A daunting map to follow?
29 Nov 2023
AFME’s Pete Tomlinson, director of post trade, assesses the current settlement efficiency landscape in Europe, likening it to London’s complicated underground network
Image: AFME
The post-trade ecosystem can, in some ways, be likened to the London Underground. If either the tube system or the post-trade system were redesigned from scratch today, neither would look much like their current incarnation. However, it is also true that both of these networks have evolved significantly over time, demonstrating a remarkable ability to continuously adapt and grow — accommodating an increasing number of network participants engaged in an ever-growing volume of ‘journeys’ (or transactions). Throughout these changes, they have managed to remain open for business, emphasising their resilience and capacity for ongoing development.
The prospect of establishing a completely new network, possibly harnessing emerging technologies like distributed ledger technology (DLT), remains a potential possibility for the future. In the meantime, progress towards facilitating more efficient journeys is likely to remain a case of evolution rather than revolution. Industry participants should continue to focus on realistic, targeted measures to improve the safety and efficiency of the current post-trade ecosystem.
Improving the efficiency of securities settlements has been a topic of significant focus in Europe for several years, attracting the attention of both regulators and industry participants.
An often-mentioned aspect of this discussion is the unique structure of securities markets in Europe.
Firms looking to trade or settle in European markets must navigate a complex ecosystem of different currencies, market infrastructures, local practices and rules, raising significant additional challenges and complexities. Pictorial representations of the European market structure are as daunting to outsiders as the tube map is to London’s tourists.
This observation is not intended to serve as an excuse as to why Europe seems to underperform compared to global peers in terms of settlement rates, but rather to highlight that Europe’s unique structure may require unique solutions. It is also clear that progress in enhancing settlement efficiency in Europe will require collaborative efforts across the full spectrum of market participants. AFME members — in their various capacities as trading and settlement intermediaries in European markets — recognise their important role in taking forward initiatives to address the underlying causes of settlement fails and other post-trade inefficiencies.
It is widely accepted that the majority of settlement fails are what can be described as ‘matched fails’, which occur when both counterparties have submitted their instruction to a central securities depository (CSD) and the details match, but the buyer lacks the necessary cash available, or — more commonly — the seller does not possess sufficient securities available for delivery.
The possible reasons behind this lack of securities are myriad and complex, but certainly should not be interpreted as always resulting from short-selling activity. A lack of securities can also result from inefficiencies in inventory management and securities financing, or the failure to receive those securities from another counterparty through a separate transaction.
Clearly, further progress is required to address ‘matched fails’ while optimising the flow of available settlement inventory — for instance, through improved availability and through the usage of partial settlement facilities.
However, we should not forget the ‘unmatched fails’. Almost all of these fails seem to arise from a preventable inefficiency in the post-trade process. One way to avoid these fails is to focus on the need to strengthen the link between pre-settlement matching processes and CSD-level matching processes. Quite simply, it should not be the case that a mismatch in economic or non-economic data is not identified until after the intended settlement date of the transaction.
A central area of focus for firms, both individually and collectively, should be to conduct further analysis of the drivers behind CSDR debits for late matching fail penalties (LMFPs). These penalties are likely to be a combination of sub-optimal behaviour by counterparties, particularly in terms of the timing and accuracy of information provided, market-wide data quality issues and internal workflow issues. To effectively reduce LMFPs within the current T+2 settlement environment, changes to internal and market-wide pre-settlement matching processes are required.
Considering the potential future transition to a T+1 settlement cycle, progress in addressing this issue becomes increasingly urgent, necessitating a concerted effort by industry participants. Now is not the time to stand still.
The prospect of establishing a completely new network, possibly harnessing emerging technologies like distributed ledger technology (DLT), remains a potential possibility for the future. In the meantime, progress towards facilitating more efficient journeys is likely to remain a case of evolution rather than revolution. Industry participants should continue to focus on realistic, targeted measures to improve the safety and efficiency of the current post-trade ecosystem.
Improving the efficiency of securities settlements has been a topic of significant focus in Europe for several years, attracting the attention of both regulators and industry participants.
An often-mentioned aspect of this discussion is the unique structure of securities markets in Europe.
Firms looking to trade or settle in European markets must navigate a complex ecosystem of different currencies, market infrastructures, local practices and rules, raising significant additional challenges and complexities. Pictorial representations of the European market structure are as daunting to outsiders as the tube map is to London’s tourists.
This observation is not intended to serve as an excuse as to why Europe seems to underperform compared to global peers in terms of settlement rates, but rather to highlight that Europe’s unique structure may require unique solutions. It is also clear that progress in enhancing settlement efficiency in Europe will require collaborative efforts across the full spectrum of market participants. AFME members — in their various capacities as trading and settlement intermediaries in European markets — recognise their important role in taking forward initiatives to address the underlying causes of settlement fails and other post-trade inefficiencies.
It is widely accepted that the majority of settlement fails are what can be described as ‘matched fails’, which occur when both counterparties have submitted their instruction to a central securities depository (CSD) and the details match, but the buyer lacks the necessary cash available, or — more commonly — the seller does not possess sufficient securities available for delivery.
The possible reasons behind this lack of securities are myriad and complex, but certainly should not be interpreted as always resulting from short-selling activity. A lack of securities can also result from inefficiencies in inventory management and securities financing, or the failure to receive those securities from another counterparty through a separate transaction.
Clearly, further progress is required to address ‘matched fails’ while optimising the flow of available settlement inventory — for instance, through improved availability and through the usage of partial settlement facilities.
However, we should not forget the ‘unmatched fails’. Almost all of these fails seem to arise from a preventable inefficiency in the post-trade process. One way to avoid these fails is to focus on the need to strengthen the link between pre-settlement matching processes and CSD-level matching processes. Quite simply, it should not be the case that a mismatch in economic or non-economic data is not identified until after the intended settlement date of the transaction.
A central area of focus for firms, both individually and collectively, should be to conduct further analysis of the drivers behind CSDR debits for late matching fail penalties (LMFPs). These penalties are likely to be a combination of sub-optimal behaviour by counterparties, particularly in terms of the timing and accuracy of information provided, market-wide data quality issues and internal workflow issues. To effectively reduce LMFPs within the current T+2 settlement environment, changes to internal and market-wide pre-settlement matching processes are required.
Considering the potential future transition to a T+1 settlement cycle, progress in addressing this issue becomes increasingly urgent, necessitating a concerted effort by industry participants. Now is not the time to stand still.
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