30 August 2014

ICMA: The impact of T+2 settlement on the European repo market

Most European exchanges will anticipate the Central Securities Depository Regulation (CSDR) by adopting a ‘standard’ settlement date of two business days after the transaction date (T+2) for cash market transactions on 6 October 2014, which is in advance of the official deadline. Although the OTC fixed-income market is exempt, AFME, ICMA and ISLA have decided that the OTC markets they represent should follow suit, with the ‘standard’ settlement date (ie the earliest date which parties can reasonably insist on delivery) for OTC cash transactions moving to T+2 and SFTs to T+1.

Earlier settlement will narrow the window within which the repo market has to fund most cash transactions from three to two days. Unexpected cash and securities positions will have to be covered same day, adding to the volume of overnight repos. Funding and short-covering requirements will therefore fluctuate widely during the day before the settlement date (SD-1), making cash forecasting and position management more challenging. This will mean more frequent resort to credit lines and more urgent securities borrowing, which may be reflected in increased fails and specialness. Increased fails will in turn complicate cash management. Late demand to borrow securities could cause disruption in the market.

There is a risk of an incomplete and uncertain switch to T+2 in cash and T+1 in SFTs leading to the fragmentation of trading in the same asset and confusion about agreed settlement dates leading to disputes. Confusion about settlement date may result in mismatches between the receipt and delivery of securities that needs to be financed or covered, while frequent amendments of settlement instructions will impose additional settlement costs.

Should inefficiencies in the post-trade infrastructure, and in firms’ systems and processes, result in a build-up of failed deliveries, investors might be dissuaded from lending securities for fear of them not being returned, which would damage market liquidity. This could be exacerbated if backlogs in settlement could put a brake on the ability of particular firms to continue trading.

Earlier settlement will narrow the window within which the repo market has to fund most cash transactions from three to two days. Unexpected cash and securities positions will have to be covered same day, adding to the volume of overnight repos. Funding and short-covering requirements will therefore fluctuate widely during the day before the settlement date (SD-1), making cash forecasting and position management more challenging. This will mean more frequent resort to credit lines and more urgent securities borrowing, which may be reflected in increased fails and specialness. Increased fails will in turn complicate cash management. Late demand to borrow securities could cause disruption in the market.

There is a risk of an incomplete and uncertain switch to T+2 in cash and T+1 in SFTs leading to the fragmentation of trading in the same asset and confusion about agreed settlement dates leading to disputes. Confusion about settlement date may result in mismatches between the receipt and delivery of securities that needs to be financed or covered, while frequent amendments of settlement instructions will impose additional settlement costs. Should inefficiencies in the post-trade infrastructure, and in firms’ systems and processes, result in a build-up of failed deliveries, investors might be dissuaded from lending securities for fear of them not being returned, which would damage market liquidity. This could be exacerbated if backlogs in settlement could put a brake on the ability of particular firms to continue trading.

Full analysis

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