Why it matters when trades settle

There is a case for redundancy in the settlement process

10/24/2021 3:13:00 PM

Pushing things too far could replace one set of risks with another, scarier one

There is a case for redundancy in the settlement process

T+2.Still, a lot can happen in two days on Wall Street, so why stop there? Spurred by the market gyrations of last year, a group representing banks, investors and clearers has been studying a move toT+1 and is expected within weeks to unveil a plan for how to get there. The signs are that the Securities and Exchange Commission will bless it. If so, the halving of settlement time could kick in as early as 2023. Europe, for one, would probably follow suit.

Lest anyone think the titans of finance are going soft, it should be pointed out that they are not pushing this solely for the greater good. They are as interested in cutting their own costs as systemic risks. During last year’s market turmoil, overall margin demanded by the

DTCC, America’s clearing agency for stocks, jumped five-fold, to more than $30bn daily. Hundreds of billions more a year are tied up by “fails-to-deliver”, delays owing to settlement failures (the causes of which range from mistyping errors to more sinister practices such as failing deliberately in order to manipulate the price of a stock). Freeing up this capital would leave financial firms with a lot more to invest profitably. headtopics.com

Why then stop at one-day settlement? Evangelists for so-called distributed-ledger technology are touting the possibility of going toT+0, known as “atomic” settlement. This looks technically feasible; indeed, some broker-to-broker trades at theDTCCare already settled on a near-instantaneous basis.

But is it desirable? There is a big difference between reducing settlement time and eliminating it. In the latter, the buyer would have to be pre-funded and the seller immediately ready to swap. Every bit of a complex process would need to be synchronised, with no room for error. It may also require a wrenching restructuring of the giant securities-lending market, which is designed to fit with settlement with a time lag.

Cue cries of “Luddite!” But Buttonwood is in good company in advocating keeping some redundancy in the process. Ken Griffin, boss of Citadel, one of America’s largest marketmakers, and thus no techno-slouch, has described real-time settlement as “a bridge too far” because it requires “everything [to] work perfectly in a world where there’s still people involved”. The message is clear: pushing things too far could replace one set of risks with another, scarier one, in which a small number of failed trades set off a chain-reaction across back offices worldwide. Atomic indeed.

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