By Jeff Kiley, Director of Industry Relations, Americas, Omgeo
Currently across the global markets, securities trades typically take three days to reach settlement, or the point at which the securities actually change hands. This three-day period is known as T+3, or trade date plus three. During this time, financial institutions face trade exposure and prolonged counterparty risk, which increases overall systemic risk across the markets. That’s three days where operational cost accrues due to inefficient processes, and three days where capital remains held on the sidelines, unavailable for reallocation. The U.S. currently operates on a T+3 cycle.
Recently, the Boston Consulting Group (BCG) conducted a cost-benefit analysis of shortening the U.S. settlement cycle from T+3 to T+2, or even T+1. While BCG didn’t take a position in the discussion, the study found that the majority of market participants surveyed would support a move to shortened settlement cycles (SSC), and many viewed it as a top priority.
Over 60 percent of survey participants indicated the move to SSC would directly benefit their firms by way of process efficiency, reduced risk, lower exposure and cost savings. The responses were particularly poignant among brokers, who see the move as critical – roughly 30 percent of the buy side still isn’t automated and this continues to be a pain point for brokers. In order to achieve even T+2, the industry will need to move completely away from existing manual and batch processes, and commit to standardized communications between trade counterparties. This acknowledgement is a key first step towards improving the efficiency of our markets.
BCG’s research indicates that once the industry commits, a full transition to T+2 is achievable within roughly three years. If the industry chooses to commit to T+1 after the initial move to T+2, T+1 would be possible within four to six additional years.
As the paper outlines, a successful transition to SSC will require that the industry coordinate its approach to implementation. By doing so, market participants would be able to benefit from the expected gains, including increased liquidity and an overall reduction in risk, while mitigating any unintended consequences. Regulators may need to step in to guide this process, in order to achieve a harmonized result without encouraging potential risks.
For one, it’s critical that the market mandate a “match to settle” requirement for institutional trades. This was identified by BCG as a key enabler to SSC and its non-existence in the U.S. market is a primary reason why settlement efficiency is so low. With a match-to-settle mandate, trade counterparties would be required to confirm the economic details of institutional trades prior to being sent for settlement. Essentially, buyers would be required to agree with sellers on what they have bought, in what quantity, and at what price. Some may it find shocking that matching is not currently a requirement to settle trades in the U.S., the only country in the world where that’s the case, and that lack of agreement is a major contributor to decreased settlement efficiency and trade settlement failure.
Market participants must also focus on achieving trade date matching for institutional trades because of its ability to reduce the length of time and expense it takes to move a trade to settlement. Trade-date matching, which can also be referred to as same-day affirmation (“SDA”), is the completion of the trade confirmation process on trade date (“T”). In a T+2 or T+1 environment, trade-date matching is an essential part of the post-trade process because allows adequate time for discrepancies to be resolved and for the trade to be instructed by the cut-off time imposed by the settlement agent.
While achieving a match-to-settle requirement and trade-date matching may seem daunting from an operational perspective, even under today’s pressures, the task of implementation at the company level is manageable – the technology already exists to make the transition. Moving to T+2 and perhaps ultimately T+1 will help financial firms achieve measurable risk reduction and operational cost savings while freeing up capital, delivering a full payback of the implementation investment of just three years for T+2 and 10 years for T+1 as BCG suggests.
Across the Atlantic, the European Commission (EC) has proposed SSC in its Central Securities Depositories Regulation (CSDR). Currently making its way through the European Parliament and Council, the goal of CSDR is to improve settlement efficiency across the European Union (EU), shortening and harmonizing securities settlement cycles across the EU. EU markets currently settle on disparate cycles, so the EC has proposed that the entire EU move to a T+2 settlement cycle by January 1, 2015, and that financial firms incur financial penalties for any trades that do not settle within that timeframe. If passed, CSDR will make a significant impact on trade failure rates, costs and operational risks, particularly for cross-border transactions.
With many markets globally now looking to accelerate settlement cycles, there’s a strong business case for shortening settlement cycles in the U.S. rooted in the significant risk reduction it will drive across the trade lifecycle, as well as the tangible industry-wide gains from a risk mitigation and efficiency perspective. The technology to make T+2 and even T+1 a reality already exists, and the industry has voiced its interest in making the transition. All we need now is a behavioral adjustment for firms to be able to begin reaping the benefits.