T+1 settlement: how to achieve shorter settlement cycles

Europe’s path to shorter settlement cycles

Shortening the settlement cycle to T+1 is becoming increasingly important in Europe and is gaining regulatory and technological momentum. At the end of November 2024, the European Securities and Markets Authority (ESMA) published its long-awaited final report on shortening the settlement cycle in the European Union. In this report, ESMA recommends a phased implementation by October 11, 2027, emphasizing the need for harmonization and standardization of processes to manage this ambitious transition.

We previously covered the implications for financial institutions in another BankingHub article from October 2024. To shed light on the challenges and opportunities of this changeover from a practical perspective, we spoke to Raik Hering. As Head of Custody and Cash Services at Deutsche WertpapierService Bank AG, one of the leading providers of securities services in Germany, he has extensive expertise and in-depth knowledge of the subject.

Mr. Hering is convinced: the transition to T+1 has the potential to make the European financial market more stable and efficient, benefiting not only financial institutions but also investors through faster processes and lower costs. But the path to this goal also poses significant challenges, especially for banks and their infrastructure.

Read on to find out how dwpbank is gearing up for this groundbreaking development and how the path to T+1 in Europe will be successful.

Fundamental differences between Europe and the USA

Three-quarters of all German banks have outsourced their securities operations to dwpbank. In his role, Mr. Hering and his teams are responsible for dwpbank’s custody network and cash management. He is also Managing Director of the subsidiary dwp Service GmbH.

Mr. Hering, how does the situation in the EU differ from other financial markets, such as the USA, which have already moved to T+1?

The initial situation in Europe is much more complex than in the USA. A transition within 18 months, as in the USA, is hardly realistic. Unlike the USA, where there is a centralized financial system with the SEC as a single regulatory authority, the European market has several unique characteristics. Despite the EU, it resembles a mosaic. Also, settlement processes in Europe are fundamentally different from those in the USA, a fact that must be taken into account when moving to a shortened settlement cycle.

Take foreign exchange procurement, for example. Unlike the securities market, the spot foreign exchange market still settles on a two-day basis. This discrepancy inevitably leads to operational bottlenecks and potentially higher foreign exchange costs. However, as demand for T+1 currencies increases, the market is likely to adjust.

Another key difference with the USA is the trade confirmation process. The so-called affirmation process in the USA allows for same-day confirmation well in advance of settlement. Europe, on the other hand, requires pre-matching processes through central securities depositories. In addition, trading hours vary widely across Europe. While the Frankfurt Stock Exchange, for example, is open until 10.00 p.m., settlement on the TARGET2-Securities (T2S) platform already begins at 8.00 p.m. All trades executed in this two-hour window are theoretically already in a T+0 environment. Both factors ultimately make it difficult to coordinate transactions within the narrow window of T+1.

These concrete examples show that Europe needs binding and uniform frameworks and regulations with as few exceptions as possible.

In your opinion, what are the decisive factors for financial institutions to successfully prepare for T+1 in Europe?

The transition to T+1 represents a demanding but promising challenge for financial institutions. They will need to manage complex processes within a shorter time frame, pushing them to modernize their systems and workflows.

The key lever in the hands of the institutions themselves is automation. Institutions should enhance their IT systems to automate all processes along the trade cycle to enable real-time operations.

Standardization is equally crucial to bringing more clarity to this fragmented market environment. In this respect, institutions naturally have less direct influence. For example, greater standardization of field mapping and a reduction of free text fields in SWIFT information in ISO 20022 format would streamline processing and improve data clarity. There should also be a standardized process for fund purchases and redemptions for transfer agents as key market participants. Mandatory use of SWIFT standard formats could be a suitable solution and have a positive impact on other delivery segments such as OTC and exchange transactions.

And this brings us to the final success factor, which is the basic prerequisite for everything else: cooperation. The transition to T+1 will only be sustainable if we define uniform standards that apply to the entire value chain and are supported by all stakeholders.
Furthermore, the additional financial burden on institutions during the transition period must be taken into account, in particular to avoid disadvantaging smaller institutions.

Reduced liquidity risk, falling costs – but also challenges for the market

Where do you see the impact along the securities processing value chain (back, middle and front office), and in which processes do you identify a particular need for adaptation?

