The Depository Trust & Clearing Corporation (DTCC) is at the forefront of market evolution and innovation, leading two of the most significant enhancements to U.S. market structure in decades: the multi-year project to accelerate the securities settlement cycle to T+1 for U.S. cash equities, corporate debt, and unit investment trusts, and supporting the new rule from the U.S. Securities and Exchange Commission (SEC) that will expand central clearing of U.S. Treasuries.
These initiatives will have a transformative impact on financial markets globally. They will reduce risk in the system, enhance operational efficiencies and strengthen protections that will benefit the end investor. We’re proud of our 50+ year track record of working collaboratively with a wide cross-section of the industry to seamlessly deliver on key market improvements and are committed to serving as a strategic partner to support our clients through this period of change.
Related: Why firms around the globe should prepare for the inevitable move to T+1
Accelerating Settlement to T+1
Removing one additional day from the settlement cycle in the U.S., Canada, and Mexico to T+1 represents a seismic shift in the functioning of the equities markets. In comparison, the industry transition from T+3 to T+2 in 2017, while challenging, was less complex because the applicable timeframes were not as compressed as they will be starting this coming May. For instance, in a T+1 environment, the window from the point of execution to settlement narrows from 19 hours to just 5 hours, which demands a higher level of coordination between the global, interconnected systems that sit at the heart of the marketplace.
Operating under a compressed timeline has rippling impacts across international borders and time zones, which is why we have offered an extended period of testing and engaged with firms all over the globe. Beginning last August, DTCC created a robust series of 21 unique cycles over nine months for clients to test T+1 settlement, end-to-end, with each cycle occurring over a two-week period. Every other Friday, DTCC loaded new end-of-day position data into the test environment; once each cycle completed, the test was then wiped and reset. This rigorous testing period – which will, in fact, continue right up until the T+1 conversion weekend – has enabled firms to conduct multiple dress rehearsals and test many different challenging scenarios to try to break the system, including double-settlement days, holidays, and corporate actions.
While the move to an accelerated settlement encourages adoption of improvements in technologies that drive automation and streamlined operations, the requirement will also drive the need for adoption of behavioural changes.
Related: Visit UST1.org for all the latest on the move to T+1
We have a unique settlement cycle process in the U.S., which differs from other global markets. Outside the U.S., affirmations are generally embedded directly within the depository system. In the U.S., affirmation is a distinct first step that takes place even before the instructions for settlement are sent to the depository. This first step should happen by 9PM ET for the trade to be eligible for the DTCC netting process, which reduces risks and frees up capital for the industry by consolidating the amounts due from – and owed to – a firm. Firms still have options to achieve timely settlement because missing the 9PM ET affirmation cutoff under T+1 doesn’t mean the trade failed since “affirmation” is not the same thing as “settlement.” However, the U.S. rules require broker/dealers to meet same-day affirmation requirements via written agreements or reasonably designed policies and procedures, so we urge the industry to improve on its affirmation rates. To illustrate the consequence of not meeting same day affirmation, for example, while the trade’s delivering party can issue an order to our depository for night or day delivery, trades submitted after 9PM ET on trade date via a Night Delivery Order or on T+1 via a Day Delivery Order will incur higher costs and add operational complexity.
Aside from affirmation, we recognise that the tightened T+1 settlement window creates other challenges for global clients settling U.S. securities, including in areas such as securities lending and FX. With less time to settlement, firms have a shorter window to work out funding requirements for different currencies, and we advise clients to work closely with their FX providers and custodians on a range of solutions being offered. It also means firms have less time to process recall notices on their stock lending programs.
Since 2021, DTCC has participated in on-going T+1 industry steering committees and working groups, hosting educational webinars for clients, issuing training materials and collaborating with the regulatory community. We appreciate the enormous effort the T+1 initiative has required of everyone, and we’re committed to working with all our stakeholders to ensure a smooth transition.
