In a continued effort to standardize processes across the European markets, the European Council's T+2 settlement mandate will come into effect on October 6 this year. The initiative will impact most equities trading in Europe, and players in foreign markets that want to continue trading on European venues will also be forced to comply with the new regulations. For most global players this will require a technological and process shift from a T+3 settlement cycle.
Europe is not the first market to implement a T+2 settlement cycle, but its scale and significance is being called a dress rehearsal for when the shortened cycle becomes ubiquitous across the global markets.
In a survey of major players in Asia/Pacific markets: Australia, Singapore, Hong Kong, and Japan, commissioned by the trade lifecycle automation firm Omgeo, and executed by the research firm Celent, the majority (71 percent) said they will need to make adjustments to their processes in order to to comply with the T+2 settlement cycle.
It's interesting to note that the 4- to 9-hour time difference between Europe and Asia puts additional pressure on the Eastern operations to comply. "For the major markets of Tokyo, Hong Kong, Singapore, and Sydney, the trading day overlaps with London or Frankfurt for just 1 or 2 hours, depending on the time of year, or not at all," reads the report. This effectively means Eastern operations are jumping from T+3 to a local T+1 settlement cycle to meet European schedules, and processing trades outside of their normal business hours.
Technology and process concerns
A large majority (73 percent) of firms said they will make changes to their front-office technologies, and 53 percent expected changes to their front-office processes in order to meet T+2 settlement. Sixty-four percent said they will need to make post-trade technology changes.
The survey found calculation of NAV versus selling price for mutual funds is the most burdensome adjustment for T+2. This is followed by portfolio rebalancing, corporate actions for depositary receipts, and buy-in procedure and rules between counterparts.
"Automation is key, including Standing Settlement Instructions (SSI) enrichment," says Matthew Chan, head of Asia strategy at Omgeo. "For the buy-side, this means connectivity to an industry-recognized settlement instructions database so that this information can be automatically communicated to the broker/dealer ahead of settlement." Incorrect, out-of-date and mishandled SSIs are a major cause of trade failure, and under T+2, firms will have limited room for error. "This is more critical in Asia-Pacific, where time zone challenges mean local firms effectively have less than T+2 to process European trades."
Unfortunately, these adjustments are not expected to be cheap. Thirty-four percent of firms expect the process and technology costs for compliance with Europe T+2 will be under $100,000, and 33 percent expect investments will be under $500,000. Further, "Large regional banks with a presence in Europe and global firms estimate their costs will exceed US$2 million," according to the report. Thirty-eight percent of firms also expect operational costs to increase with T+2 settlement.
Very few firms intend to change their investment strategies to avoid European regulations altogether. These are largely expected to be the smaller banks with older systems that can not easily adjust process and post-trade technology.
Perhaps the most surprising finding of the report is that with less than two weeks until implementation, 58 percent of Asia/Pacific players are not prepared for the switch. The 42 percent of prepared firms "tend to be global brokers, investment managers and custodians in Hong Kong, Singapore and Japan," according to the report. "The remaining firms, however, will likely still be working on the improvements even after the cutover to T+2 settlement in October 2014. This could put them at risk in regard to meeting the deadlines."
Sixteen percent said they are mostly completed with necessary changes, and another 16 percent have not yet begun to make changes.
Most worrying, the 19 percent of those surveyed were unaware of the October 6 deadline. However these are largely specialized brokers who expect third parties to handle these regulatory challenges for them. Even some buy-side firms aware of the deadline intend to continue a T+3 operation internally and rely on their brokers to meet the T+2 requirements.
Penalties for noncompliance include potentially severe daily fines and suspension of trading for those who fail repeatedly. Unfortunately, nearly 40 percent said they still fear incurring failed trades in a T+2 settlement cycle.