The transition to T+1 affects almost all areas of the securities settlement value chain. Technologically, both the T2S settlement platform and the central securities depository are generally capable of settling T+1 transactions. The bottleneck is not so much in the settlement as in the upstream processes in the front and middle offices of the trading parties. Due to the different trading hours within Europe, uniform settlement via T2S is hardly possible. While in some markets, such as Germany, trading continues until 10.0 p.m., in other regions, such as Greece or Poland, settlement processes start as early as 4:20 p.m. There is no way around harmonizing trading hours.

Currency planning and transaction reconciliation processes should also be standardized. Information such as trade confirmations or SSI data needs to be exchanged more quickly and accurately between parties. In addition to operational processes, infrastructure and systems will have to be adapted. Manual intervention must be optimized to meet the increasing demands for speed and accuracy. Failure to do so could expose institutions to additional costs from potential penalties or lead to liquidity problems.

The task of all market participants is now to create a uniform framework for the European securities market. To achieve this, all process steps along the entire value chain need to be closely examined: we believe that it is essential, especially on the trading day, to ensure that all allocation processes are completed, relevant data is transmitted, confirmations are reconciled at an agreed time, and FX transactions are settled on the same or next day.

What do you see as the main opportunities for the European financial market from a shortening of deadlines, apart from limiting risks and increasing liquidity in the financial market?

If Europe does not want to be perceived as lagging in the global securities market, the introduction of T+1 is the next logical step. This will increase our competitiveness in global trade. The harmonization, automation and standardization of the market infrastructure will, in the long run, reduce settlement costs and lead to a more efficient flow of capital. The market will also become more appealing to investors.

However, one of the most important opportunities lies in the reduction of operational risks and the release of capital previously tied up in covering market risks. We would also benefit from a more stable financial market, as the shorter time window means fewer market and credit defaults.

However, these positive effects will only materialize if non-EU countries such as the UK and Switzerland aim to make the transition at the same time. Any exceptions could complicate the transition process.

Measures taken by dwpbank and a look ahead to T+0

How is dwpbank preparing for T+1? What can their clients expect?

As a securities service provider to three-quarters of Germany’s credit institutions, it was important for us to prepare our processes and systems for the transition to T+1 early on, together with our client institutions. As part of the transition in the North American market, we have already made our securities platform more flexible to adequately service T+1 transactions, depending on the market and taking into account the time difference. Foreign exchange procurement has been accelerated. In addition, securities relocation processes no longer take place overnight but during the day.

We have also launched a comprehensive implementation project for the planned Europe-wide transition, covering all relevant areas and ensuring that the necessary technical and operational adjustments are made in time for the launch in autumn 2027. Our clients’ institutions can rely on us to support them throughout the entire transition process. We also participate in committees and associations to help shape the regulatory framework. Our central concern is to represent the interests of our client banks from all three banking sectors and to structure the transition in such a way that it remains feasible for all market participants, regardless of their size.

What are the benefits of T+1 for end users in the EU, and how will it affect customer satisfaction and trust in the market?

First and foremost, investors will benefit from faster settlement of their transactions. Their funds will be available to them sooner. This can be a significant added value, especially for active investors who regularly trade between different markets. Automation and standardization of processes and systems can also have a positive impact on transaction costs and make the European capital market more attractive for investors.

Do you see T+1 as the endpoint, or are there considerations to aim for an even shorter settlement time (e.g. T+0) in the EU in the long term? And what role could distributed ledger technology (DLT), for example, play in this context?

T+1 is an ambitious target for the EU as it already requires considerable adjustments to processes and systems. While a further shortening to T+0 is technologically feasible, it would require additional significant adjustments to post-trade processes and costs. This was also highlighted in a consultation with market participants launched by the EU in December 2023.

In a T+0 environment, there would no longer be a window for error correction, which would significantly increase operational risk. In addition, the benefits of netting in securities settlement for institutions and investors would no longer apply. This would significantly increase liquidity requirements, which could be particularly burdensome for smaller market participants. On the other hand, new technologies such as DLT could provide the infrastructure for T+1 and T+0 for real-time transactions, while increasing data security and transparency.

In the European context, however, these technologies are not yet ready for the market and have so far only been used to a limited extent in the financial industry. At present, they play a role mainly in pilot projects and specialized niche applications. The announced Digital Wholesale Euro is an example of such a DLT infrastructure to enable real-time settlement of coins and money as well as tokenization of assets across the entire value chain. Settlement of crypto assets against euros is currently T+1, but T+0, for example, has long been technologically possible. However, it must be introduced gradually so as not to destabilize existing systems and to allow all market participants to participate fairly.