With the capital markets viewed as targets by enemies of the United States, the settlement date cycle has suddenly been transformed into a national security issue, argues Michael Brennan, a principal with the CSC Consulting Group.
With so much focus on the risks related to the closing of the U.S. Equity Markets, not much has been made of the settlement risk associated with the previous three days worth of transactions. Specifically, in the current three day settlement cycle or T+3, transactions from September 6, September 7 and September 10 were scheduled to have settled within three business days - including September, 11.
Settlement risk refers to transactions that are not completed (unsettled) where securities and cash are not exchanged between buyers and sellers. Incomplete or unsettled transactions negatively impact the cash flow of financial institutions and damage the efficiency of the marketplace.
Clearly, as demonstrated by the authorities rush to reopen the marketplace, the benefits of efficient capital markets extend beyond the Financial Services Industry and are fundamental to the well being of the United States.
Two weeks ago, CSC released a series of essays highlighting the challenges and opportunities associated with moving from the current 3 day (T+3) settlement cycle to a next day (T+1) settlement cycle in the United States.
Following the terrible events of September 11th, CSC expands its point of view and calls upon the industry to move to a same day or T+0 settlement.
For the past few years, the SIA has been leading the T+1 initiative in the United States and much research has been done on the reduction in operating risk associated with taking 2 days out of the settlement process.
Why not go further and reduce risk even more significantly?
CSC believes that while the amount of work necessary to achieve T+1 is substantial, the additional work to get to T+0 is not.
In the summer of 1999, the SIA published a T+1 Business Case containing ten building blocks identified as necessary for achieving next day settlement. Looked at closely, those building blocks position the Industry as much for T+0 as they do for T+1.
1) Modify internal processes to ensure compliance with compressed settlement guidelines.
2) Identify and comply with accelerated deadlines for submission of trades to the clearing and trading systems.
3) Amend DTCC’s trade guarantee process to provide guarantee on trade date.
4) Report trades to Clearing Corporation in locked in format and revise clearing corporation’s output.
5) Rewrite Continuous Net Settlement (CNS) to enhance speed and efficiency.
6) Reduce reliance on checks and use alternative means of payment.
7) Immobilize shares prior to conducting transactions.
8) Revise the prospectus delivery rules and procedures for IPOs.
9) Develop industry matching utilities and linkages for all asset classes.
10) Standardize reference data and move to standardized industry protocols.
As an example, a core building block is matching or locking in buyers and sellers as quickly as possible. The timeframe narrowed to within one hour of the execution when the SIA followed up the Business Case with Institutional Processing and Fixed Income Street Side White Papers.
Completing the post-trade pre-settlement work so quickly raises the question -- how much additional effort would it take to then settle the transaction same day?
With the SIA administrative infrastructure already in place, and financial institutions in the process of preparing for T+1, CSC believes the time is now to make the move to T+0.
Michael Brennan works as a management consultant within CSC's Financial Services Practice. He has over twenty years of experience in the financial services industry and holds three NASD licenses. Most recently he spent 4 weeks at an Asian Stock Exchange as part of the CSC team performing a strategic and technology review. Earlier in the year he spent four months with the CSC project office that managed the Paine Webber/JC Bradford merger, managing the integration of the respective firms’capital markets groups.