Here's why it's time to shorten the settlement cycle for US stocks

Here's why it's time to shorten the settlement cycle for US stocks
Michael Bodson, DTCC.DTCC
  • Michael Bodson is the president and CEO of the DTCC.
  • In this op-ed, Bodson makes the case for moving the settlement cycle for US securities from two days to one.

In the world of one-click purchasing, instant payments, and two-hour delivery, many investors find it counterintuitive that securities trades in the US can take two business days to complete or settle, known as the T+2 settlement cycle.

Given the pandemic-related market volatility in March 2020, and other occasions since then, market participants are looking for ways to increase efficiency, reduce risks and lower costs in the equities settlement cycle. The answer is to shorten the settlement cycle.

But questions remain: How fast should the settlement cycle be and how quickly can we, as an industry, get there?
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DTCC believes the right timeframe for the equities settlement cycle at this time is T+1.

This would deliver significant benefits to the markets and investors by lowering margin requirements, improving capital liquidity, and reducing risk, while maintaining the efficiencies, resilience, and soundness that makes our capital markets the deepest, most efficient, and liquid in the world.

T+1 will reduce risk and lower margin requirements

Under the T+2 settlement cycle, risk is spread over two full business days. To reduce this risk, clearinghouses -which are responsible for clearing and settling trades - guarantee the completion of trading activity.
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This trade guarantee operates like an insurance policy, with the clearing agency assuming the risk in the event that either of the trading parties defaults on their obligations. Buyers have peace of mind they will receive their shares and sellers have confidence they will receive their money.

To be able to provide this guarantee, clearing agencies collect margin, such as cash, from their members to cover the portfolio risk presented by their individual activities. Members include banks, broker-dealers, and other market participants. Reducing the time from the point of trade execution to the point of settlement to one day (T+1) would lower that risk and, therefore, reduce the amount of margin that firms need to post to the clearing agencies. At the same time, a T+1 settlement cycle would provide market participants with enough time to purchase equities using margin, or loans, from brokerages, as brokerages typically arrange financing or purchase shares to settle trades each day.
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With T+1, market participants could also continue to take advantage of a key benefit of the clearing agencies' processing: the end of day multilateral netting process.

On a typical trading day in 2020, DTCC's equity clearinghouse, NSCC, processed an average of $1.7 trillion in equities transactions. The multilateral netting process reduced that number by about 98% and the total value settled at the end of the trading day was around $38 billion. This critical process saves the industry significant capital, creates operational efficiencies and lowers risk.

Real-time settlement would require a massive overhaul

So why not go further to real-time gross settlement?
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DTCC's clearing agencies already have the operational capability to clear and settle on T+1 and same day for some transactions with existing technology, but it is infrequently used due to structural and process complexities.

One key concern with real-time settlement is that netting would no longer be possible. As a result, hundreds of millions of shares and trillions of dollars would move through the markets during the trading day, resulting in massive capital inefficiencies and straining liquidity.

And without the clearing agencies' trade guarantee, transactions would be unsecured, leaving market participants to rely on anonymous trading partners to make good on their transactions.
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While DTCC does believe the industry should aspire to real-time gross settlement in the future, at the moment, this would require a complete and fundamental restructuring of the operational processes and financing structures underpinning today's marketplace.

DTCC will continue to explore ways to get closer to that goal, including finalizing the prototype for a T+0 digital settlement platform using distributed ledger technology (DLT) and other emerging technologies.

Today, DTCC believes a T+1 settlement cycle is the optimal cycle for the US equities market. Based on our engagement with a broad cross-section of the industry over the past year, consensus is growing that now is the time to build upon the successful move from T+3 to T+2 in 2017 to implement T+1 by 2023.
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DTCC's core mission remains the reduction of risks and costs across the industry for the benefit of all market participants and individual investors, and we look forward to partnering with the industry and regulators to make this important and timely initiative a reality.

Michael C. Bodson is president and chief executive officer of DTCC. He is also president and chief executive officer of DTCC's principal operating subsidiaries, DTC, FICC and NSCC and a member of DTCC's Board of Directors. He is also a current member of the board of Digital Asset Holdings and a trustee of the World Economic Forum's Financial Services Initiative. He is also a member of the Federal Reserve Bank of New York Fintech Advisory Group as well as the Federal Deposit Insurance Corporation (FDIC) Systemic Resolution Advisory Committee.
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