European ETF Issuers Cautiously Watch U.S. Move to T+1

Issuers of European-domiciled ETFs have been overhauling their operations over the past 12 months as they brace for one of the biggest changes to trading for years.

The May 28 switch to a T+1 from T+2 settlement cycle in the U.S. has created a litany of potential issues for European ETFs, all of which could create additional costs for the industry and investors.

Despite intentions to boost trading efficiency, a move to T+1 means European issuers risk falling foul of UCITS cash and overdraft rules while authorised participants (APs) are to be hit with additional funding burdens.

This comes amid simmering frustrations with the way the European Securities and Markets Authority (ESMA) has supported the market ahead of the changes.

Europe and Asia will continue to settle trades two days after the trade agreement (T+2), however, primary market trades involving US equities will need to settle a day earlier, creating a misalignment between primary and secondary markets that must be carefully managed.

Concerns have been raised over industry preparations and the lack of help from regulators. Tara O’Reilly, co-head of asset management and investment funds group at Arthur Cox, said she was “less optimistic” about the task at hand and questioned the lack of regulatory forbearance in helping the market transition.

“The industry has indicated there will be issues and, in our engagement with the Central Bank of Ireland (CBI), there is no indication there will be anything other than breaches,” she said.

The European Commission has earmarked a move to a T+1 cycle in the future, expected to resolve the issues of the shortened cycle in the US. However, the fragmented nature of Europe’s capital markets poses its own challenges, all at a time when settlement fail rates face increasing scrutiny under the Central Securities Depositories Regulation (CSDR).

Europe: Unprepared for T+1?

Europe’s ETF market has been keen to stress its readiness for the shortening of the settlement cycle in the US, but others have warned of an industry unprepared for the changes.

Asset managers with exposures to US equities were required to update their prospectus before the switch on 28 May—with little regulatory leeway—leaving many waiting to be finalized just days before the deadline, according to O’Reilly.

“We went through this process with no fast track or appreciation by the regulators of the steps needed,” she said. “We went through the normal processes and some prospectuses were still waiting to be finalised before the deadline.”

There were also concerns about a lack of engagement from smaller asset managers about moving to T+1. One person familiar with the topic told ETF Stream smaller players “have not been very present in the conversation” which could contribute to higher settlement fails across the industry.

“It could be they are less impacted with less US exposure, but this has also been an issue in the US,” the person said. “A large part of the market is good to go, but there is a whole cross-section of asset managers that could be caught off guard.”

Many asset managers have prepared their ETF settlement cycles ahead of the move, shifting their primary market models to T+1 for creations and redemptions for US equity ETFs and T+1 create and T+2 redeem for global exposures.

Ciaran Fitzpatrick, head of ETF solutions for Europe at State Street, who has been heading up an industry working group on T+1, played down the issues, noting larger issuers have been helping to educate the smaller issuers on the topic over the past year.

“We have spent months working with issuers, service providers and custodians to make sure everybody is doing the same thing,” he said. “We have been settling nearly 60% of creations on T+1 for several years. The changes will amplify this, but the planning has been significant.”

UCITS breaches ‘unavoidable’
One of the major concerns for asset managers is breaching the rules around cash and overdraft limits for UCITS funds. Under the rules, UCITS funds must limit cash held with a single bank to 20% of its net assets while its overdraft is limited to 10%.

Jim Goldie, head of ETF capital markets and indexed solutions, EMEA, at Invesco, told ETF Stream breaching the cash or overdraft limit will be “unavoidable” depending on the size of the trade, noting Invesco’s funds would have breached the limits on 6% of its create-redeem trades if it had not prepared its funds to be long cash ahead of the switch.

The unabridged version of this article originally appeared here in etf.com sister publication ETF Stream.