Within financial circles, a name is currently haunting older market participants, and still sending shivers down their spines: Herstatt. The insolvency of the Cologne-based private bank triggered a threatening chain reaction in global payment and settlement systems in 1974. After German regulators closed the bank, large foreign currency transactions remained half finished. Chase Manhattan, as the correspondent bank in New York, which had paid in dollars to Herstatt, waited in vain for the corresponding payment in Deutschmark. This eroded trust in the Clearing House Interbank Payments System (CHIPS), and global payments slowed dramatically.

The Herstatt risk, which the financial sector believed it had overcome through the founding of CLS Bank as a settlement system for transactions in the 18 major currencies, is now relevant again. As of May 28, the clocks for securities transactions in North America will tick differently than in Europe – settling trades in the United States, Canada, and Mexico will occur one day after the trade instead of the previous two. The US Securities and Exchange Commission (SEC) aims to increase efficiency for investors, and reduce „credit, market, and liquidity risks in securities transactions“ through this step enabled by technological progress.

„Certain segments of the market, including European asset managers, will have a very limited ability to access CLS for their dollar trades“, warns the European Fund and Asset Management Association (Efama). A significant portion of trading occurs around the New York Stock Exchange's close at 4 p.m., while the submission deadline at the CLS Bank ends at 6 p.m. Eastern Time – meaning midnight in Frankfurt.

As long as the US, like Europe, operated on a T+2 settlement, this was not an issue. After all, there was always an additional day available to submit foreign currency transactions for netting through CLS.

Now, however, up to 40% of trades by European asset managers in dollar currency pairs no longer have enough time available, as industry surveys by Efama have shown. As a result, these market participants would need to inefficiently use their capital, with cash reserves in greenbacks for trades worth 50 to 70 billion dollars on normal trading days, conduct operationally complex derivative transactions, or resort to bilateral clearing, as was common before the CLS era.

„The fact that 50 to 70 billion dollars in the world's major currencies are at stake every day should raise significant concerns“, Efama writes. Because, as in the Herstatt case, this could have consequences for global financial stability. Vikas Srivastava, Chief Revenue Officer at Integral, a California-based cloud service provider specialized in the financial sector, describes the results of the Efama study as a „wake-up call for market participants“. And Basu Choudhury, Head of Strategic Initiatives at Osttra, the post-trade subsidiary of S&P Global and the CME Group, emphasizes the interdependence between different assets. Structural changes triggered by the US switch to T+1 settlement also affect markets for bonds, stocks, and securities lending.

The European Union now needs to catch up. At the recent Finanzplatztag hosted by Börsen-Zeitung, industry representatives expressed the expectation that the switch to T+1 would soon be decided in Brussels. „I firmly expect a decision in 2024, followed by an implementation period of between two and three years“, said Heidi Dittmar, Managing Director of financial software provider Broadridge.

Raik Hering, Head of Custody and Money Services at DWP Bank, also considers it plausible that the EU will soon follow suit. „There are already working groups on T+1 in the United Kingdom and the European Union“, said Hering in a panel discussion. If the EU does not follow the United States in shortening its settlement cycle, situations could arise where an IBM share purchased in the United States must be settled with T+1, while the same security purchased in Frankfurt settles with T+2. Such differences increase overall complexity.

Dittmar and Hering also point out that there are already some countries in Asia where the T+1 requirement applies. For example, India shortened the cycle in January 2023. Nevertheless, the upcoming change in the United States is significantly more consequential for Europe's securities service providers, due to significantly higher transaction volumes.

The switch to T+1 involves costs. Nonetheless, according to Hering, not much technology needs to be adapted. Dittmar also sees the costs primarily on the personnel side. „Very few providers will replace entire systems just because of T+1," he said. The conversion cost is unlilely to be more than a low single-digit million-dollar expense.

The question remains: what benefit does the shortened settlement bring to banks? Here, securities service providers primarily point to collateral. Halving the settlement time does not automatically mean that only half as much collateral will be tied up, but certain less.

With the debate about T+1, the discussion about an even bigger step is gaining momentum – namely, „Atomic Settlement,“ or T+0. This change no longer appears to a distant dream of the future. Nevertheless, there are still some obstacles to T+0. Firstly, there are not yet enough high-performance systems based on distributed ledger technology or the necessary digital central bank currencies available, as Osttra strategist Choudhury emphasizes. Secondly, such a change would indeed be associated with a more comprehensive technological overhaul – something that would currently overwhelm small and medium-sized market participants.

Despite the obstacles, Choudhury regards T+0 as „inevitable“ globally in the long term. Gerhard Summerer, a trader at DZ Bank in New York, also sees a strong trend towards simultaneous settlement after the switch to T+1 in the United States. This means that market operators and trading service providers still face significant challenges.