The Essence of Timing Within the U.S. Equities Settlement System
The United States equities settlement system is reliant on timing. The essence of timing is never more apparent than the risk exposure seen following a current standard T+2 settlement cycle. Now is the time to enhance that cycle and move it forward leveraging technology and other advancements to T+1. The Depository Trust & Clearing Corporation is aiming to do just that over the next few years.
A move to T+1 would reduce systemic #risk, operational risk, liquidity needs, buy-side counterparty exposure, and broker-to-broker counterparty risk. Read more in this article from Michele Hillery: https://t.co/sk48vUZqHi #settlement pic.twitter.com/NyzeQC4oQV
— DTCC (@The_DTCC) November 11, 2021
Risk Exposure Around the T+2 Cycle
The concept of the T+2 settlement cycle is that there are two whole business days between when the transaction takes place and the settlement finalizes. Think about everything that can happen within that timeframe.
The parties of the settlement transaction face risks in the areas of:
- Operational Risk
- Liquidity Risk
- Systemic Risk
- Broker to Broker Risk
- Buy-Side Risk
All of these risks see elevation due to the T+2 cycle. With a move to a T+1 cycle, eliminating an entire business day, you see gains and more certainty around settlement transactions.
Margin and Collateral Requirements
The T+2 U.S. equities settlement cycle requires excess margin and collateral requirements. The risk of counterparty default is high within the system and the margins requiring holding is due to the timing of everything. When you cut down on the settlement cycle, you improve the balance between the parties, reduce risk, and lower margin requirements.
Collateral is another piece in play here when it comes to the settlement cycle. Putting up collateral helps ensure that, if something were to happen before settlement finalization, it is there to settle the transaction. Collateral reduction due to shortening of the timing makes the transaction more seamless.
The Push for Real-Time Gross Settlement
There is an industry-wide push in many pockets for what is known as real-time gross settlement (RTGS). With the RTGS approach, you are funding all transactions one at a time. Netting and financing are not necessary in this scenario, since funding is in place just-in-time when the settlement processes. Many think this is the same as a T+0 settlement, but it is different. With T+0, the transaction settles on the same day, but not in real-time. This distinction is critical in understanding the differences and benefits of RTGS.
So will RTGS be the go-forward approach? Not likely. There would be a lot of strain on back-office operations to put RTGS in place. Brokers and asset managers would face the strain that goes with it, and suffer the consequences. This is why the push to T+1 is what is coming instead.
Technology and Process Enhancements
The Depository Trust & Clearing Corporation (DTCC) is aiming to cut the time it takes for equity trades to T+1 by the year 2023. The DTCC runs the largest U.S. securities clearinghouse. How do we get to a shorter transaction cycle when it comes to the U.S. equities system? Technology is going to be the key to everything.
There are technology road maps on the horizon that will bring new applications, new infrastructure, all with the intent of reducing the cycle time of a settlement. Much of the delay today is due to the process, with much of it still manual, being in place. By employing technology platforms to speed things up, it gets to the end goal many seek.
Improvement of the U.S. equities settlement cycle is within reach. By cutting down on the cycle time, the risk exposure also sees a drop. Technology is going to pave the way, as well as a general openness to change. Market participants will need to embrace the future, and by doing so will realize the gains that go along with it.