Nothing Good Happens between Trade and Settle Date

Written by James Alford on

In the post-trade space, there has been a lot of chatter about migrating to a shortened settlement cycle in the US from trade date plus 3 (T+3) to trade date plus 2 days (T+2) with a current target of end of Q3 2017.  Industry problems such as the 2008 financial crisis have forced the industry to focus on T+2 to help address the risks associated with post-trade processing.  As a colleague once said to me, "nothing good happens between trade and settle date."  T+2 is neither a new concept nor one that has not been all the buzz in times past.  The question: is it just rhetoric or does it have a substantive chance of happening this time around?

The move is being driven by a group of investment managers, broker/dealers and service providers (T2 Settlement) with an overall goal to mitigate operational and systematic risk and optimize capital.  On the flip side, the tighter settlement cycle will force firms to spend precious capital to streamline and automate their post-trade activities.  Although driven by the participatory firms based on the merits, it will not occur without regulatory change due to the capital outlay.

But first the benefits.  And there truly are benefits.

  • First and foremost, risk mitigation.  It has been said that time = risk.  T+2 reduces trade exposure between the counterparties, the counterparties to the central counterparties (CCPs) and the CCPs themselves.
  • There is a substantial amount of capital tied up during the settlement cycle.  T+2 reduces CCPs margin requirement (clearing fund) held in case of default which in turn fees up capital.
  • T+2 also reduces procyclicality……and what the heck is that!  Procyclicality are the changes in risk management practices correlated with market fluctuations.  In other words, the more volatile the market, the higher the exposure and clearing fund requirements are.
  • Related, with a shortened settlement cycle, the CCPs require fewer committed resources for liquidity which in turn reduces cost and frees up capital.
  • Finally, migrating to T+2 would align us with other global markets in Europe and Asia.

The related history provides mixed results.  The industry succeeded in 1995 to shorten the settlement cycle from T+5 to T+3 but only after it was mandated.  On the flip side, the industry failed in 2000 to move to T+1 because it wasn't.  The current T+2 target to have the necessary technology and processes in place is aspirational and presumes that the SEC, FINRA and other self-regulatory organizations publish rule changes mandating T+2.  (SEC Commissioners Express Support for Move to T2 in U.S.)

Although the benefits are clear and the initiative is widely supported, it will require a regulatory mandate to force the change and subsequent spend by the participatory firms.  So, for now, the settlement cycle remains the same as it has for 20 years.  But be aware...big changes may be right around the corner.

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