LONDON, March 21 (Reuters) - Halving the time to settle

a stock trade in Europe could harm markets if not organised

properly, and coordinating the move with Britain will not solve

challenges faced by smaller financial firms, the EU's securities

watchdog ESMA said on Thursday.

The EU is looking at how it will copy Wall Street, which is

cutting settlement time to one business day, known as T+1, in

May, along with Canada and Mexico, in a step U.S. regulators say

will cut risk in markets.

The EU has said matching this shift is a matter of when,

rather than if, though it could take several years, and it asked

ESMA to look into the practicalities.

"ESMA understands that, although T+1 is technically possible

... mandating a harmonised shift from T+2 to T+1 in the EU would

have considerable operational impacts and could even negatively

affect the market if not organised properly," the watchdog said

in an interim report based on a public consultation.

Britain is studying a similar move.

"A significant part of the feedback received suggests that

an alignment would be beneficial, including cooperation within

geographical Europe, although this will not solve challenges

related to cross-border settlement within the EU," ESMA said.

It makes no recommendation on timing, and industry officials

say that late 2026 or early 2027 is realistically the earliest

date given the fragmented nature of Europe's stock market.

ESMA said it would further study costs and benefits of

moving to T+1, and lessons learned from the U.S. change before

reporting back in the second half of the year.

European asset managers have warned that an inability to

line up dollars in time to pay for U.S. stocks would see a rise

in "settlement fails" from May, which are subject to penalties.

Buy-side firms told ESMA that the cost of moving to T+1

would be so high for smaller asset managers that it would

trigger consolidation.

The watchdog said it does not agree with arguments

suggesting a rise in settlement fails, and that cash penalties

are a "good tool" to encourage efficiency in markets.