Back to the Future
Why the Sixties Provide an Answer for Today’s Post-Trade Problems
By Arjun Jayaram, CEO & Founder, Baton Systems
Few of today’s Wall Street and investment industry leaders are old enough to have been working in finance or even to remember the Street’s paperwork crisis of the late 1960s.
But the issues and problems that culminated in a near post-trade processing meltdown 50 years ago — while denominated in numbers that now seem almost humorous — are strikingly similar to those that characterize today’s settlement muddle.
What happened back in the days when Wall Street was both the metaphorical and literal center of U.S. finance?
Remember that Wall Street in the 1960s was still very much a cottage industry. Decimated by the Crash and the Depression, then virtually asleep during World War II, the Street didn’t show signs of life until well into the 1950s, and in the 1960s was still marked by relatively thinly-capitalized partnerships that tended to stick to particular niches.
The rise of pension funds and institutional investing in the late 1950s and early 1960s spawned a rise in trading volume, and by 1968 a then-staggering 12 million shares a day were being traded on the NYSE — a huge increase from the five million shares traded daily in 1965. Settlement took place on T+5, and every one of the five days was necessary for settlement at a time of paper-based procedures.
As volume mounted, the system staggered. Trading had to be halted on Wednesdays so firms could process the volume. Certificates representing thousands of shares of stock and checks worth millions often were lost when “runners” — the hundreds of often-retired older men shuffling between firms’ back offices with small valises stuffed with paperwork — would stop off for lunch or a cup of coffee.
The industry understood the problem: the process had to become more automated. But computers were expensive, few of the smaller firms could afford them and many of the larger ones looked askance at investing in processing when efficient settlement meant little to the bottom line.
Ultimately, however, the problem threatened firms’ very existence. The number of failed trades soared, jeopardizing firm capital. Things were so out of control that organized crime syndicates were believed to have stolen more than $400 million in securities.
The solution came in the form of the Depository Trust Company and the National Securities Clearing Corp. (now both part of DTCC), created in 1973 as industry utilities to reduce risk in the settlement process by centralizing clearing, immobilizing certificates, and replacing all the paper shuffling with electronic transfers. Today, it would be impossible to imagine equity trading without these centralized functions.
In many ways, today’s bank settlement systems are computerized versions of the Balkanized system that existed in equities a half-century ago. While current systems do not threaten the financial strength of today’s players, consider the key parallel between today’s settlement problems and those in equities 50 years ago.
Despite the systemic inefficiencies, there is currently little incentive for any one bank to replace its legacy post-trade systems. Simply put, the pain at this point, while costly and annoying, isn’t great enough to warrant an investment in a non-revenue producing area.
Today, as a half-century ago, the solution lies in a centralized settlement solution. But since today’s settlement problems pose little threat to banks’ financial soundness, there is little likelihood that a centralized, mandated solution akin to DTCC will come about.
Fortunately, today’s technology provides an alternate solution — “renting” a centralized solution rather than investing in one or creating their own bilateral solutions. For instance, a platform on which any legacy settlement system can communicate quickly and efficiently with any other bank’s legacy system.
Blockchain technology, of course, holds the promise of being able to support an efficient settlement solution. But developing such a solution at each bank will be expensive and marked by glitches and dead ends, which means that a blockchain solution could be years away.
In the meantime, using existing platforms that effectively simulate centralized systems through seamless bilateral information flows can bring immediate savings and efficiencies.
Why wait for a Sixties-style crisis to join the 21st Century?