December 7, where experts tackled a range of topical issues, including T+1, regulation, and the future of clearing.
2024 will be the year of shorter settlements
In May 2024, the US, Canada and Mexico will go live with T+1.
Although T+1 should help reduce settlement and counterparty risk – along with margining costs, a speaker said shorter settlements will have major operational implications for the industry, impacting activities like FX management, collateral management, securities lending and corporate actions. As not all markets will adopt T+1 at the same time as North America, the changes will have repercussions for American Depository Receipts, dual listed securities, and Exchange Traded Funds whose underlying baskets may include non-US securities, which settle on T+2.
“I believe investors will face issues with T+1. One of the big challenges will be getting the US Dollars and securities in place ready for settlements and getting affirmations ready for 9PM Eastern Time,” noted a speaker.
T+1 has certainly divided the industry, a point made by Javier Hernani, Head Securities Services, SIX.
“We at SIX recently conducted a survey, which found that 47% of people believe North America’s adoption of T+1 will provide an excellent opportunity to automate processes, increase efficiency and reduce costs; a further 41% said it will facilitate global alignment across major markets; and 39% reckon it will reduce counterparty risk. Conversely, the same survey also revealed 45% of people think T+1 will result in greater operational complexity, 43% said it will cause settlement fails to rise leading to more penalties, and 39% believe it could lead to an increase in funding costs,” commented Hernani.
Preparations for T+1 have been varied across the industry. “On balance, I think US institutions are prepared for T+1. My concerns are less with the custodian banks, but more so with the broker dealers and market makers, a number of whom already have internal challenges when dealing with T+2,” said one panellist.
Financial institutions based in APAC, due to the time-zone differences with North America, will be the most impacted by the transition to T+1, although some worry that they still have a lot of work to do. T+1’s introduction next year will likely require APAC financial firms to either overhaul (i.e. automate) their middle office processes, relocate their operations teams to North America, or introduce night shifts.
More markets get moving on T+1
With North America pushing ahead with T+1, other markets are now catching up.
Chile, Colombia and Peru became the latest countries to commit to T+1, while regulators in India, the first market to introduce T+1 for equities, are now talking about phasing in T+0 on an optional basis. In the UK, the Accelerated Settlements Taskforce is due to publish its findings on T+1 in January 2024. Meanwhile, the European Securities and Markets Authority (ESMA) has issued a call for evidence about shortening the EU’s settlement cycle to T+1, a consultation that Hernani said SIX is contributing to.
Whereas the US, Mexico and Canada are relatively simple markets by design (i.e. there is only one CSD in the US), the EU is more complicated. “We need to do some sort of analysis where we measure the financial cost, time and energy spent on moving the US to T+1, and then we need to multiply that by 30, as there are 30 different CSDs in the European Economic Area, each using their own different technology. Some of these CSDs will have their own interfaces with Target2Securities (T2S) and lot of that T2S technology will have aged by the time the EU adopts T+1, which many anticipate will happen in the late 2020s. Some of the T2S technology will be over 20 years old by then,” according to a speaker.
Opinions differ on whether the EU should do like the US and adopt a big bang approach towards T+1. Some warn this strategy will be too complicated, due to the high number of CCPs and CSDs in the EU, the absence of a shared currency and the different regulatory regimes across the 27 member states.
However, Jesus Benito, Head Domestic Custody and TR Operations, SIX, suggested that the EU, the UK and Switzerland should work together and introduce T+1 at the same time. This comes as some industry figures warn there could be teething issues in North America because securities in Canada will begin trading on T+1 one day before securities in the US. This has happened because the US is implementing the T+1 switchover during the Memorial Day weekend, a public holiday which is not celebrated in Canada.
The EU should also not rush its implementation of T+1, as it will not gain any competitive advantage from doing so. “The EU moved to T+2 in 2014, and the US did not transition until 2017, and the US did not face any competitive disadvantages during that three year period,” said Benito.
New regulations encroach on the industry
Moving into 2024, it is clear that the industry will still have to deal with its fair share of regulations.
In the EU, the Central Securities Depositories Regulation (CSDR) Refit is currently underway, and it is still possible that mandatory buy-ins (MBIs) could be imposed on the industry - if the authorities conclude that cash penalties have not been a sufficient enough stick to improve settlement discipline.
Furthermore, the European Market Infrastructure Regulation (EMIR) Refit is also in train, with reporting changes due to take effect in the EU from April 29, 2024 and in the UK from September 30, 2024, said Irene Mermigidis, Managing Director at REGIS-TR, SIX. The latest version of EMIR, which requires financial institutions to report details about their exchange traded derivatives and OTC trades to trade repositories, will have an additional 87 and 88 reporting fields in the EU and UK respectively.
CCPs will also be affected by possible updates to EMIR. New proposals could require EU financial and non-financial counterparties to have active accounts at EU CCPs. Additionally, there is a regulatory push to reduce EU financial institutions’ exposures to third country, systemically important CCPs. Given that 90% of euro-denominated interest rate swaps (IRS) are currently being cleared at a UK CCP, the EU – in light of Brexit – has decided this is a systemic risk, and wants to bring more IRS clearing onshore.
“However, it is also possible that EU regulators may make it easier for CCPs when obtaining approval for new products and risk models. The European Association of CCP Clearing Houses (EACH) did a survey of its membership where it found that it took on average 2.5 years to get new products approved by the regulator. The European Commission (EC) wants to bring this down to 70 days,” noted an industry expert.
Elsewhere, the US Securities and Exchange Commission (SEC) is shaking up the post-trade world with its updated Custody Rule. First proposed in the wake of the FTX failure, the rules will require qualified custodians to safeguard more assets beyond just securities and funds, in what will potentially include things like digital assets, swaps, commodities and real assets.
An executive at a leading bank said the rules will also force custodians to keep cash off their balance sheets, a move that could dramatically affect how revenues in the industry are made. The proposals, he added, will make custodians take full liability for the activities of their sub-custodians and FMIs.
The Future of Clearing
The debate about interoperability vs preferred clearing featured extensively at the Post Trade Forum.
Appetite for CCP interoperability, whereby trading counterparties can choose which CCP they clear their trades at has waned, which some blame on the refusal of certain trading venues and exchanges to open up. In contrast, there is growing momentum behind the preferred clearing model, a setup where both counterparties to a trade must choose their preferred CCP, but if there is no agreement then that trade is sent to a default CCP. Both models have their pros and cons. While interoperability facilitates greater competition, some argue it contains hidden costs. Although preferred clearing offers competitive pricing, it cannot be guaranteed that users’ trades will be cleared at their first choice CCP.
According to Marcus Harreus, Head Commercials, SIX, there is scope to further develop the so-called preferred interoperable clearing model, whereby there are multiple individual preferred CCPs, sitting alongside the incumbent CCP. Despite giving users better choice, some warn this approach could worsen fragmentation. “Without doubt the interoperability model is the best model we have. Our settlement efficiency in the interoperable space at SIX is about 98.6%, which is incredible,” he added.
With the emergence of new digital asset classes – such as crypto-currencies and security tokens – CCPs are looking to clear more products. Harreus said the Spanish CCP, BME Clearing, now has the capabilities to clear crypto-currency exchange traded products, and will be extending the offering shortly to crypto derivatives. Should the digital asset market keep growing, it could become an attractive revenue stream for CCPs.
The industry will have a lot on its plate in 2024, as shorter settlements, regulation and changes to the CCP model, take effect. However, the industry is well-positioned to ride out these challenges.
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