Industry Supports Shortening Equities Settlement
The financial industry appears to support cutting equities settlement from two days after a trade to one day according to The Depository Trust & Clearing Corporation, the US market infrastructure provider.
Michael McClain, general manager of equity clearing and DTC Settlement Services at DTCC, spoke on a panel on accelerated settlement at the 2021 DTCC Forum.
McClain said DTCC’s current technology can support a settlement cycle for U.S. equities of one business day after the trade is executed (T+1) and even same day settlement.
“However, the multilateral netting that occurs at DTCC reduces the the number of resulting security movements by 99%,” he added.
For example, if an investor buys 100,000 shares of a stock from a brokerage and the same broker then sells 98,000 shares of the same stock to a different investor later that day, then only 2,000 shares have to be settled. This materially reduces operational and market risk and enables firms to arrange financing on behalf of their clients.
In 2017 the US regulators shortened the settlement period for securities transactions from T+3 to T+2 after a cost and benefit determined this was the best outcome. In February of this year DTCC released a white paper on potentially moving to T+1 by 2023, but the infrastructure provider does not have the regulatory or legal authority to unilaterally change the settlement cycle.
DTCC said a move to T+1 allows the retention of the core benefits of centralized netting and risk management, while moving to a shorter settlement time.
Murray Pozmanter, head of clearing agency services and global business operations at DTCC, said on the panel that the average daily margin held by the clearing house two years ago was $6bn but rose to $13bn last year.
“There were several periods that we spiked at over $30bn last year in response to extreme volatility that we saw in the market,” he added.
Pozmanter added that a move to T+1 could bring a 41% reduction in the volatility component of the margin.
McClain continued that DTCC launched Project Ion to investigate using distributed ledger technology in settlement and some clients are using a prototype.
“From a technology perspective T+0 isn’t that hard but, from a processing and a market structure perspective, financing, reconciliation and securities lending would be significantly compressed,” McClain added.
For example, clients would likely not know their financing needs for a given day until trading has stopped under T+0, so securing end-of-day funds could be difficult and more expensive.
McClain said DTCC has been consulting with industry associations such as SIFMA, ICI and STA and there appears to be broad support for T+1.
In addition to T+0, there have been suggestions of moving to real-time gross settlement. This means that when a trade is executed, it is recorded immediately, money and securities move between the two parties and the trade is complete. Funding on a transaction-by-transaction basis would require trades to be prefunded on an unsecured basis, which could decrease liquidity. In addition without netting, the number of transactions to be settled and the number of failed transactions could rise significantly.
McClain said DTCC could move to T+1 in 2022 but 2023 gives the entire industry time to move and budget for the project next year.
“This gives us some time to coordinate testing for the whole industry which was a very crucial part of our move from T+3 to T+2,” added McClain. “This is a big effort, and everybody’s got to be ready or there will be problems.”
Over the next several weeks the industry organisations should reach consensus on the process to reach T+1.
“Then you’ll see DTCC begin to put together the industry plan, as we did for the move to T+2,” said McClain.
Equities settlement came into focus in January when shares in GameStop rose 1,600%. Retail investors drove up the price after users of online forum Reddit had posted that hedge funds had taken a large short position in the US video game retailer.
Trading app Robinhood was forced to temporarily suspend trading in GameStop and other “hot” stocks in order to cover its clearing margins which led to allegations of market manipulation and unfair treatment of retail investors. As a result the House Committee on Financial Services in the US Congress held a hearing into the issue in February.
The Security Traders Association said in a letter to the committee that reducing the equites settlement period from the existing T+2 regime would cut risk in the financial system.
“Given the market volatility experienced in early 2020 and more recently, it seems prudent to revisit this topic,” said the STA. “Competition in this space could also help drive innovation to keep our markets moving forward while continuing to maintain the safety, fairness and efficiency of the market.”
Kenneth Griffin, founder and chief executive of Citadel and founder and principal shareholder of Citadel Securities, also told the committee that the settlement cycle for equities should be shortened from T+2 to T+1.
“Transparent clearing house capital requirements will enable brokers and market makers to better prepare for potential capital demands and minimize the risk of associated market interruptions,” Griffin added. “Both of these enhancements are well within reach today.”