DTCC is launching yet another review on the potential for shorter settlement cycles. Those who have been in the industry for a few years may be excused for feeling this is somewhat like playing an old, worn record. The debate has taken place in almost every market and in every time zone across the world. The core driver for shorter settlement cycles is risk limitation by cutting the pending settlement position of the markets. The core impediment is the lapsed time needed for a trade to be funded and instructed across the transaction chain from end investor through to the appropriate local settlement agent. Broker-to-broker trades, with often the benefit of netting through central counterparties, are not part of this problem. But broker-dealers are the core of the client-side settlement risk challenge as their credit risk is the issue on the table.
Logically,T+2 should be the maximum time between trade and settlement. That allows information to pass down the lengthiest of transaction chains across the most unfriendly time zones, gives time for trade repair and should, if banks change some habits of a lifetime, enable cover to be put in place for almost all cross-border transactions.
But this overlooks two fundamental factors. First, most investors manage their broker open position by credit assessing their broker counterparties, and few have a problem with the result. In fact, the replacement cost of failed settlements in the event of broker default is not their prime concern. Even in volatile markets, such exposure is likely to be just a few percent of their open positions; market practitioners prime concern should be the reliability of the delivery-versus-payment processes in each market, for exposures there could be up to 100% and more. Several markets have achieved true delivery versus payment with simultaneity of finality stock and cash side, but many still operate pale, and potentially flawed, imitations of that original 1988 G30 recommendation on the subject.
It also overlooks another apparently taboo subject for international banks, namely the ridiculous two-day lag between trading and settlement on the spot foreign exchange market. In major currencies a shorter lapsed time is possible, and it appears illogical for the two-day gap not to be shortened by at least 24 hours. The original gap is a result of the manual processes that prevailed in the pre-telex era when STP was unknown. It is inconceivable that T+1 could not become the norm for any currency that operates an RTGS payment system and that must cover securities markets with over 99% of all transaction flows.
So what is the solution? We definitely do not need a GSTPA to move to T+2. For those recent adherents to our industry, that was a failed attempt to build a high-cost, high-performance network between all parties to a transaction:investors, brokers, custodians of all variety and other affected agents. For T+2, we need two simple changes, namely banks to jettison their archaic two-day foreign exchange cycles and all investors, or at least those wishing to survive, to forsake paper and ensure they leverage on the electronic matching and settlement messaging that is already freely available in the market.