What are the possibilities and potential challenges to moving the financial industry to accelerated settlement? Shane Swanson, Head of Equities Practice, Market Structure & Technology at Greenwich Associates, led a panel to discuss industry efforts with Craig Messinger, CEO of Virtu Americas LLC, Michael McClain, Managing Director and General Manager of Equity Clearing and DTC Settlement Services, DTCC, and Murray Pozmanter, Head of Clearing Agency Services and Global Business Operations, DTCC.
DTCC partnered with the industry in 2017 to reduce the standard settlement cycle from three days to two. And while discussions to further shorten the trading cycle were already happening, the excessive volume and volatility witnessed in March of last year in response to the pandemic, as well as market actions of this year, accelerated those conversations. DTCC has extensively explored the topic of shortened settlement and released its findings in the recent white paper, “Advancing Together: Leading the Industry to Accelerated Settlement,” which proposes shortening the settlement cycle to one day by 2023.
The current structure aggregates trading among parties and nets the transactions into one obligation per cusip for each client, allowing the extraordinary volume of last year to process seamlessly. Pozmanter noted that the daily trade average in 2020 was $1.77 trillion, and through netting, the value of transactions requiring settlement was reduced by 98% to $37.7 billion. DTCC processes between 250-300 million trades a day, and through multilateral netting, those securities movements are reduced by 99%.
The benefits of a T+1 settlement include reducing the amount of time between trade and settlement as much as possible, which decreases the amount of capital and margin to be deposited at the central clearing counterparty while still preserving the efficiencies of multilateral processing.
Current technology already supports a shortened settlement. Pozmanter noted, “DTC clears in excess of 1 million transactions on a T+0 settlement basis.” Decisions to accelerate settlement also needed to consider existing market structure, including financing, and reconciliation and securities lending.
The benefits of a T+1 settlement include reducing the amount of time between trade and settlement as much as possible, which decreases the amount of capital and margin to be deposited at the central clearing counterparty while still preserving the efficiencies of multilateral processing.
Margin Demand Rises
The amount of margin has increased dramatically. Pozmanter noted that two years ago, the average margin at NSCC was $6 billion per day — and in 2020, that spiked to $13 billion. “There were days last year when the average margin was in excess of $30 billion in response to extreme volatility. By reducing settlement to T+1, approximately 41% of the volatility component would be removed, saving the industry an estimated $3 billion.” The shortened settlement would substantially reduce the burden to post margin, as well reducing credit and counterparty risk from two days to one.
Given the increased capital and margin requirements over the past year, the level of interest in T+1 has increased. As with any change of this size, cost-benefit analysis by all participants is necessary. Messinger noted the engagement DTCC has had with the industry and how the fairly recent shift from T+3 to T+2 can be used as a guide to prepare and engage with regulators and stakeholders. And while markets responded remarkably well to the enormous stress of increased volume and volatility last year while working from home, Messinger said, “recent events, such as the trading activity around GameStop and the family office issue, highlight the urgency of executable solutions.”
T+1 Challenges
Messinger spoke of the competing demands the industry is facing, including market-data reforms and growing cyber concerns. Commission-free and fractional trading, as well as momentum trading and rebalancing are all adding to the stress of clearing and settling. “We can’t underestimate the level of existing activity in the markets, and yet we need to find a way to deal with the backlog of current commitments and at the same time move this forward.”
Why was 2023 chosen for the shift to T+1? Panelists recalled the time spent discussing the move from T+3 to T+2 and that the main driver in choosing 2023 was to move the project forward to make it a reality. McClain noted the date allows the entire industry the opportunity to coordinate testing, which took a year and was a critical part of the move from T+3 to T+2. “It’s a huge effort. Everyone needs to be ready.”
A high level of attention is needed across the organizational spectrum — not just by operations — to successfully move to a shortened settlement. “There’s no magic bullet, we need to do the work. Executives, technology, trading groups should all have buy-in,” said Messinger.
T+0 and RTGS
In response to questions about moving to shorter settlement timeframes, panelists discussed that moving to T+0 or real-time gross settlement (RTGS) are not the same. T+0 is end of day at trade date settlement, and all the benefits of netting are still accomplishable. RTGS is an instantaneous trade, with securities moved right to cash or vice versa. This scenario assumes that all securities and cash are accessible when the trade is executed.
Technology is just one facet of the trade lifecycle, and a move to RTGS should not be rushed. Financing and reconciliation need to be compressed in a T+0 world. While RTGS instantaneous settlement is attainable in the future, especially with smart contracts, today’s market structure does not support real-time settlement at scale.
There is broad industry and stakeholder support for moving settlement to T+1. Industry partners SIFMA and ICI are currently doing their own studies and discussing time frames. Over the next several weeks, DTCC plans to continue discussions with regulators as well as industry counterparts and begin planning to move to T+1.