Push for T+2 Settlement Is On

Terry Flanagan

The on-again, off-again push for post-trade settlement efficiency in the U.S. is on again, due in large part to post-financial crisis concerns about counterparty risk and operational costs, according to a report by Boston Consulting Group.

The report, which was commissioned by the Depository Trust & Clearing Corp, the U.S. post-trade financial services group, demonstrates that shortening the trade settlement cycle is an achievable goal, as 68% of surveyed firms support the move—and 27% view it as a top priority.

The BCG and DTCC anticipate that it would take three years for the U.S. financial industry to move to a point where trade settlement occurs two days after the trade is enacted, a concept known as T+2.

“The DTCC-Boston Consulting Group analysis marks a key first step toward improving the efficiency of our markets,” said Matt Nelson, executive director of strategy at post-trade service provider Omgeo. “The industry as a whole is in favor of a move to shortened settlement cycles, and many firms view it as a top priority.”

The financial crisis and ensuing events have highlighted risk and inefficiencies in post-trade processing.

The industry had considered and decided against a move to a shorter settlement cycle in 2000. At that time, a study sponsored by the predecessor to industry trade group Sifma identified 10 building blocks that would need to be implemented prior to moving from T+3 to T+1.

However, a global push by regulators for higher risk standards following the financial crisis has rekindled the consideration of shorter settlement cycles, according to the BCG report.

The report concludes that the key drivers for the move are operational cost savings, risk reduction and the ability to free up capital for more efficiently reallocation.

In 2011, the International Securities Association for Institutional Trade Communication, an organization of financial institutions and technology providers, released an updated Market Practice for Standing Settlement Instructions (SSIs) associated with cash and FX instruments. The best practices aim to provide investment managers, brokers and custodians with a consistent standard for exchanging SSIs between parties in order to improve automation and efficiency across the industry.

This is as relevant for the OTC markets as for the listed markets.

“Buy-side firms are concerned about errors in trading, pricing and regulatory reporting,” Ed Elgerzawy, a partner at trading technology firm SunGard’s consulting services unit. “Some are implementing their own swap reconciliation engines with their counterparties and prime brokers. Reconciliation engines may also be used to match trade reporting, positions, limits and trades against swap data repositories created by Dodd-Frank.”

Moving to T+2 and perhaps ultimately T+1 will help financial firms achieve operational cost savings and risk reduction while freeing up capital.

According to the BCG analysis, the anticipated costs for such a move are manageable and would require a three-year payback period. Broker dealers and large firms would need to invest around $4 million and buy-side firms around $1 million to prepare for T+2, but they could expect an internal rate of return of 18% on their investment.

“There’s a strong business case for shortening settlement cycles with a solid ROI [return on investment],” Nelson at Omgeo said. “For a project like this with the resulting operational savings and industry benefits, most companies would approve this kind of initiative even in challenging markets. This is definitely doable and long overdue.”

Lack of straight-through processing and standardization in client side settlement was one of the major inefficiencies identified in the BCG report.

Inefficiencies span allocation, confirmation and affirmation processes, and maintenance of settlement instruments and communication of trade instructions between buy-side firms and custodians.

Although systems exist to streamline many of these processes, many firms don’t use them, according to the report.

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