A different approach to accelerating settlement and reducing risk

• The traditional approach to shortening the settlement cycle has been to maintain current processes while shrinking the time gap between trade date and settlement date.
• By modifying the processes occurring in the overnight hours, DTCC seeks to significantly increase settlement rates going into the next morning
• By optimising and accelerating settlement beyond T+2, firms will be able to significantly reduce capital requirements, systemic risk and operational costs while preserving the resiliency of the current infrastructure.

The financial industry’s model for clearing and settling securities has been on a long trajectory toward shorter cycles.The global trend toward reducing settlement cycles is picking up speed.

In Asia,in March 2018,Thailand joined Australia, Hong Kong, and South Korea in adopting a trade date-plus two days (T+2) settlement, with Japanese Government Bonds following suit on May 1. Similarly, Singapore has started preparing for a move to T+2, initially planned for the second half of 2018.

While the existing system is extremely efficient, there is opportunity to do more and to accelerate settlement without reducing the number of calendar days in the process.

Cutting calendar days not the only option

The traditional approach to shortening the settlement cycle has been to maintain current processes while shrinking the time gap between trade date and settlement date. The T+2 initiative in the US was a prime example of this. In September 2017, it successfully shortened the settlement cycle to T+2 and reduced industry risk without market disruption.

However, industry-wide efforts are costly and can take years to implement. For this reason, the industry needs a coordinated approach that can be executed with more agility and with less disruption than traditional calendar-day reductions in the settlement cycle.

Although China notably operates its Qualified Foreign Institutional Investor(QFII) market on a shorter settlement cycle,there are now no formal plans for an industry-wide adoption of a T+1 cycle. Yet there are opportunities to allow firms more seamless access to shortened settlement processing, both pre- and post-trade. This can be accomplished via two major proposals, accelerated settlement and settlement optimisation. Both initiatives are being discussed with regulators and industry participants in the US and are outlined in a white paper titled “Modernizing the U.S. Equity Markets Post-Trade Infrastructure”, from The Depository Trust & Clearing Corporation (DTCC), released earlier this year.One proposal largely focuses on the pre-trade period involving a trading venue that would send matched T+1 trades to the clearing house. In the US, talks are underway with potential venues.

Reducing exposure without removing a calendar day

More concretely at this point,the proposal to move the settlement of eligible trades from after the market close on the settlement date to the morning of settlement date is taking shape. This would eliminate an entire market day of settlement exposure without removing a calendar day from the standard trade settlement process.

This will be accomplished through“Settlement Optimisation”,and the first phase will begin with night cycle re-engineering, scheduled for implementation in the third quarter of 2019. By modifying the processes occurring in the overnight hours, DTCC seeks to significantly increase settlement rates going into the next morning.

Today’s more sequential algorithm brings an overnight settlement rate of about 45% for all transactions eligible to settle during that period. However, re-engineering these processes could result in that same settlement rate increasing to an estimate as high as 90%.

The new approach is pending regulatory approval, but it introduces an advanced settlement processing algorithm capable of evaluating each member’s transaction obligations, available positions, transaction priority instructions and risk management controls while identifying the transaction processing order that maximises the number of transactions settled.

Achieving the predicted increase in settlement overnight is a prerequisite for the introduction of morning settlement in addition to today’s end-of-day settlement process. That will be “Settlement Optimisation Phase 2”, moving from the afternoon of settlement date to the morning before market open, allowing the risk associated with funds settlement to be reduced, and essentially achieving T+1.5.

By optimising and accelerating settlement beyond T+2, firms will be able to significantly reduce capital requirements, systemic risk and operational costs while preserving the resiliency of the current infrastructure. This represents an important step towards leveraging the gains we have seen with T+2 to achieve even greater efficiencies for the industry.

Murray Pozmanter is Managing Director and Head of Clearing Agency Services and Global Operations at The Depository Trust & Clearing Corporation (DTCC).