Settlement compression – where next?
Now that India, the US and Canada have confirmed they are reducing trade settlement cycles from T+2 to T+1, what are the risks and what are the benefits? flow takes a closer look at accelerated settlement
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ost securities transactions currently settle within a couple of days of the actual trade date. So, for stock
bought on a Wednesday, the buyer would have paid for the shares and the seller would have delivered them by the Friday, with the buyer becoming the holder of record of that security (T+2). A combination of better technology,
the sheer volume of securities trading and regulatory momentum is making this window smaller. The flow article ‘Accelerated settlement – the move towards T+0’ (Sep 2021) examined the trend of market volatility driving compression of the securities settlement cycle and outlined the benefits and risks of shorter settlements. Despite the ongoing global transition
towards a harmonised T+2 settlement cycle, some market participants believe that improvements are still needed. Following unprecedented market volatility in 2020 and 2021, there are growing calls for a further compression of the existing T+2 settlement cycle to either T+1 (trade date + one day) or T+0 (same day). However, such a shift will not be a straightforward exercise.
India, the US and Canada make the leap To date, three major markets – India, the US and Canada – have each confirmed they will transition their trade settlement cycles from T+2 to T+1. India has been phasing in T+1 for publicly traded equities since February 2022. Starting with the bottom 100 stocks by daily market capitalisation, it has since added 500 stocks each month, so that all of India’s 5,200 stocks will be settled on T+1 by January 2023. Most Foreign Portfolio
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Investors (FPIs) have not been affected by India’s transition yet, as their exposures are mainly to blue chip equities, which are not currently settling on T+1. Turning to the US, after its relatively trouble- free transition from T+3 to T+2 in 2017, the Securities and Exchange Commission (SEC) confirmed in February 2022 that the market would shorten the settlement cycle from T+2 to T+1 by no later than Q1 2024. The SEC’s decision comes in the wake of a high-profile campaign pushing for T+1 adoption led by a number of market participants in the US. This includes the Depository Trust & Clearing Corporation (DTCC), the Securities Industry and Financial Markets Association (SIFMA) and the Investment Company Institute (ICI), together with market makers such as Citadel Securities and Virtu Financial. As Canada’s financial markets are so
deeply interwoven with those of the US, the country has also pledged to adopt T+1 in 2024, in lockstep with its southern neighbour. Market participants have commented that it is likely other markets with close financial links to the US will also introduce T+1 in due course.
5,200
Total of India’s stocks to be settled on T+1 by January 2023
Source: BSE India
Explaining the sweeping away of T+2 While a handful of experts have been arguing the case for T+1 for some time, it was the equity market volatility triggered by Covid-19, and the meme stock trading turmoil, which highlighted to the world the risks of having to wait two full days for a trade to properly settle. Supporters say a compressed settlement cycle will help negate settlement, counterparty and operational risk. The principle benefit of leveraging T+1 – as opposed to, say, T+2 – is that the former has a shorter settlement duration, meaning there is significantly reduced operational and counterparty risk between different trading counterparties. This can enable firms to lower their Central Counterparty Clearing House (CCP) margin requirements, leading to meaningful capital and collateral savings. The DTCC notes that shorter rolling settlement cycles could help unlock vast sums of untapped liquidity once market participants no longer need to post as much margin on trades to cover counterparty exposure. While the DTCC concedes there might be some implementation costs to adopting T+1, it expects financial institutions to ultimately achieve net savings and benefit from infrastructure modernisation and the
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