Europe is now in a ‘when not if’ situation when it comes to its plans to shorten its settlement cycle, as confirmed by the European Commission in January earlier this year.

In their statement, the AMF and Banque de France have suggested a two-pronged approach as “the most pragmatic way forward”.

The first step is a prerequisite to the second and will involve all trades being confirmed/allocated “as soon as practicable and no later than on trade date”.

The industry will be responsible for ensuring improvements in standardisation and common market practices in the EU such as market infrastructure cut offs and settlement of cross border transactions and ETF shares.

As part of step one, the T2S operator must be offered sufficient time to prepare for the settlement of an increased volume of trades during the real time settlement period, as well as for the postponing of the night batch settlement.

The pair confirmed that in order to ensure step one is completed, the European Commission should launch working groups with all stakeholders.

Step two is dependent on step one – wherein if the level of transactions confirmed/allocated on trade date is deemed as ‘sufficient’ then the settlement cycle could be reduced to T+1.

In the event of this happening, the AMF and Banque de France have suggested that rules should be carefully designed to ensure the continued attractiveness of European instruments to foreign investors.

The pair said this two-pronged approach would allow Europe a sufficient observation window to learn the necessary lessons from North America’s shift to T+1.

“Even if these markets are not fully comparable with the EU markets, it will be interesting to observe the impact,” said the pair in their proposal.

As part of their paper, the AMF and Banque de France have also tabled other methods for achieving T+1, such as leveraging the best execution or additional settlement costs of US processes to “go beyond setting up a mandatory cap and find incentive measures or tools” or the transitional measures used to implement the CSDR cash penalties mechanism.

A united approach

Coordination between the UK and Europe has been routinely flagged by stakeholders from across the industry.

The current misaligned nature of the global settlement regime has unearthed several market nuances that participants are now trying to navigate in the best possible manner.

One such theme noted by traders is the Thursday conundrum. Given that the settlement cycle is now shorter in the US trading volumes on a Thursday have dropped off significantly thanks to funding requirements that require brokers to fund a position for an additional three days on Friday, Saturday and Sunday given the slightly longer settlement cycle in Europe, the UK, and most of Asia Pacific.

Thursday volumes have been noted as “muted” thanks to what some are claiming is an extra five basis point charge on trading for orders made on that day thanks to broker funding requirements over the weekend.

While the UK is a less complex market and a shift to shortened settlement cycle could be achieved on a quicker time scale than Europe, UK regulators have slowed immediate plans for the shift following calls from participants that issues around misalignment would simply be repeated.

The AMF and Banque de France have suggested a coordinated approach with the UK and the UK Accelerated Settlement Taskforce.

“Given the interdependencies between these two markets and the ambitious timeline put forward in the UK report, such a coordination should start as soon as possible,” they said.

The UK put together a taskforce in 2022, releasing its first report in March this year which confirmed that the UK should move to T+1 no later than December 2027. Its final report will be published at the end of this year.

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Putting the topic into context, John Rothstein, chief executive of Optiver UK highlighted the core differences in options as compared to spot, explaining that there are three key areas.

Firstly, the fact that options are very highly regulated as compared to spot was highlighted, with a second consideration being the fact that connectivity is still very high touch for things like expirations and negotiating prices.

The third point linked to data: “[…] the last thing is that the data that comes out of the options market is very light, sparse for everybody – which makes things like TCA and knowing where the market is and knowing who the liquidity providers are very difficult to come by.”

Elke Wenzler, head of trading at MEAG, agreed with Rothstein, asserting that having access to liquidity on the options side is very different and that the main consideration for swaps is to have access to the right liquidity.

Sana Horrich, senior FX trader at Banque de France, shared that from her perspective the next step is for FX swaps to move to a higher electronification.

In terms of the challenges facing FX swaps, she pointed to the risk of signalling for large amounts, further highlighting: “Today what we expect from the market is to have new tools, such as price streaming and algos for FX swaps to help us enhance our trading outcome.”

Paul Lambert, chief executive of New Change FX, suggested that when it comes to the electronification of the swaps market, you have to break it down into its parts: “Foreign exchange is a market where the price that you pay depends on where you are and who you ask.”

“With swaps this is even more true because of the credit element so you need to break it down into its elements for that market to really truly move forwards – what’s the neutral rate and what’s the credit element.”

Read more: FX swaps algorithms not currently a priority for buy and sell-side due to workflow preferences

Wenzler made clear that from her perspective, automating huge amounts of the swaps market is not the way forward, while Lambert asserted: “The worst thing you can do is automate a bad process – it’s like making a wonky wheel.” 

Importantly, Rothstein made sure to highlight that the issue of automation of vanilla FX options has already been solved by some exchanges, further adding that this is something for OTC players to keep in mind.

When asked to compare the tools which are used in spot and derivatives, panellists agreed that there were key differences and as a result bases that still need to be hit in order to facilitate use.

“We want to use the same tools but it’s a different set up you need to have the axes the same on the spot side, which needs a lot of involvement from other teams. A lot of problems you have to solve,” said Wenzler.

Rothstein highlighted the role that platforms and those with the tools can play, suggesting that the priority lies with these entities trying to connect as many dots as they can.

“They can’t necessarily solve all of the underlying problems in getting that access to credit, but they can at least allow some pass through of the requesting of price and the giving of price – which makes it so at least one or two of the steps for users accessing liquidity.”

The post TradeTech FX Europe 2023: FX derivatives trading can be streamlined through electronification, but data quality must be assured, say experts appeared first on The TRADE.