When an investor buys or sells a stock, corporate or municipal bond or mutual fund, the trade joins millions of others on a complex but highly orchestrated two-day journey to settlement. What occurs during this time is critical to providing stability to the global financial markets and protecting the investing public should either side of the transaction default.
Related: A Simplified Look at the Post-Trade Process
While the industry shortened settlement times from 5 days to 3 days in the 1990s and then again from 3 days to 2 days in 2017, the time has come to move to one day settlement (T+1) to further reduce costs and risks in the system. In support of this, we recently partnered with SIFMA and ICI to issue an industry roadmap that details plans to move to T+1 by the first half of 2024.
Why is further accelerating settlement good for the industry and end investors? Because generally speaking, in financial markets time equals risk. The longer it takes to settle a trade, the greater the likelihood of a trading party failing to meet its obligations. While this thankfully happens very infrequently, reducing the industry settlement timeframe can further mitigate counterparty risk, especially during times of market stress. This will better safeguard investors against a firm defaulting and deliver significant cost-savings by lowering margin requirements for brokerages, which are required to pledge cash and securities to a clearinghouse – somewhat like an insurance policy – to protect against the risk that their trading counterparty will be unable to meet its obligations.
While margin is the single-most effective risk management tool to protect investors and provide stability to the financial system, particularly during periods of extreme volatility, it also can create a liquidity strain on trading firms by tying up assets over two full business days, when those resources could be used for other business purposes.
While we are excited to advance the T+1 initiative, we recognize that some investors may wonder why the industry doesn’t move directly to same-day (T+0) or even to real-time settlement. It’s a fair question to ask, especially at a time when instant purchasing and expedited delivery of consumer products and services are the norm.
The simple answer is that financial markets operate uniquely, and moving to T+0 across the industry would require a fundamental overhaul of parts of the financial system’s processes and technology. In addition, moving the entire industry to T+0 would necessitate significant changes in industry convention, major investments in automating processes and technology, introduce greater levels of operating risk and require a longer timeframe to implement than T+1, which can be achieved in a reasonable period with a high focus on maintaining strong risk management while reducing margin requirements.
However, we expect that market structure will continue to evolve in the future, including even shorter settlement times, like T+0, after T+1 is successfully introduced. In fact, we are working closely with our clients right now to explore the impact of a potential netted T+0 settlement cycle, where trades are netted throughout the day and cash is settled at the end of the same trading day. Part of this effort includes our Project Ion initiative, an alternative settlement platform that leverages distributed ledger technology (DLT) to support netted T+0 activity. The platform, now in development, is also capable of supporting T+2, T+1 and extended settlement cycles, providing the flexibility to meet the unique needs and settlement timelines across market participant firms.
Even though the industry isn’t ready to move to a T+0 cycle just yet, DTCC is able to support market participants that want to settle same day. In fact, DTC currently processes over 1 million daily same-day transactions, with many settling almost instantly. At the same time, we are supportive of efforts like BSTX, which will bring automation and liquidity to firms that want to voluntarily opt-in to a shorter settlement cycle, including T+0. The key, in the short term, is optionality and flexibility when it comes to same-day settlement.
Moving forward, we will continue our work with SIFMA, ICI and the industry on moving to T+1 because it offers great potential to reduce risks across the industry and will be a significant step forward in safeguarding investors and protecting the stability of the global financial markets. At the same time, we will also evaluate opportunities to further accelerate settlement while preserving all of the benefits of the current system.