Settlement Cycles on Industry Radar

Terry Flanagan

Reducing settlement failures a high priority, says DTCC’s Cosgrove.

As regulators push for harmonization of trade settlement cycles, firms and service providers are zeroing in on reducing inefficiencies in middle office functions such as affirmations, confirmations, and reconciliations, which is a prerequisite for shorter settlement.

Having as many post-trade, pre-settlement functions take place the day of the trade (T+0) will facilitate settlement finality two days after the trade (T+2), which regulators are seeking to adopt on a global scale.

In the U.S., The Depository Trust & Clearing Corporation (DTCC), through its National Securities Clearing Corporation (NSCC) and The Depository Trust Company (DTC) subsidiaries, handles the clearing and settlement of virtually all equity, corporate and municipal bond, and unit investment trust (UIT) transactions.

“Both DTC and NSCC are engaged in re-evaluating the business case for a shortened settlement cycle with the industry and policy makers,” Susan Cosgrove, managing director and general manager of settlement and asset services at DTCC, told Markets Media.

A shortened settlement cycle means reduced risk and more efficient processing. “A shortened cycle will reduce the time that clients need to post margin and collateral during the settlement process,” said Cosgrove.

The implementation of Target2Securities (T2S), a uniform, pan-European settlement system led by the European Central Bank, has forced the debate over harmonization of settlement cycles in Europe: Germany currently settles on T+2 whereas the rest of Europe settles T+3.

The consensus is that Europe will move to T+2 once T2S goes live in 2015.

The European Commission’s proposed regulation on harmonization of securities settlement noted that differences in settlement periods tend to increase costs, complexity, and operational risk. It the regulation proposes measures to harmonize settlement periods in the EU.

“The proposed solution will create a substantial amount of change in terms of system upgrades for the market participants and the CSDs to handle the change in settlement day convention and the trade messaging,” Alberto Corvo, managing principal, financial services at eClerx, told Markets Media.

Once the new regime is live, there will be far more process exceptions that will need to be resolved. “This will have the inevitable impact of increasing the cost of doing the business, which may lead market participants to oppose the change, or at least the timing,” said Corvo.

Achieving same-day affirmation is critical to achieving T+2 settlement.

Securities trades verified on the day of execution, known as Same Day Affirmation, or SDA have a much higher chance of settling on time and are less likely to fail, according to a study published in 2010 by Omgeo, a provider of post-trade processing services.

Settlement efficiency in countries with SDA rates of over 90% – India, Taiwan, Hong Kong, Japan, Singapore and Korea – were 26% higher than in countries with SDA scores of less than 70% – Brazil, Italy, South Africa and the United States.

The study also found a direct correlation between SDA and shortening settlement cycles. Four of the five countries that displayed the highest SDA rates and settlement efficiency rates required T+2 settlement for most securities. These include India, Taiwan, Hong Kong and Korea.

Similarly, South Africa, which had one of the lowest SDA rates and settlement efficiency scores, operates on a T+5 cycle.

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