John Abel, Vice President, Product Management, Settlement and Asset Services for DTCC
A shortened trade settlement cycle will bring greater certainty, safety, and soundness to capital markets around the world. But while trade settlement may be a global issue, local circumstances dictate how each market proceeds.
Case in point: Europe and the United States
In order to comply with the Regulation on settlement and Central Securities Depositories (known as “CSDR”), which was adopted by the European Union in July 2014, it is expected that more than 20 financial markets in 28 European Union (EU) countries are set to move to a shortened trade settlement cycle this autumn. In the United States, however, the industry has only recently reached a consensus to move toward shortening the settlement cycle and has yet to decide when the move should occur.
In Europe, the move from trade date plus three (T+3) to trade date plus two (T+2) is as much about harmonisation among European markets, as it is about reducing risk and promoting operational efficiencies. Today securities markets in the EU settle on a variety of different timetables, causing increased costs and risks in domestic and cross-border transactions.
Concurrently with this move toward a unified T+2 settlement cycle, the EU is also looking to migrate to a new, single European platform, called Target-2 Securities, for the settlement of securities transactions. The platform, built by the European Central Bank and four national central banks in the EU, will give European central securities depositories (CSDs) a common platform to leverage across markets. The solution will not only increase efficiency and help reduce cross-border transaction costs, it will also promote increased competition.
In all, more than 20 European markets say they will make the transition to a T+2 settlement cycle on or around October 6, 2014, and 24 European CSDs in 17 EU countries are expected to migrate to the new securities settlement platform between 2015 and 2017.
While the EU has made significant progress in the area of harmonisation across securities markets, the move to a T+2 settlement cycle in the United States has experienced a much more circuitous route. Although some assets classes such as U.S. Treasury securities and most mutual funds settle on T+1, equities, corporate and municipal bonds and unit investment trusts have generally settled on T+3 since 1995.
More than a decade ago, the U.S. financial markets considered making a much bigger jump from T+3 to T+1, but abandoned the move as a result of competing economic priorities. With the adoption of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, there is renewed interest in shortening the settlement cycle in the U.S. and The Depository Trust & Clearing Corporation (“DTCC”) has taken the lead by beginning industry-wide discussions on achieving this goal.
DTCC also commissioned the Boston Consulting Group to conduct a cost/benefit study of shortening the settlement cycle in the U.S. market. The study results showed that the vast majority of market participants in the U.S. supported the shortened settlement cycle because it would reduce risk throughout the cycle and it would generate operational savings. While the study showed that the cost of moving to T+2 is estimated to be around $550 million, it also estimated industry savings in a shortened settlement cycle of approximately $195 million each year.
The greatest benefits of this initiative to the U.S markets, however, are the reduction of counterparty, liquidity, and systemic risk. Here is how:
A shortened cycle will foster a reduction of risk by moving trades more quickly to settlement, enabling funds to be freed up faster for reinvestment, and reducing credit and counterparty exposure.
Reducing credit and counterparty exposure will also free up capital for broker/dealers by reducing Clearing Fund requirements due to the National Securities Clearing Corporation (“NSCC”, DTCC’s clearing agency subsidiary for the U.S. equity markets).
Typically, a shortened cycle could also lead to lower liquidity requirements of NSCC, the central counterparty in the U.S. equity markets, which would also result in savings to NSCC Members.
Finally during periods of high volatility, buy-side counterparty exposure and NCSC Clearing Fund requirements both increase substantially. A shortened settlement cycle could reduce the need for increased margin and liquidity – called procyclical increases – during these high-stress times and could help maintain financial stability in the markets.
The industry and DTCC have continued discussions following the completion of the Boston Consulting Group study, and, in April 2014, DTCC gained wider industry support to continue to pursue a move to a T+2 settlement cycle in a timeframe that is acceptable to the industry. At this time, DTCC also issued a white paper recommending that the U.S. shorten the settlement cycle from T+3 to T+2 and, after that is achieved, that the U.S. markets then assess the industry’s readiness for a move to T+1.
An industry steering committee, chaired by representatives from The Securities Industry and Financial Markets Association (SIFMA) and the Investment Company Institute (ICI), has been assembled to help move the initiative forward in the U.S., by establishing a timetable and putting in place the technological and process building blocks to move the U.S. markets to T+2. This move will provide a local solution in support of a global trend.