A recent working paper from the Swift Institute discusses the progress made towards T+1 and instantaneous settlement in financial markets, and industry preparedness for such a change. Researchers from the London Institute of Banking and Finance, Ulster University Business School, and the International Securities Association for Institutional Trade Communication (ISITC) Europe CIC cover the various equity settlement technologies and analyze how collateral, stock lending and margin requirements can impact the settlement processes.
The paper draws on 44 unstructured interviews and two focus group workshops with key stakeholders in the financial industry. This sample represents firms with total assets in the tens of trillions.
The paper provides a comprehensive overview of the issues surrounding accelerated settlement and offers insights for industry practitioners. Researchers showed there is a perceived trade-off between the benefits of improving market efficiency and infrastructure and the increased risk of settlement failure.
“As our interviews were focused on those with settlement and operations functions, the tone of the responses was biased towards the latter. The findings of this study will help stakeholders identify gaps in their current settlement processes and develop strategies to meet the demands of accelerated settlement,” researchers wrote in the paper.
The debate on the move to accelerated settlement is important because settlement failure has direct consequences for the parties directly involved. Indeed, systemic failure could lead to gridlock. That would impact liquidity and smooth functioning of financial markets.
When initially arguing the case for moving US equity markets from T+2 to T+1, the Depository Trust and Clearing Corporation (DTCC) argued that the reduction in the volatility element of central counter-party clearing margin requirements would be 41%, itself representing 60% of overall margin requirements.. Additionally, a shorter settlement period can lead to increased liquidity in the market, as investors can quickly reinvest the funds received from selling securities.
However, as researchers found in the interviews, there are potential drawbacks to accelerating settlement cycles. Not least of which is the increased operational burden on market participants. Increasingly participants are having to execute sometimes quite complex instructions in a very short time period. With a shorter settlement period, there is less time to complete the necessary paperwork and processes to settle a trade, and this can be challenging for some market participants. This is particularly the case for smaller firms.
There is also a risk of increased errors in settlement as the settlement cycle shortens, which can lead to delays and additional costs. This challenge is even greater for firms in mismatched time zones where time sensitive settlement activities could take place into the early hours of the morning. In such instances, there is no flexibility to delay these functions until normal office hours as the slot for that activity (for example matching and affirmations of trade) will be closed.
In an emailed statement, Daniel Carpenter, CEO of Meritsoft (a Cognizant company) said: “Financial institutions globally need to be planning for how they will manage the likely increase in trade settlement fails, as they contend with the T+1 timeframe. Many institutions we speak to are looking at managing this as a continuation of the processes they implemented to improve settlement efficiency that began with CSDR [the Central Securities Depositories Regulation].
“European operations teams with experience of handling fails under CSDR are heavily involved in the planning for T+1 at their organization. As those who have handled CSDR effectively will know, key to improving settlement efficiency is a clear understanding of why settlements are currently failing, where they are failing, and who they are failing with.
“This can only be done effectively if all the settlement data from multiple systems is normalized and made centrally accessible to enable any meaningful analysis. Having this insight provides the foundation for optimizing and automating settlement processes to reduce the overall volume of fails more quickly.
“Systems for routing and processing trade fails need to be updated with a strategic goal of improving settlement efficiency across the bank’s different regional hubs and desks. Without this, banks will not only struggle to meet the T+1 requirement but will also be at risk of significantly higher costs from interest claims charged for trade fails, something we are also seeing an increase in as today’s higher interest rates bite.”