By Michele Hillery, General Manager of Equity Clearing and DTC Settlement Service at The Depository Trust & Clearing Corporation (DTCC)
The financial markets successfully navigated the pandemic-induced volatility in March and April 2020, and again in early 2021, a testament to the operational resilience of both market participants and market infrastructures. On 12 March 2020, DTCC set a new single day record, processing over 363 million equity transactions. This was more than 15% higher than the previous peak of 315 million transactions, set at the height of the financial crisis in 2008.
While the industry demonstrated its resilience, the market volatility caused by the Covid-19 pandemic served as a reminder of the importance of robust market infrastructure and risk management practices. As a result, we thought the first quarter of this year was an appropriate time to share the results of ongoing discussions with the industry about how we can further reduce risks in the settlement cycle as volumes and volatility rise. We did this through our white paper, which highlighted the benefits of reducing the US equity settlement cycle from T+2 to T+1 and raised awareness of optimal settlement cycles.
However, in raising awareness of the advantages of accelerating the US equity settlement cycle, several myths were exposed about the current US equity settlement cycle and the infrastructure that supports it. We’re here to debunk those myths.
- Myth 1: Same-day settlement (T+0) capabilities were not possible until recently.
Same-day settlement is not a new capability. DTCC’s National Securities Clearing Corporation (NSCC), the equities clearing subsidiary, and The Depository Trust Company (DTC), the depository and securities settlement system, can clear and settle transactions on the same day (T+0) a trade is executed. However, market convention is to settle on a T+2 basis due to market structure complexities, and legacy business and operational processes.
- Myth 2: All trades must be sent to DTCC by 11:30am ET each day to be settled the same day.
Not exactly. DTC, a T+0 platform, is DTCC’s central hub where all securities positions are held in the US. Transactions settle at DTC on a near-instantaneous basis throughout the day. Clients involved in bilateral transactions, in which two firms transact directly with one another, send their trade details to DTC for near-instantaneous settlement. These transactions can include money and securities transfers between DTC members – typically custodian banks and broker/dealers.
NSCC, which clears and efficiently nets US equities trades down to a single position each day, processes same-day settlement for transactions received prior to 11:30am ET. This timing is critical because it enables transactions to go through NSCC’s continuous netting process, which is crucial to market participants as it consolidates the amounts due from – and owed to – a firm across the securities it has traded, down to a single net debit or net credit.
Every day, netting at NSCC reduces the value of payments that need to be exchanged by an average of 98% or more, which frees up capital and reduces risk for the entire industry. After completing the clearing and netting process in NSCC, the netted positions are sent to DTC for near-instantaneous settlement on the same day.
It is important to note that while NSCC has the capability to extend the deadline beyond 11:30 am ET until later in the afternoon, such a move would require industry demand and coordination, and regulators would need to be engaged.
- Myth 3: New technology, like distributed ledger technology (DLT), is required to achieve same-day or real-time settlement.
When speaking about the settlement cycle timelines, the current T+2 settlement cycle (two business days after the trade is executed) is a market structure convention, and shortening it would require industry alignment. Technology – whether legacy or new – is not a factor in determining settlement times.
DTCC has been building industry support for the move to T+1 for some time, and market participants are galvanizing around this because it will deliver significant benefits, such as increased capital efficiencies, significant risk reduction and lower margin requirements, especially during times of high volatility.
DTCC continues to explore distributed ledger technology (DLT) and other emerging technologies to determine whether their application could further modernize settlement and reduce cost and risk for the industry. As mentioned, same-day settlement (T+0) is already supported today at NSCC and DTC using existing technology.
- Myth 4: Speed of settlement should be prioritized above everything else.
As market participants have indicated to us, when it comes to settlement, speed is not everything. If trades are settled instantaneously, the benefits of netting are lost. Also, real-time settlement would require all transactions to be paid in full by investors with cash in hand and securities owned for each trade at the moment it’s executed. This makes it extremely difficult for brokers to arrange for the financing that allows people to buy securities on margin, which is a loan from the broker to the investor.
While choice in the speed of settlement cycles is important and available today, most market participants choose to prioritize the risk mitigation and cost efficiency benefits of clearing and netting alongside efficient settlement.
