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.
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