In the aftermath of the meme stock frenzy, European fund managers and banks are hurrying to brace themselves for sweeping reforms in the US securities market, with potential consequences for global trading.

The urgency stems from a groundbreaking US initiative to reduce the settlement window for share and bond deals from two days to just one day, set to take effect in May next year. This move represents one of the most significant transformations in the US market structure in recent years, with profound implications for traders worldwide.

As of last year, European institutions held over $11 trillion worth of US equities and debt, according to data from the Federal Reserve. However, the impending transition to a T+1 settlement model, known in the industry, threatens to disrupt interconnected markets, including foreign exchange and cross-border ETFs. Previously, institutions had the luxury of a full working day to address operational issues and discrepancies, but as of late May, that timeframe could shrink to a mere few hours before trades face cancellation.

Gareth Bateman, the trade execution manager at Montanaro asset manager, voiced concerns, saying, “If for whatever reason we’ve got the wrong settlement instructions, we’ve only got a few hours to try and sort that out.”

The settlement process, a critical but often overlooked market service where buyers and sellers reconcile deals and transfer assets, garnered increased regulatory attention following the meme stock episode. Brokers struggled to cope with the overwhelming trade volumes, and the two-day settlement window exacerbated the strain by holding 48 hours’ worth of unsettled trades, obstructing investors from purchasing popular stocks like GameStop and AMC.

Shortening the settlement period aims to reduce the margin payments brokers need to post at clearing houses to cover potential losses during the trade settlement.

Jim Goldie, the head of ETF capital markets for Europe, the Middle East, and Africa at Invesco, stated, “The move to T+1 is going to impact all US securities and all baskets that contain US securities. The bulk of the pain is really the misalignment between one region and another.”

Due to the substantial influence of US markets, Canada and Mexico subsequently announced their plans to reduce settlement windows to a single day, with all three countries planning to go live with these changes at the end of May next year.

While the European Securities and Markets Authority is assessing the costs and benefits of adopting a T+1 model for its market, the European settlement teams will have only a few hours between the end of the US trading window at 4 pm Eastern Standard Time and the end of the settlement window at 9 pm, which corresponds to the early hours of the next day in Europe.

The US’s transition to a one-day settlement is a more dramatic reduction than its previous shift from three to two days in 2017. AFME, a European trade body for banks and brokers, estimates an 83% reduction in settlement times for local banks and investors.

This change will also create misalignment with global markets, including the vast $2 trillion-a-day spot foreign exchange market, which currently settles within two days. Non-US traders acquiring American assets will need to secure dollars in advance or scramble to find the cash in time.

In the ETF market, funds that contain both US and non-US assets will face operational and back-office risks as the system adjusts to new stress points. Some European asset managers are relocating staff to the US to assist with the workload, while smaller firms may find the costs prohibitive.

To mitigate the impending challenges, international investors are rapidly automating their processes to minimize late-night work. Virginie O’Shea, founder of advisory firm Firebrand Research, noted that many issues stem from manual processes that need human intervention, prompting asset managers like Montanaro to seek automation wherever possible.

Photo Source: MD Rockybul Hasan

By Delino Gayweh
12th, October 2023
Serrari Financial Analyst