DTCC has proposed major structural changes in the settlement of equities, corporate debt and municipal debt securities as well as changes in the settlement of money market instruments (MMIs) to reduce risk and strengthen intraday settlement finality in the U.S. financial markets.
DTCC introduced the changes in two separate white papers issued in December. The first paper – A Roadmap for Promoting Intraday Settlement Finality in the U.S. Market – proposed implementing major settlement changes for equities and corporate and municipal debt in the course of the next five years. The second paper – Reducing Risk and Enhancing Intraday Finality in the Settlement of Money Market Instruments – proposed a new settlement model to eliminate the need for intraday reversals within the existing settlement MMI system.
All proposals are subject to regulatory approval and are still under discussion with DTCC clients and supervisors.
The Roadmap To Settlement Finality
In the first white paper, DTCC, through its depository, The Depository Trust Company (DTC), said it would introduce major enhancements that “represent DTC’s vision for the future of settlement finality and risk reduction” in the U.S. financial services industry.
While “DTC continuously monitors and reviews its settlement processes and makes adjustments as needed…DTC’s recent efforts to further reduce systemic risk…have identified a number of significant enhancements to the U.S. settlement process that will further improve the safety and soundness of the system for years to come, while at the same time aligning its settlement system more closely with global standards,” the paper states. These enhancements are the subject of ongoing discussions with participants, industry organizations and regulators.
The paper offers a “settlement roadmap that will provide a high-level overview of the proposed upcoming structural enhancements and a proposed implementation timeline for each enhancement.” The proposed enhancements will be made in four key areas:
- Settlement Matching will provide DTC customers the ability to authorize or match transactions prior to DTC attempting to process these transactions. This will eliminate the need for reclamation transactions or “reclaims,” enhance intraday settlement finality, promote settlement certainty and help eliminate systemic credit and liquidity risk.
- CNS for Value will improve the way transactions from National Securities Clearing Corporation’s (NSCC) Continuous Net Settlement (CNS) service are settled in DTC, providing clients with improved intraday liquidity management. CNS for Value also positions DTC to introduce intraday settlement slices – moving away from today’s end-of-day model.
- A Shortened Settlement Cycle study analyzes the business case for shortening the settlement cycle for U.S. equity and corporate and municipal debt transactions from its current three days (T+3) to two days (T+2) or one day (T+1). Shortening the settlement cycle would lower risk as well as reduce a customer’s liquidity and capital requirements. DTCC commissioned a study by the Boston Consulting Group and will discuss next steps with the industry in early 2013.
- Improving Intraday Finality for MMI Transactions will create a new model for settling MMIs by aligning issuance and maturity activity within specific issuers, eliminating risks associated with transaction reversals and further reducing intraday uncertainty.
“The suggested changes discussed in the settlement white paper represent the most significant structural enhancements to the settlement process in decades,” said Susan Cosgrove, DTCC Managing Director and General Manager, Settlement and Asset Services. “In addition to promoting intraday settlement finality and reducing systemic credit and liquidity risk, these initiatives will align DTC with internationally-established best practices, promote straight-through processing and better position DTC for a shorter settlement cycle, if and when recommended.”
[To access the white paper, click A Roadmap for Promoting Intraday Settlement Finality in the U.S. Markets.]
Reducing Risk In MMI Processing
In a white paper on MMI processing, DTCC said that its depository, The Depository Trust Company (DTC), plans to enhance the settlement model to eliminate the risks that come with intraday reversals of transactions in DTC’s MMI system.
“The MMI process at DTC has facilitated the growth of MMIs over the years by offering enormous settlement transaction efficiencies,” said Susan Cosgrove, DTCC Managing Director and General Manager, Settlement and Asset Services. “As the next phase of development, DTC will continue to promote risk mitigation and improve intraday finality, but will also introduce a new optimization engine to retain settlement efficiency for DTC members and the system as a whole.”
In 2012, DTCC, in partnership with the industry and the Securities Industry and Financial Markets Association (SIFMA), developed the new settlement model to conform to guidelines recommended by CPSS-IOSCO that “final settlement should occur no later than the end of the settlement day. Intraday or real-time finality should be provided where necessary to reduce risks.” CPSS-IOSCO stands for the Committee on Payment and Settlement Systems (CPSS) and the Technical Committee of the International Organization of Securities Commissions (IOSCO).
‘Refuse to Pay’
Under the current MMI settlement model, Issuing and Paying Agent (IPA) banks, that act on behalf of issuers, can instruct DTC to “refuse to pay” when the IPA has not received adequate funding from the issuer. In the event of a “refuse to pay,” DTC will reverse all valued transactions processed for the designated issuer on the current day.
“MMI settlement reversals can create credit and liquidity risk since they are processed without regard to risk management controls, and they undermine intraday finality by allowing IPAs to unilaterally instruct DTC to reverse processed transactions,” according to the paper. “This interferes with the timely updating of customer accounts by participants and extends the window of risk associated with processed transactions until very late in the settlement day when there is generally little opportunity to react.”
The new MMI settlement model will require changes to DTC’s “refusal to pay” procedures and to current market practices. The proposed change will require confirmation that issuer funding has occurred before MMI transactions are submitted for processing. This, in effect, will eliminate the reversal of MMI transactions currently associated with a “refusal to pay.”
Once DTC’s new MMI model is in place, Cosgrove said, it will offer many benefits to DTC and the industry, including:
- Mitigating the credit and liquidity risks associated with intraday MMI settlement reversals
- Increasing transparency of intraday issuer funding for custodians and IPAs.@
[To access the white paper, click Reducing Risk and Enhancing Intraday Finality in the Settlement of Money Market Instruments.]