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Why Shortening the Settlement Cycle Will Benefit the Industry and Investors

A Q&A with Michael McClain, DTCC Managing Director and General Manager of Equity Clearing and DTC Settlement Services | February 4, 2021

DTCC has long advocated for shortening the settlement cycle to enhance market resilience, reduce margin requirements and lower costs for investors. In 2017, we led the industry-wide initiative to shorten the U.S. settlement cycle to T+2 – the most significant change to the market’s settlement cycle in over 20 years.

Although DTCC’s equities clearing and settlement subsidiaries, NSCC and DTC, can support some T+1 and even same-day settlement using existing technology, many market participants don’t leverage this option because of market structure complexities, legacy business and operational processes.

While the industry continues to align itself around shortening the settlement cycle further, as announced in January 2018, DTCC has begun steadily implementing a series of operational improvements that optimize current processes to further accelerate settlement times, and to lay the foundation for what we see as an eventual move to T+1. For example, in early 2020, DTC reengineered its night cycle processing, which produced greater operational and capital efficiencies, improved intraday settlement finality, and delivered substantial savings in the form of lower transaction costs.

Most recently, in mid-2020, DTCC announced Project Ion – an initiative that explores accelerated settlement, including T+1 and T+0 settlement cycles, by possibly leveraging digital assets and distributed ledger technology (DLT) within DTCC’s clearing and settlement services. We look forward to advancing this important work and other key projects in partnership with our clients, the regulatory community and key stakeholders, as we have done for decades, to deliver even greater value and risk reduction for the benefit of clients and ultimately the individual investor.

Is DTCC advocating for T+1 or T+0?

DTCC has engaged with its clients, including asset managers, brokers and banks, its regulators, and other key stakeholders to explore a move to T+1, or potentially T+½, to achieve greater reductions in margin requirements and costs.

Based on in-depth client feedback conducted over the past 6 months as part of the Project Ion research, DTCC does not believe the industry is adequately aligned on moving to T+0. Industry participants perceive the barriers to this change, such as challenges with predictive financing, real-time reconciliation and current workflows in the institutional trade processing lifecycle as outweighing the benefits.

Would a move to T+1/T+0 require regulatory approval?

Any change to settlement cycle timing would require regulatory engagement.

Why can’t DTCC impose T+1/T+0?

DTCC does not have the regulatory or legal authority to unilaterally change the settlement cycle. Industry participants must align and agree to shorten the settlement cycle by implementing the necessary operational and business changes, and regulators must be engaged. Nevertheless, DTCC will take a leadership position, as we did for the move to T+2, in advancing any further shortened settlement cycle, including engaging market participants to gain a deeper understanding of the views and concerns of a wide range of industry stakeholders. Meanwhile, DTCC will continuing seeking ways to deliver enhancements to the current system to help mitigate risk, enhance efficiencies, achieve margin reductions and lower costs.

Can you provide examples of market structure and legacy operational issues that have hindered a move to shorter settlement cycles?

Equity clearing and settlement is part of a much larger ecosystem of linked financial markets. Accelerating the settlement cycle would have upstream and downstream impacts on other parts of the market structure, including derivatives, securities lending, cash borrowing, foreign exchange and collateral processing.

Are there disadvantages to real-time settlement?

Accelerating settlement requires careful consideration and a balanced approach so that settlement can be achieved as close to the trade as possible (for example, T+1 or T+½), without creating capital inefficiencies and introducing new, unintended market risks, such as eliminating the enormous benefits and cost savings of multilateral netting.

As described in “Steampunk Settlement,” a white paper published by Greenwich Associates in partnership with DTCC in September 2019, real-time settlement could potentially mark a return to pre-1891 bilateral gross settlement, requiring that all transactions in the U.S. market be funded on a transaction-by-transaction basis, and thus losing the liquidity and risk-mitigating benefits of today’s netting features. Instantaneous settlement makes it impossible to fund trading on a secured basis because it doesn’t allow traders to pledge shares they have yet to transact as collateral. This scenario would require trades to be prefunded and on an unsecured basis, which could limit market liquidity.

How is DTCC working with the industry?

DTCC is engaging with industry working groups that represent a cross-section of clients and key stakeholders, to understand their views and seek input on further shortening the settlement cycle. We conducted in-depth interviews with a wide range of market participants last fall as part of this effort.

When do you think the industry will be aligned around moving to T+1 or T+0?

DTCC is ready to support the move to T+1 at the pace set by the industry. Considering the industry-wide effort involved in the move to T+2, approximately 600 professionals from all impacted segments of the industry participated in working groups and sub-groups over multiple years to develop and implement the operational framework for shortening the settlement cycle. Until industry participants and regulators collectively agree to work toward further settlement cycle changes, DTCC remains focused on continuing to deliver optimizations and enhancements that mitigate risk, enhance efficiencies, achieve margin reductions and lower costs.

 

 

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