With increased scrutiny of all aspects of electronic trading and impending changes to OTC derivatives clearing, why has the shortening of the settlement cycle taken a backseat and what benefits could the buy-side reap?
Technology has powered forward since the last change to the US cycle in 1995, which saw a reduction of settlement from T+5 to T+3. Despite being far down regulators’ to-do list, shortening the number of days to settle a trade could bring widespread gain for limited pain.
But do the potential benefits for the buy-side warrant the effort of workflow changes that would impact the whole securities market industry?
A report released last week commissioned by the Depository Trust & Clearing Corporation (DTCC) and authored by the Boston Consulting Group, gauged industry temperature on a possible switch, which could save buy-side firms in reduced risk on institutional trades.
“The primary benefit to the buy-side was attenuated loss exposure associated with market risk on in-process institutional trades, whereas it is operational cost for the other constituents,” the report reads.
The report’s cost benefit analysis suggest migrating to a T+2 model for US equities trades would cost some $550 million, with reduction in risk exposure on guaranteed buy-side trades estimated at US$200 million, annually.
The report calculates that T+2 would result in US$170 million in annual operational savings and US$25 million in annual return on reinvested capital from clearing fund reductions, based on a 3.5% cost of capital and on firms investing proceeds in Fed funds, calculated from average return between 1998 and 2008. Migrating to a T+1 model would cost $1.8 billion, and bring in $410 million of savings per year.
Industry bodies in the US have twice flirted with the idea of reducing the cycle since 1995. In 2000, the Securities Industry Association (SIA, the predecessor to SIFMA) investigated the option and in 2004 the Securities and Exchange Commission followed, but in both cases it was decided the industry was not yet automated enough for a shorter cycle.
Michael Bodson, president and CEO of DTCC, said the push for contracting the settlement cycle will be fully supported by his organisation.
“Over the coming months, DTCC will spearhead further outreach with all industry constituents to enlist feedback on the various scenarios the report outlines to determine next steps, if any, to be taken,” Bodson said.
The report states that its findings should be used to craft a recommendation which industry can support, while regulators are engaged to determine their levels of support.
Regulatory bodies that would need to alter existing rules are also listed in the report, including the Securities and Exchange Commission and the Financial Industry Regulatory Authority, the Municipal Securities Rulemaking Board, who would have to play a central role in the reducing settlement time.
A timeline is included in the report, which indicates that by March 2013, broad support for a proposal would be achieved with involvement from regulators, and a clear timeframe for change.