The idea of T+0 settlement is a non-starter, according to industry expert and consultant Tony Freeman, who suggests it would have “huge side effects and remove all of the benefits of netting which are significant”.
The comments come after Robinhood’s CEO Vladimir Tenev recently called for a fix on the ‘antiquated settlement structure’, and is pushing for the settlement infrastructure to be modernised.
But is the system ‘antiquated’ or is it extremely reliable and well understood?
While every country has its own settlement cycle, most countries operate on T+2 or two business days after the transaction date.
There are no real fundamental technological issues that would prevent the move to a real-time settlement system but major work would be required due to significant behavioural and operational challenges.
Real-time settlement means that as soon as a trade is executed, it is recorded immediately, the money and securities move between the two parties and the trade is complete.
Freeman says the systems can do it but it is the willingness and capability of market participants to do it that makes the difference.
With the current system, you can have the cash or stock expected to arrive which allows for the trade to be settled. Same-day/real-time settlement would mean settling every trade individually and if you are buying you’ve got to have the cash and if you are selling you’ve got to have the stocks meaning every purchase would need to be pre funded.
Freeman says: “This would massively reduce the number of transactions that are possible in the market and also requires real-time processing. The retail market is simply not geared up to do this. They are not professional investors. While they may be technologically sophisticated in the way they trade, they are not all operations/back office professionals.”
For example, Freeman suggests there are quite a few retail investors involved in the Gamestop phenomenon that didn’t seem to understand margin.
Freeman notes: “If you are a day trader then you don’t get involved in this because you take a position during the day and you close it out during the day. You don’t have any open position at the end of the day so you are never actually physically involved in clearing and settlement processes.”
“It is not terribly surprising that they do not know much about it,” he adds.
There were massive amounts of trading taking place in a relatively small stock but not a huge amount of trading going on which meant that lots of failed trades occurred, increasing the margin required by the clearinghouse.
“This came as a surprise to many people, which tells me that they are not sophisticated about the middle office and back-office processes, and they do not really understand the full rules of the game despite being in the market,” says Freeman.
Because of this, Freeman argues that T+0 cannot happen.
He explains: “T+1 has lots of fundamental issues that would need to be resolved as it does require quite a lot of process improvement. The cost of moving to T+1 is significantly higher.”
“If I were to sit down with Robinhood’s CEO then I’d ask him what he thinks the advantages of same-day settlement would be because there are already significant benefits to the way things are done now and if you join a market you have to follow the rules of the market. Margin is one of those rules of the market.”
Freeman continues: “I have heard the word ‘antiquated’ a lot. This is a pejorative term that I do not agree with. Some of the platforms in use are quite old but the benefit of that is that they are ultra-reliable and well understood. There is a significant risk in saying we are going to move to blockchain technology and the disruption risk in migrating to an entirely different form of technology is largely significant.”
It is important to remember that this is a cautious part of the market and it has to be cautious, Freeman highlights.
It is incredibly highly regulated and it has to be risk-averse. Freeman notes that settlement cannot fail because it would block up the whole market, which is why clearinghouses are classed as systemically important.
“Breezily saying blockchain could solve the problem is to understate the complexity and underestimate the risk in the market,” he concludes.
Look out for the next issue of Asset Servicing Times on 3 March to read the full article.
