The settlement lifecycle for equity trades is being shortened from T+3 to T+2 across developed markets. Cost benefit analyses have shown support from correspondent banks, custodian banks, buy-side firms and service bureaus on the basis of risk reduction
and efficiency improvements, however the costs for implementation may be disproportionately felt by smaller players in the business.
Q: Why don’t trades settle straight away?
A: Trading in many markets works on credit. That creates flexibility in the trading process and allows for some slightly fanciful arrangements of buying and selling to take place. For example, short selling (borrowing a stock you don’t own, selling it and
buying it back later when you hope the price has fallen) is predicated on having the time to get hold of a security after a sale has already been agreed. The flexibility also removes the need for a real-time transfer of stock and cash. As stock ownership is
recorded at a central securities depositary (CSD), administrated by a custodian bank, but exchanged at a market by brokers who act on behalf of asset managers often employed by funds, it is not surprising that they all need some time to figure out who’s got
Q: If they are moving from T+3 to T+2, why don’t they need that extra day anymore?
A: Efficiency. They have managed to reduce the amount of time taken to efficiently process trades down to T+2. As Michael Bodson, president and CEO at the US securities depositary DTCC says, “It’s clear that time equals risk.”
It will also save intermediaries money as they will not have their assets in ‘transit’ for such a long time. India, Hong Kong, Korea and Taiwan already operate on a T+2 basis, while China runs at T+1.
The costs and savings could be significant; a Boston Consulting Group (BCG) study suggested that it would cost the US approximately US$550 million to set up T+2 but would save US$170 million a year in operational costs, US$25 million in clearing fund contributions
and reduce the risk exposure on unguaranteed trades by about US$200 million a year.
Q: Why just shorten by one day? Why not move to T+0?
A: T+0 requires brokers to hold stocks and cash in order to trade as they have to deposit both with the exchange at the point of trade execution, rather than moving them from a custodian after a trade has been confirmed. Brokers are not the safe pair of
hands that a custodian bank is and that creates risk. The operational costs would increase significantly to make the leap to T+1; in the US, BCG estimated that the outlay would be US$1.7 billion but the operational saving would only be increased by US$5 million
a year. That said, the reduction in risk exposure would more than double.
Q: So who’s in?
A: Everyone in the US seems ready, Europe will make the leap in October 2014 and other markets such as Australia are migrating. However smaller firms will have to overhaul their systems without anything like the same payback for bigger firms. And Asia is
wondering what the fuss is about...