Benefits Of Reducing Settlement Time In Securities Ecosystem

By Othman Darwish

The settlement process is defined as a legal transition during the time span between trade and settlement, a purchaser’s rights are purely contractual and thus personal, and only after settlement, they become proprietary, terminating counterparty risk. Securities settlement usually follow the delivery of securities against ( and in the same time ) the transfer of fund , this is termed as DvP in which a linkage between securities and fund transfer occur simultaneously to ensure delivery happen if and only if corresponding payment occurs.

The abbreviation of T+1,T+2 ,and T + 3 donate the day settlement occurs on a transaction , if investor buys shares stock on Monday , then Monday is the transaction date , if the transaction has T + 3 settlement date ,the settlement date is Thursday ,T +2 would be on Wednesday , the settlement date is the day ownership transfers , settlement periods among securities vary ,stock and mutual funds are T + 3 ,bonds and some money market funds is between T +1 and T + 3 . In U.S. settlement of equities, bonds, mutual funds securities requires three business days after the transaction date T +3, where the European standard is T + 2.

Despite technological advancements in the past years , The U.S settlement of equities, bonds, mutual funds securities not changed since 1995. Boston Consulting Group (BCG) conducted an independent study, authorized by The Depository Trust & Clearing Corporation (DTCC), to analyze the benefits, costs, and challenges result from shortening the settlement cycle in the U.S. market to T+1 or T+2 .The study concluded that migration to T + 2 settlement would provide immediate benefits ,This is include the reduction of counterparty risk that exist during the time between trade execution and settlement ,by moving trades in shorter time to settlement ,the risk of counterparty default and the capital requirements to mitigate that risk is minimized . As result ,shorting settlement cycle will reduce the liquidity requirement of National Securities Clearing Corporation ( NCC ) ,and thus would freeing up capital for broker-dealers . The study argue that although the initial cost of movement from T+ 3 settlement to T + 2 is approximately 550M dollars, the annual saving -that result from operational efficiency and reduced NSCC liquidity requirement - is approximately 195M dollars , this result to investment payback time of between 2.5 to 3.5 years .Also , the move to T+2 settlement will increase the U.S market global harmonization which will result in decreases of the complexity and the cost of cross-border trades ,since 2014 many EU members states moved to T+2 , many Asia and Pacific countries already settling in T +2 ,Moving U.S security market to T+2 will harmonize it with global trend. From the investor perspective, shorting the settlement cycle , as the study argue it will improve the investor protection , it will give more confidence in the U.S equity market , and enable them to have more efficient and quick access to capital and securities , and will reduce unlikely investors broker defaulting between trade execution date and settlement date .

 Although ,the benefits of shortening settlement cycle are vital and agreed on by many financial industries and regulators, the migration will require core changes in the financial industry and it's practices. Commissioner LuisA. Aguilar of U.S. Securities and Exchange Commission , addresses in his point of view noteworthy issues which need to be considered during the migration from T+3 to T+2 in U.S financial market , this include , industry members have to develop and adhere coherent processes for testing software updates before the implementation. Also shorting settlement time requires more efficient trade affirmation process ,currently only 48% of trade affirmation occur on the same day of trade, this is because many brokers still relay on manual affirmation processes like email or fax ,migration to T+2 require implementing streamlined trade matching procedure.