By Adrian Sharp, Principal, Fairfield Insights.
What a long, strange trip it’s been. (Weir, Garcia et al, 1970)
Earlier this year, the SEC published the final rules shortening the settlement cycle for US securities from T+2 to T+1 with a target compliance date of May 28, 2024. The case for a shortened settlement cycle remains the same today as it did in 2002:
- Reduced default and counterparty credit risk
- Reduced capital and margin requirements
- Improved liquidity
But those old enough to remember the Straight Through Processing (STP) initiatives of the late 90s and early 2000s might share a wry smile and wonder: Why has it taken so long?
The road to T+1 is as old as the automation of the capital markets industry, a story punctuated by dramatic and sometimes catastrophic events. The market crash of October 1987 brought several market inefficiencies into focus, including the credit risk inherent in the T+5 settlement cycle at that time.
Various regulatory changes were introduced following the crash to prevent extreme market moves – circuit breakers – caused by electronic trading. The bulk of these regulations were front-office focused and the post-trade functions remained largely underfunded.
The SEC shortened the settlement cycle to T+3 in 1995, but post-trade processing remained largely paper-based through the dawn of the new millennium, and double-digit trade fail rates were commonplace during high-volume markets. Phone and fax were the primary means of sharing post-trade details, and where automated processing existed, a lack of standards hindered communication between participants.
In 1998, an industry-wide initiative – the Global Straight Through Processing Association (GSTPA) – was formed with the mission to standardize cross-border clearing and settlement. The heart of the proposed solution was the concept of a virtual matching utility (VMU) that would allow participants to match and affirm trade confirmations on trade date.
A functional system – TFM – went live in September 2002, but a combination of politics, money, and commercial conflicts led to the demise of GSTPA three months later. What finally emerged was OMGEO, a partnership between DTCC and Thomson Financial ESG.
The 9/11 attacks on the World Trade Center devastated global financial markets. The impacts of the dot-com bubble were still being felt at this time. Wall Street. technology investments were redirected to business continuity and operational risk management. In response, the Securities Industry Association (now SIFMA) pushed the target date for T+1 out to 2005. It was eventually shelved.
A further complication to STP adoption and T+1 was pushback from the buy side – fund managers in particular – who felt they were being asked to pay for market inefficiencies that were not of their making.
The Credit Crisis that started in June 2007 and lasted through 2008 led to new regulations that forced financial institutions to shore up their risk management practices. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was the most impactful. It introduced stress testing and additional reporting requirements, forcing the industry to clean up its data management practices. While not directly focused on T+1, the improvements in data management and transparency laid the groundwork for overall gains in productivity.
In 2017, the US securities industry moved from T+3 to T+2 with little detrimental effect on overall settlement efficiency, a significant improvement over the dysfunction following the move to T+3 in 1995. The T+1 Testing window opened at DTCC on August 14th. DTCC subsidiaries ITP, NSCC, and DTC are participating with the Cboe, Nasdaq, and OCC. Testing will run bi-weekly through May 31, 2024.
So, the burning question this time around is: Will this be a replay of 2017 or of 1995?
It certainly feels different this time, with the ICI, SIFMA, and DTCC working in concert with both sides of the industry, and regulators, through an Industry Steering Committee (ISC) and Industry Working Groups (IWG). All indications at the time of writing suggest the transition will advance during 2024.
So, why not T+0?
T+0 was considered by the ISC in 2021. The analysis showed that attempting to move to T+0 at this time would result in a diminishing returns effect, given the structural changes across the global markets and the technology challenges for individual firms required to pull it off. The output from the ISC can be found in the SIFMA whitepaper – Accelerating the U.S. Securities Settlement Cycle to T+1.
As we look to the future, it’s worth noting that DTCC is T+0 capable and already clears and settles a sizeable portion of trades on T+0 today. Also at DTCC, Project Ion is piloting a Distributed Ledger Technology (DLT) based solution designed to facilitate T+0 settlement whilst preserving the netting capability currently provided by NSCC.
There was an expression on The Street in 1990s post-trade operations: “The back is moving closer to the front.”
It’s a lot closer today than it was back then.
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