Mind the Gap: Brokers Address US-European Settlement Discrepancy

Europe’s move to a two-day settlement cycle in October will cause a lot more stress for broker-dealers than just trying to communicate with their fund managers more quickly.

The reason: their clients among US asset managers may have difficulty funding more of their purchases of European securities in at least ten European markets come October 6. From that date, any trades executed in either Eurobonds or European equities in the affected markets must be settled in two days.

The US won’t be joining the European markets in moving to T+2 settlement in October. US fund managers — used to having three days to come up with the funding — may not have cash immediately available to meet the two-day timetable. The discrepancy in funding schedules between the US and Europe could cause a serious capital crunch for the largest global asset management shops, some of which trade heavily in Europe, predicts a director of global operations for a large New York brokerage who spoke with FinOps on condition of anonymity.

So what’s a global fund manager to do? There is one often-used solution: ask the broker-dealer to fund the position — that is, put up the cash on the asset manager’s behalf. Sounds reasonable, right? Maybe, but there is some concern about handling a spike in demand. “Right now, there are only a few global asset managers needing such an accommodation for a handful of European markets — primarily Germany which works on a T+2 settlement cycle,” he explains. “Imagine several dozen asset managers needing funding for at least ten European markets.”

Just how can a broker-dealer come up with such cash? International operations experts at New York brokerages tell FinOps that in addition to tapping into cash already in their coffers, they can voluntarily settle US trades on a T+2 settlement cycle. Alternatively, they can receive securities settling on T+2, and either pledge or lend the securities to come up with cash.

Accessing cash reserves and pledging securities are already done in some combination by the  largest US broker-dealers to accommodate their favored asset manager clients. The largest broker-dealers will likely have an easier time using their own excess cash to fund transactions than smaller broker-dealers, predict operations executives. However, they will need to evaluate whether they will want to increase any fees charged to fund manager customers to handle a potential higher number of funding requests.

The gap between the US market and the markets that are going to two-day settlement will not last forever. US market infrastructure Depository Trust & Clearing Corp. (DTCC) has been leading the charge to shorten the US settlement timetable to T+2, but there is no set deadline and there is plenty of speculation it could take another two years at least for the US to catch up. DTCC is parent to Depository Trust Company (DTC), the US national settlement depository.

Officials at DTC were not available to respond to questions on whether the depository has received any requests from broker-dealers to support a voluntary T+2 settlement period for dual-listed US securities — those listed in the US and European markets — and whether it will do so.

Meanwhile, operations executives at three New York-based broker-dealer firms report that intense internal discussions are taking place on how they will accommodate their largest asset manager customers. “Our operations, technology and credit departments are now talking about it,” says one. “We have to prepare for a higher volume of transactions needing funding.”