In the late 1990s and early 2000s, the global hospitality industry spent billions installing wired internet connections in their hotel rooms. Marriott alone reportedly spent $1 billion dollars to make sure every one of its US properties had a wired high-speed connection in every room. At the end of the process, which took about three years, wireless internet, which was in its infancy at the beginning of the transition, was by then in widespread use in homes and businesses. There was no question that, despite the massive investment in wired connections, hotel guests were now going to demand Wi-Fi, and the industry would comply.
The truth is, tech-savvy hotel industry leaders saw this coming, and they had already started planning for Wi-Fi. But it wasn’t going to be ready before wired internet could be rolled out, so they plodded on, installing a technology that was quickly losing favor and would be replaced in short order.
Does this sound familiar?
The US securities industry is about to embark on a two-to-three-year transition from two-day settlement (T+2) to one-day settlement (T+1), and most industry participants are expecting the transition to netted same-day settlement (T+0) to begin right after that. Indeed, a significant number of post-trade professionals would prefer to bypass T+1 and go directly to netted T+0.
Like the transition from dial-up phone connections to wired high-speed Internet, and finally to Wi-Fi, the technologies and processes do already exist for netted T+0. The Depository Trust and Clearing Corporation’s (DTCC) clearing systems can already handle same-day settlement, as can their DLT-based Project Ion, which the infrastructure giant is urging its members to experiment with even during the run-up to T+1.
Widescale real-time settlement is still science fiction
Adding to industry impatience is the growth of private networks such as Paxos, which boasts same-day settlement for its members’ trades, and up-and-coming FinTech-based trading platforms like Extraordinary Re that settle trades in real-time.
But let’s stipulate that adoption of industry-wide real-time gross settlement (RTGS) is likely a long way off. Abolishing netting, which currently eliminates the need to settle almost 99% of daily transactions, would inexorably increase settlement fails, in effect exchanging one set of operational risks and inefficiencies for another. Even more important, the elimination of the central counterparty (CCP) trade guaranty under RTGS is not a risk scenario the industry has any appetite for. And don’t even get me started on how the securities lending folks feel about it.
So the settlement cycle the industry will likely set its sights on after T+1 is netted T+0. And similar to what more proactive hotel industry CTOs advised almost of a quarter of a century ago, many firms will examine what they can do the next two or three years – while preparing for T+1 – to also facilitate the eventual move to netted T+0.
One of the key areas to look at will be trade reconciliation. Reconciliation is difficult enough today, under T+2, with a full day available to fix trade breaks before they become settlement fails; it will be even more difficult under T+1, when reconciliation will need to be done without the one-day buffer. Imagine the difficulty under netted T+0, when the process has to be squeezed into hours, at best. This is an area ripe for process improvement.
Emphasis will shift from identifying and correcting breaks to preventing them from needing reconciliation in the first place. Artificial Intelligence and Machine Learning will be leveraged to assist in identifying patterns and probabilities of fails so that they can be systemically addressed. And outsourced reconciliation vendors will become more popular as they can adapt to changes faster and can analyse break patterns from multiple clients to determine common solutions.
Along those same lines, the trend toward full life cycle vendor propositions, and even front-to-custody/prime STP, will intensify under T+1 settlement, and should be considered sooner rather than later as a springboard to netted T+0. Let the vendors do the heavy lifting instead of doing it yourself twice in the span of a few years!
Finally, we should start thinking outside the box. Infrastructure organisations are doing their parts to provide DLT-based settlement platforms; let’s get into high gear on blockchain applications for internal processes and peer-to-peer transactions as well. Almost by definition, DLT-based applications will eliminate the need for reconciliation. And then we are 90% of the way to netted T+0.
So, it’s wired vs. wi-fi. What about real-time settlement? That’s subspace transmission. Live long and prosper.