Q: Let’s start with the basics. Tell us about the role DTCC plays in the markets.
DTCC has been the backbone of the U.S. financial industry for more than 45 years, providing clearing and settlement services for the industry. While investors might be familiar with the front end of trading, such as brokers and the exchanges, DTCC’s subsidiaries make up the organizations, systems and networks that provide the underlying infrastructure that enable the financial markets to operate seamlessly. They can include payment and settlement systems, clearinghouses, and depositories.
Q: Walk me through the process of a typical trade, and how DTCC comes into play.
After an investor places a trade, that transaction is sent to a clearinghouse. After the trade is compared and verified, the clearinghouse steps in between the two sides, and regardless of what happens to either party, it guarantees the trade will be completed. This gives buyers the peace of mind that they’ll get their shares, and it gives sellers the confidence that they’ll get their money.
One of our most important responsibilities is guaranteeing trade completion in the event one or both parties to a transaction defaults.
Q: What is the current settlement cycle, and what is DTCC proposing?
The settlement cycle for U.S. equities is currently T+2 – or, two business days after the trade is executed. DTCC recently outlined an industry roadmap for shortening the cycle to T+1 by 2023.
Q: What are the benefits of removing a day from the settlement cycle?
Taking a day out of the settlement cycle essentially removes a day’s worth of risk. Under the current T+2 settlement cycle, risk is spread out over two full business days. Time increases the risk that an unpredictable event could significantly affect the transfer of cash or ownership of securities from the point of trade execution through settlement. Shortening the standard settlement cycle to just one day after trade execution could further reduce operational and systemic risk across the industry.
The benefits of moving to T+1 would extend beyond risk reduction, however. Another big advantage is margin relief. Clearing members are required to post margin with us every day to help manage counterparty default risk in the system. Shortened settlement times would reduce those margin requirements, allowing firms to use these financial resources in other ways. DTCC estimates that a move to T+1 could bring a 41% reduction in the volatility component of the National Securities Clearing Corporation (NSCC)’s margin.
Q: This isn’t the first time DTCC has pushed for shortening the settlement cycle?
We’ve long been advocates of shortening the settlement cycle, especially because the benefits it brings – like margin relief, risk reduction, and cost savings – can be felt across the entire financial ecosystem. In 2017, we led the industry-wide initiative to shorten the U.S. settlement cycle from T+3 to T+2 – the most significant change to the market’s settlement cycle in over 20 years.
More recently, we’ve been steadily implementing a series of operational improvements that optimize current processes to further accelerate settlement times, and to lay the foundation for what we see as the eventual move to T+1. In early 2020, DTCC's subsidiary, The Depository Trust Company (DTC), reengineered its night cycle processing, which produced greater operational and capital efficiencies, improved intraday settlement finality, and delivered substantial savings in the form of lower transaction costs.
In May 2020, DTCC announced Project Ion, exploring whether the digitalization of assets and application of distributed ledger technology (DLT) can accelerate settlement and reduce cost and risk for the industry.
Q: Why stop at T+1? Why not clear and settle in real time?
Real-time settlement is something we should continue to aspire to as an industry, but it would necessitate complex and significant market structure changes. Real-time settlement would require a fundamental restructuring of today’s marketplace, including changes to securities lending practices and the need to prefund all transactions on an unsecured basis. Additionally, netting would not be possible, which would create massive capital inefficiencies, strain liquidity and increase risk for firms and investors.
Netting is a major risk-mitigating tool that, through an automatic process, offsets a firm’s buy orders for a particular security against its sell orders for that security. Netting consolidates the amounts due from – and owed to – a firm across all the different securities it has traded to a single net debit or a net credit. Every day, netting reduces the value of payments that need to be exchanged by an average of 98%. For context, an average day in 2020 saw $1.77 trillion dollars in trades netted down to a final settlement value of just under $38 billion.
If you’re settling trades in real-time, you're losing the benefit of netting. That means trillions of dollars in cash and hundreds of millions of shares would be moving through the markets each day. It would create massive market and capital inefficiencies, increased credit and operational risks, and heightened costs between trading parties, possibly undermining the stability of the markets.
Q: What needs to be done from a technological standpoint to get to T+1?
DTCC’s equities clearing and settlement subsidiaries, NSCC and DTC, can already support T+1 and even some same-day settlement using existing technology. However, many market participants don’t leverage this option because of market structure complexities, legacy business and operational processes.
Q: So what are the next steps to get to T+1?
DTCC can’t unilaterally act to make this happen. To put things in perspective, equity clearing and settlement is part of a much larger ecosystem of linked financial markets. Accelerating the settlement cycle would have upstream and downstream impacts on other parts of the market structure, including derivatives, securities lending, cash borrowing, foreign exchange and collateral processing.
In order to move to T+1, industry participants must be aligned and implement the necessary operational and business changes – much in the same way we accomplished the move to T+2 – and regulators must be engaged. At DTCC, we’ve been working with a wide cross section of the industry to build support for further shortening the current settlement cycle over the past year, and we’ve recently outlined a plan to increase these efforts to forge consensus on an approach to achieve T+1.
DTCC is continuing the conversation on accelerated settlement and the future of post-trade in the 2021 DTCC Forum on April 8. Click here to register.
To become an active part of the industry discussions that DTCC is leading, please email [email protected].