The E.U.’s T+2 cycle is causing misalignments for FX funding, ETFs, and corporate actions processing.
At a recent European Securities and Markets Authority (ESMA) public hearing on T+1 settlement, market participants expressed confidence that misalignments caused by North America’s transition will be resolved once the European Union (E.U.) adopts a shortened settlement cycle.
While North America’s transition to T+1 was largely uneventful, hailed as a success by many, including DTCC officials, ESMA’s meeting on July 10, 2024, brought to light issues that have since surfaced. Panelists highlighted problems such as foreign exchange (FX) funding challenges around exchange-traded funds (ETFs) and the misalignment of corporate action dates for dual-listed securities.
Jim Goldie
Jim Goldie, EMEA head of markets, ETFs, and indexed strategies at Invesco, reports that the misalignment of settlement cycles is causing a funding gap in the ETF sector, leading to higher spreads. For ETFs invested in U.S. or global baskets, spreads are now about a basis point higher on average.
Goldie elaborated on the “Thursday dynamic” created by the U.S. transition, which makes trading U.S. ETFs more expensive. These ETFs settle on a Thursday with a T+2 cycle, while the hedge or underlying basket settles on Friday with a T+1 cycle. This discrepancy requires weekend funding when U.S. overnight interest rates exceed 5 percent, adding an extra four or five basis points to ETF transaction processing costs.
Since the T+1 transition, Invesco’s ETF market-making volumes have surged by around 40 percent, but Thursday volumes have only increased by 5 percent. Industry-wide, secondary market volumes for ETFs tracking U.S. or global securities are up 18 percent on Wednesdays, 24 percent on Fridays, but down 13 percent on Thursdays.
While the market is adjusting by avoiding Thursday trades, Goldie notes that European alignment will fully resolve the issue. “If Europe aligns on T+1 in a harmonized manner, those funding issues will disappear overnight,” he states.
James Cunningham, head of European regulatory and market initiatives at BNY Mellon, echoes this sentiment. He points out that the misalignment of settlement cycles between the U.S. and the E.U. has complicated corporate actions for dual-listed securities, resulting in different key dates for the same security, which impacts pricing and derivatives.
When a security is traded on two different venues with varying settlement cycles, market participants face a tough choice: adopt a single set of corporate action dates, which might be operationally unsuitable for one venue, or maintain two sets of dates, risking confusion and operational errors.
Cunningham says that synchronizing the European settlement cycle with the U.S. will eliminate this issue, adding, “There isn’t a perfect solution until we get realignment of settlement cycles; once that happens, the problem will disappear.”
However, some are skeptical about the E.U.’s ability to harmonize quickly.
Kaisha Schnoll
Kaisha Schnoll, assistant vice president of trade settlement and T3 at STP Investment Services, says she doubts the E.U.’s ability to align by 2027.
“The E.U. markets are much more complex, with specific market requirements, taxes, securities that trade across multiple exchanges, and CSDR [Central Securities Depositories] penalties, which create additional risks. The CSDR adds an extra layer of compliance and regulations, making it much more problematic for the markets to move to T+1,” she says.
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