The Boston Consulting Group (BCG) has completed its study of a shortened securities settlement cycle in the United States, commissioned by the Depository Trust & Clearing Corporation to examine the risk, capital and cost repercussions of reducing the cycle. After an 18-week business case analysis, BCG has concluded that shortening the settlement cycle for equities, corporate and municipal bonds could reduce risks in the securities industry but also costs by hundreds of millions of dollars.
The settlement cycle in the U.S. currently is T+3, or three days after the trade is executed. BCG examined a potential switch to T+2, T+1 or T+0.
BCG estimates the industry cost to switch to T+2 approximately $550 million, while a switch to T+1 would cost $1.77 billion. T+2 would align the settlement cycle for securities with the settlement cycle for foreign exchange in the United States, and with the T+2 cycle that is expected to be established across the European Union ahead of the launch of TARGET2-Securities in 2015.
BCG determined that T+0 would be infeasible due to the vast scope of changes that would be required to achieve it.
Despite the costs at the outset to a cycle reduction, the annual operational cost savings for a switch to T+2 are estimated at $170 million, while the annual value of clearing fund reductions would be $25 million, BCG says. For a T+1 switch, the group estimated annual savings of $175 million and clearing fund reductions of $35 million.
The reduction in risk exposure on unguaranteed buy-side trades is estimated at up to $200 million on a T+2 cycle and up to $410 million on a T+1 cycle.
DTCC will be seeking industry feedback on the report to decide if a shorter cycle would be supported by market participants. It is not predisposed to a specific outcome and rather will drive discussions with the industry to decide if the benefits outweigh the interim challenges, DTCC said in a statement.
With a strong focus on risk reduction and capital optimization, DTCC, along with the financial services industry, believes its an opportune time to examine the potential benefits of an accelerated trade settlement cycle, says Michael Bodson, DTCCs president and CEO. Over the coming months, DTCC will spearhead further outreach with all industry constituents to enlist feedback on the various scenarios the report outlines to determine next steps, if any, to be taken.
Chandy Chandrashekhar, partner and managing director of BCG, says the group found that while shortening the settlement cycle will involve up-front investments, the payback period in the industry would be about three years for the T+2 model and ten years for the T+1 model.
Our initial industry outreach, prior to the results of the cost benefit analysis, also shows that 68% of participants favor a shorter cycle and 27% of participants consider such a move a high priority for bringing greater efficiency and risk mitigation to the U.S. financial markets, Chandrashekhar says. Other constituents stated that competing priorities and regulatory initiatives represent a potential challenge to shortening the settlement cycle at this time.
BCG says a switch to T+2 would require trade-date matching, match to settle, a cross-industry settlement instruction solution, full dematerialization of physical securities, access equals delivery for all products and increased penalties for fails. In addition to those, a switch to T+1 would also require building an infrastructure for near-real time processing, transforming securities lending and foreign buyer processes and accelerating retail funding.
Earlier this year, global financial industry group CPSS-IOSCO issued its Principles for Financial Market Infrastructures report, which suggested settlements should be no longer T+3 but that individual markets should consider the benefits of even shorter cycles.
This is not the first time the U.S. has considered shortening the settlement cycle. The current cycle of T+3 was established in 1995, when it was reduced from T+5. In 2000, the Securities Industry Association (SIA), the predecessor to SIFMA, did a study on a potential switch to T+1, and in 2004 the Securities & Exchange Commission considered a shortened cycle, but in both cases it was decided too much work particularly around straight-through processing was yet to be completed to rationalize the cost. The 2000 study, for instance, concluded a switch to T+1 would cost the industry $8 billion.
For more on the ongoing push to shorten the settlement cycle in the U.S., see From T+2 to dj vu, Global Custodian, Summer 2012.
As part of its latest study, BCG interviewed or surveyed institutional and retail broker-dealers; buy-side firms including asset managers, hedge funds and pension funds; registered investment advisers; custodian banks; transfer agents; service bureaus; exchanges; and market utilities.
The full BCG report is available here.
‑Christopher Gohlke