March 20, 2013

With European markets likely to move to a T+2 trade settlement cycle on January 1, 2015, experts suggest that the US markets — currently at T+3 — will likely move to a shortened settlement cycle (SSC) in the near future, to help reduce risk and costs associated with trading in the markets.

"It is quite amazing that it still takes three days to settle a trade," says Tony Freeman, executive director of industry relations at Omgeo, in an interview with Wall Street & Technology, noting that the SSC will be T+2. "Regulators keep asking why it takes so long. Many things have changed, but the settlement cycle remains the same."

For example, when a trade is executed it usually takes three days to settle, which means that there is a chance — albeit a small one — that the trade could fail. "When you buy a ticket on Delta.com, you don't have to wait three days to see if the airline actually has a seat for you," Freeman relates.

In Europe, the European Commission plans to enforce a T+2 cycle within its Central Securities Depository Regulation (CSDR) which will mandate that all 27 EU member states move to the shortened cycle by 2015. Moving the industry in the US to T+2 will also take a regulatory effort, Freeman says. "There are always a lot of other regulations to accommodate, so this will not be a priority unless it gets mandated" by US regulators," he adds. "It is going to take regulations to put SSC in place."

[To read more about Shortened Settlement Cycles (SSC), read: Reaching 100% STP -- Why Not? Why Now?.]

Despite the costs and the additional regulation that it will take to make T+2 a reality in the US, Freeman says there is broad support in the industry for shortening the trade cycle. "The shortened settlement cycle (SSC) wasn't on the agenda ahead of the [financial] crisis because the focus was on efficiency," Freeman says ."Now there is a risk and cost agenda."

According to a whitepaper from Omgeo, titled "The Road to Shorter Settlement Cycles," a Boston Consulting Group (BCG) study on the impacts of shortening the trade settlement cycle in the US financial markets for equities, corporate and municipal bonds and unit investment trust (UIT) trades, found that "75% of all survey respondents view SSC as a way to reduce risk," with "68% supporting the move and up to 60% mentioning their firms would benefit directly from risk reduction. Other benefits cited included process efficiency, reductions in loss exposure and cost savings, according to the white paper.

"The Lehman Brother situation brought it about, particularly," Freeman continued. "Lehman had thousands of in-flight transactions that went bust. Putting the proper audit trail in place is still going on five years later. The financial services industry has spent a huge amount of money speeding up the trading process, but not a lot on the middle office."

Moving to Trade Date Matching, also known as Same Day Affirmation (SDA), is identified as one area where institutions should focus because "of its ability to reduce the length of time and expense it takes to move a trade to settlement," noted the white paper. The EU's CSDR supports moving to trade date matching and Canada already requires that 90% of trades be matched "on T+1."

Another focus that would help the move to SSC is "Match to Settle," where "the requirement that economic details of institutional trades be matched between trade counterparties prior to being sent for settlement." The US is the only country that does not mandate this process today, leading to lower settlement efficiency and SDA rates when compared to other major markets. As an example of how far behind the US markets are when it comes to having an efficient post-trade cycle, Freemen says that less than 50% of trades have a same day affirmation in the US. Europe has 80-90% same day affirmations and Asia has over 90% same day affirmations.

According to the BCG's study, industry participants agree that Match to Settle needs to be improved. Eighty percent of custodians, 57% of institutional broker/dealers, 55% of buy-side firms and 32% of RIAs think Match to Settle should be mandatory to achieve SSC, according to BCG.

ABOUT THE AUTHOR
Greg MacSweeney is editorial director of InformationWeek Financial Services, whose brands include Wall Street & Technology, Bank Systems & Technology, Advanced Trading, and Insurance & Technology.