The conversion process over the 2024 U.S. Memorial Day weekend in May will be a coordinated global effort across diverse stakeholders and markets. The path to T+1 has been a multi-year journey for the industry, and the months of testing have been critical as we approach U.S. implementation. With the clock ticking, we are encouraged that most of the industry has confirmed they’re prepared and that all systems are a go for T+1. We continue to support industry testing and are strongly urging clients to automate to meet the shorter deadlines in a T+1 environment.
Expanding Central Clearing of U.S. Treasuries
At the center of the U.S. financial markets, DTCC clears approximately $10 trillion of securities transactions every day – and by far the biggest share, at an average of almost $7 trillion daily, is clearing U.S. Treasuries.
Currently, U.S. Treasury Market activity is split between two disparate clearing processes: bilaterally cleared transactions and centrally cleared transactions through our subsidiary, Fixed Income Clearing Corporation (FICC). The final rules announced by the SEC in December will require a significantly larger portion of the U.S. Treasury cash and repo markets – specifically certain eligible secondary market transactions – to be centrally cleared by December 31, 2025, for cash transactions and June 30, 2026, for repo transactions. As a long-time proponent of central clearing, we view the new expanded Treasury Clearing requirement as a logical expansion of the services provided by FICC for almost 40 years. It is also consistent with our mission to protect the stability of the financial system.
FICC has steadily grown both its Treasury volumes and its community of market participants beyond its traditional dealer and bank members. We have evolved a variety of access model solutions to meet the needs of the diverse array of firms in the Treasury market – sell-side, buy-side, lenders, and borrowers. FICC has a well-earned reputation for consistently introducing client-driven innovations to support the industry. Market participants can have their activity submitted directly, agency-intermediary style, or via our unique sponsored access indirect model. FICC’s open, flexible approach to client clearing promotes the fair and equitable availability of central clearing services. For example, today FICC serves more than 2,400 Sponsored members from all around the world, up 60% year over year. Sponsored Service clearing volumes have also seen a year-over-year increase of 74% to a daily average of $938 billion.
Related: See how we're strengthening the U.S. Treasuries Market
As the only central counterparty that currently offers central clearing services for the types of Treasury transactions covered under the SEC’s new rules, FICC is well-positioned to take all the necessary steps required under those rules to meet the 2025 and 2026 implementation deadlines. Phase 1 of this preparation includes FICC establishing a new separate house and customer margin and account system, as well as some updated and forward-looking refinements to FICC’s access models and governance so that FICC can continue to evolve and respond to the market’s growing demand for central clearing services. In support of this, FICC recently submitted proposed rulebook changes to the SEC in March, and we expect to submit additional proposed changes in June. We are committed to soliciting and responding to public comments on these and any additional rulebook changes and enhancements, and we will use this feedback to continue to deliver innovative solutions that meet the needs of the diverse players in the Treasury markets.
Delivering for the Industry
We are excited about the benefits a shortened settlement cycle and expanded central clearing of U.S. Treasuries will bring to the industry.
T+1 will deliver greater operational efficiencies and reduce margin requirements, while taking both systemic risk and operational risk out of the financial system. It will also allow investors much quicker access to their funds following trade execution and settlement. Additionally, shortening the settlement cycle will mitigate risk by reducing exposure between the counterparties to a trade, between the counterparties to the clearinghouse, and for the clearinghouse itself. As other markets consider adopting an accelerated settlement cycle, the lessons learned from North America’s move will provide valuable insights.
The U.S. Treasury Market is the largest and most liquid sovereign debt market in the world. Because the Federal Reserve uses the U.S. Treasury Market as a key tool to implement monetary policy and the federal government relies on the sale of Treasuries to finance essential services, the smooth and uninterrupted functioning of these markets is critically important to the strength and stability of the entire U.S. economy. Expanding central clearing will promote market stability and improve risk management, producing benefits such as standardised risk management, reduced settlement risk, centralised default management and increased transparency.
During this period of intense market transformation, we remain deeply engaged and excited to be able to serve as a strategic partner to all our diverse stakeholders. At its heart, DTCC is an industry-owned, industry-driven risk management organisation, and given our 50+ year track record we are proud to be recognised as battle-tested in protecting market stability and certainty. We are fully committed to building on this legacy in the future.
This article was originally published to WFE on April 3, 2024.