By Adam Nasli, Head Analyst, BrokerChooser
The “meme stock” trading frenzy in January 2021 was an important event in US trading history and highlighted problems around US market structure. Retail traders started to push the price of highly shorted meme stocks, such as GameStop or AMC. As a result, the volatility of these stocks jumped rapidly, which put pressure on some hedge funds, broker-dealers, and clearing processes. At the end of January, the trading of many meme stocks was halted at some brokers, including Robinhood, because the daily collateral requirement at National Securities Clearing Corporation (NSCC) increased significantly. NSCC acts as the central clearing party for US equities.
In the aftermath of the frenzy, US regulators and policymakers put more emphasis on the structural issues of the US market, such as how clearing and settlement processes could be improved or if payment for order flow practice should be banned. Other important topics relating to retail traders also received more emphasis, including how gamification at broker-dealers affect retail traders’ behaviour and if it should be regulated.
Last week, the US Securities and Exchange Commission (SEC) released a proposal about shortening the settlement period from T+2 days to T+1 day (settling a trade one business day after it is executed). If this proposal is accepted, the deadline for implementation would be March 2024. As the SEC states, some of the advantages of a shorter settlement period would be:
- Reduced market and credit risk because aggregate value of unsettled trades and the time between transaction and settlement would be decreased.
- Reduced liquidity risk as investors would receive proceeds of the transaction sooner.
- The collateral requirement by the Central Clearing Party and fees collected by clearing members would be decreased. For example, the Boston Consulting Group (BCG) estimated that transition from T+3 to T+2 settlement resulted in $25 million clearing fund fee reduction per year.
These settlement changes would have positive impacts on many parties, such as broker-dealers which would be required to pay less for clearing members to clear their trades or required to deposit less margin. On the other hand, the changes require many parties to implement technological and operational changes which would carry a cost.
There are some factors that should be considered when implementing this regulation.
Here are a few aspects:
- Participants should implement more technological and operational changes. For example, affirmations/confirmations should be no later than the end of the trading day.
- At securities lending, there is less time for recalling the securities by lenders and returning them by borrowers.
- There would be less time for handling settlement errors.
- There would be a mismatch in settlements between the US and other countries, where currently T+2 settlement exists.
- There would be a mismatch between FX settlements as FX trades typically settle in T+2 days.
- There is less time for documentation to be prepared and sent, especially if there is a physical delivery.
A relevant question that emerges in the context of a shorter settlement period is whether a T+0 or real-time settlement is achievable. Techs, like blockchain, would make it technologically possible to do a shorter than T+1 settlement. However, the current post-trade infrastructure should be overhauled and the costs required for transition wouldn’t be proportional compared to the advantages of a shorter settlement period.
