UK T+1 Taskforce report: accelerating settlement one step at a time

At a glance:

• The UK Accelerated Settlement Taskforce (AST) has published its long anticipated report recommending the transition to T+1 settlement for all securities trading on UK trading venues.
• The UK government responded, accepting all the report’s recommendations and fully endorsing the high-level transition timeline of “no later than the end of 2027”. The timeline leaves a substantial period for firms which trade on UK venues to plan and budget for the transition as well as make the necessary changes and test their operational readiness. However, it comes at a cost of a longer period of divergence from the US which transitions in less than two months’ time.
• If the EU decides to transition within this timeframe, the UK could align with it. The UK government will be engaging with the EU and Switzerland to see if the work can be aligned. The European Securities and Markets Authority (ESMA) is expected to produce its report on the EU transition in Q3 24.
• In response to the AST’s recommendations the government has also established a Technical Group (TG) to take forward T+1 implementation. The TG will publish a report by the end of 2024 defining an appropriate date for the UK to transition before the end of 2027, operational changes that should be mandated for making in 2025, and other technical changes that will be needed to facilitate the transition.
• In our previous research we highlighted some of the challenges of T+1 transition and these are also identified by the AST. In this blog we highlight key details of the AST’s report and actions that various stakeholders can take to prepare for the transition.

Key elements of the AST report

Scope

The AST has recommended that the UK transitions to T+1 settlement for all securities that trade on UK trading venues, including those which settle outside of the UK. All OTC transactions are out of scope of the AST report in the expectation that this market will transition on a voluntary basis following the underlying security. Primary issuance is also out of scope as its settlement is defined by the prospectus. The scope of the transition will ultimately be finalised by the TG and could include a “safe harbour” mechanism for ETFs and other securities that trade in the UK but settle outside of the UK.

Timeline

The AST has recommended that the date of the transition is no later than the end of 2027 with a more precise date to be determined by the TG. Although the final timeline will likely be confirmed by the end of 2024 it looks to be significantly more generous than the US one which gave firms only 15 months to prepare. The AST’s expectation is that firms will plan for UK transition in 2024 and budget all capex in the 2025 budgeting cycle. This then leaves enough time to perform testing in 2025-26 and implement the transition in 2026-27.

The AST recommends that some changes should be mandated from a date in 2025 determined by the TG. This will include market standards for onboarding of new accounts, an electronic process for sharing Standing Settlement Instructions (SSIs), market standards for allocation, confirmation and matching to take place on the trade date, market standards for securities lending recalls and extended operating hours for CREST.

Proposed UK T+1 industry implementation activities/milestones

Source: Accelerated Settlement Taskforce Report

International alignment

In determining the transition timeline, the UK was faced with a difficult choice between transitioning as soon as possible to minimise a cost of divergence from the US or allowing a longer time for transition to increase the probability of aligning with the EU. The transition timeline proposed by AST favours the latter option and allows sufficient time to incorporate lessons learned from the US transition. If the EU decides to transition within this timeframe, the UK could align with it. The UK government will be engaging with the EU to see if the work can be aligned. ESMA is expected to produce the report on the EU transition in Q3 24.

The role of the Technical Group

In addition to finalising the scope and transition deadline, the TG will identify and suggest solutions for the technical and operational challenges of the transition and select a date in 2025 for the operational changes to be mandated before the formal move. In addition, the TG will identify lessons learned from transition to faster settlement in other jurisdictions and provide a central governance function to ensure consistency of approach and action across the market including agreeing common operational standard, processes, systems, interpretations, definitions, and testing. The TG will publish its findings before the end of 2024.

Required regulatory changes and other amendments

The relevant UK authorities will need to mandate a move to T+1 once the TG produces the report. This will include amending Article5(2) of UK CSDR to mandate a maximum settlement cycle of 1 business day for transactions executed on a UK trading venue regardless of the location of the Central Securities Depository (CSD); mandating matching, allocation and confirmation on the trade date; mandating electronic SSIs; providing a framework for potential exemptions and considering amending UCITs rules to relax the 10% borrowing limit.

In addition, trading venues will need to amend their rulebooks to reflect shorter deadlines. CREST and other CSDs will likely need to extend operating hours. ETF documentation will need to be amended. Trade associations should consider collaborating to produce new best practice guidelines and encourage migration of T+1 trades on a voluntary basis.

Transition challenges

Product challenges

The AST identified several challenges in the case of a prolonged period of misalignment between the UK and EU which the TG will need to address. These includes settlement mismatch challenges for products with potentially divergent settlement cycles (XS ISIN securities, ETFs and CDIs). Firms which trade these products will need to wait for the outcome of the TG work at the end of the year for more clarity and for any decisions on potential “safe harbours”.

The report also highlighted challenges for firms which engage in securities financing (repo, securities lending, and collateral management) which will need to change their processes to accommodate shorter deadlines. The Bank of England Securities Lending committee has established a Settlement Efficiency sub-group which is examining potential improvements in this area.

FX challenges

FX is a significant issue for the UK market as c62% of shares traded on the London Stock Exchange are held by non-UK investors. The report listed several proposals for tackling the FX issue which include an increased role for custodians, entering FX trades before the underlying trade is confirmed, executing FX trades bilaterally at T+0, pre-funding transactions or extending the FX trading hours – all these options are likely to lead to higher costs or increased risk. The AST is looking to the market participants (rather than the TG) to identify and overcome the FX challenges – a process which the TG will need to monitor.

Stakeholder challenges

The report notes a divergent effect of the transition on different types of capital markets participants. For example, smaller participants will not benefit from extensive automation to the same extent as the largest participants. The costs and burden of implementing the transition is also likely to fall on different stakeholders to those who will benefit most immediately as some firms will need to do more work than others. For example, some firms which are still using faxes, emails and PDFs for settlement instructions will need to invest more in process automation. The report also recommends that mutual and other open-ended funds transition to T+2 for subscriptions and redemptions (from T+3/T+4 currently) to be better aligned with broader T+1 settlement.

Conclusion and actions for firms

The AST report notes that the major difference between the T+1 transition and large regulatory change programmes from the recent past (LIBOR transition, MIFID II) is that it does not require the introduction of new processes or financial products but does mean performing existing activities faster and more efficiently. That said, the investment that may be required to facilitate the transition is still likely to be significant. The report cites an estimate of total investment of $30-50 million per year for three years for a large financial institution.

The AST found that in other jurisdictions key investment was spent on re-engineering the settlement system architecture to facilitate intraday processing; improving understanding of inefficiencies in the settlement process, causes of friction, client communication weaknesses and workflow delays; incentivising clients to change behaviours that delay settlement; and the adoption of pre-matching solutions to increase speed and reliability of settlement.

Although the timeline proposed by the AST is quite generous compared to the US, firms may choose to accelerate their preparation to secure the benefits of settlement modernisation earlier and reduce challenges of transition at a later stage. Firms which choose to delay the preparation till later may be faced with the higher cost of a last-minute solution, increased manual input, and potential remediation.

Firms can use the current AST report to trigger a review of their back-office processes to provide an initial basis for planning their transition. As part of this, firms can:

• Identify pinch points in the settlement process today, resolve any existing operational backlogs, and review their incident management processes to understand where the main areas of contention are and reasons for outages.
• Where there are bottlenecks in the existing processes – review and simplify them, and address issues with interoperability of data.
• Reduce as much as possible manual intervention and streamline operational processes.
• Analyse the root causes of current settlement failures and identify any specific clients which contribute to them.