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T+2: Not Everyone Is on the Bandwagon

The industry has been debating the topic of reducing the equities settlement cycle from trade date plus three days (T+3) to either T+2 or T+1 for over a decade. Europe has finally bitten the bullet and enshrined the move to T+2 via regulation, but does that mean we'll see the U.S. market follow suit? If so, it could be an unwelcome and challenging move for some market participants, despite the potential risk management benefits.

The U.S. Depository Trust & Clearing Corporation has been championing the move for some time (somewhat unsurprisingly, given its ownership of matching platform provider Omgeo, which would likely see a significant uptick in business as a result of the move), and the Securities Industry and Financial Markets Association (Sifma) threw its weight behind the initiative, but the U.S. regulatory community has been fairly quiet on the topic thus far. And there is no doubt that in order for the market to move, some form of regulatory incentive will be required.

Aite Group's white paper on the move to T+2 and the numerous operational challenges therein indicates that the self-clearing retail brokerage community and smaller institutional brokers in particular are reticent to support a shortening of the cycle. For example, our interviews with retail broker-dealers indicate that their estimated cost of systems upgrades exceeds the DTCC estimates by upward of 20% to 50%. Beyond core processing system upgrades, a shortened settlement cycle would require adjustments to all downstream systems that tie into the core processing system, which in many cases would entail upgrading legacy systems. Self-clearing firms that use a service bureau likewise would not be totally insulated from the cost of systems upgrades, as they are likely to see either explicit or implicit cost increases passed on from their service bureau providers in addition to the costs associated with enhancing proprietary downstream systems.

Moreover, the challenges of moving to T+2 settlement fall broadly into two categories—those that represent direct operational challenges in which technology and process changes will be required, and those that represent cultural and market practice changes. If the costs are perceived to outweigh the benefits—and for some firms this is absolutely the case—then a regulatory stick will absolutely be required to get them moving. All the soapboxing in the world will not have an impact. And don't get me started on the buy-side …

Something else to bear in mind—one of the likely short-term impacts of a shortened settlement cycle will actually be a rise in the number of settlement failures. For example, when central counterparty clearing was introduced in Finland in 2012, the level of settlement failure increased from 5.4% in 2009 to 11.31% in 2012 (an increase of 5.91%). The establishment of new market practices and processes tends to result in an increase in settlement fails as market participants transition from one practice to another.

I may sound negative, but in fact I am a firm believer that a move to shorten the settlement cycle is a positive change for the industry overall. The challenges inherent within the move, however, should not be underestimated.