On the road to T+0: The global trend towards shorter securities settlement cycles

There are benefits and challenges on the road to T+0 but technological developments such as DLT, CBDCs and smart contracts could make this a reality in the future.

To its detractors - of which there are many - T+0 or same-day trade settlement is simply not feasible, mainly because it requires market participants to pre-fund their transactions, creating added costs and increasing counterparty risk. Attitudes are, however, slowly shifting. Fuelled by increasing industry pressure to shorten the existing T+2 rolling settlement cycle, along with the emergence of new technologies such as distributed ledger technology (DLT) and Central Bank Digital Currencies (CBDCs) - both of which can support faster settlements - T+0 could arrive far sooner than previously assumed.

Incumbents make a push towards T+1

Although the US - along with the EU and some of the major markets in Asia-Pacific - have only recently transitioned to T+2 away from T+3, there are growing calls for the settlement cycle to be shortened even further to T+1. This comes after a number of deficiencies and risks in the T+2 settlement cycle were exposed in early 2021 when market participants were subjected to unprecedented margin calls during the meme stock trading saga. Among those now advocating for a shorter settlement cycle are the Depository Trust & Clearing Corporation (DTCC); market makers - namely Citadel and Virtu Financial; together with industry bodies such as the Securities Industry and Financial Markets Association (SIFMA) and the Investment Company Institute (ICI). In August 2021, the DTCC along with SIFMA and the ICI informed the Securities and Exchange Commission (SEC) that they saw no challenges or risks to prevent an eventual migration to T+1. In fact, the DTCC argues T+1 offers numerous benefits.

The DTCC elaborates a shorter settlement cycle would mitigate systemic risk, operational risk, liquidity needs, buy-side counterparty exposure and broker-to-broker counterparty risk. “DTCC believes – and the industry agrees – that T+1 is the optimal cycle right now and will deliver significant efficiency, cost savings and safety to the system overall”, says Michele Hillery, General Manager of Equity Clearing and DTC Settlement Service at the DTCC. By curtailing these risks, the DTCC adds, margin and collateral management requirements would be dramatically reduced. Others concur. “A shorter settlement cycle would free up capital that is being held to cover unsettled liabilities and transactions. If trades settle more speedily, then cash and securities will be available more quickly to market participants too. We have already observed that central counterparty clearing house (CCP) margin demands have significantly fallen in the markets which transitioned from T+3 to T+2. All of this is helping to drive liquidity”, explains Ryan Marsh, Global Head of DLT and Digital Innovation, Securities Services at Citi. According to Hillery, the DTCC intends to complete its analysis on achieving T+1 by the end of the third quarter of 2021, after which it will develop a definitive timeframe for the transition.

“A shorter settlement cycle would free up capital that is being held to cover unsettled liabilities and transactions. If trades settle more speedily, then cash and securities will be available more quickly to market participants too."

Michele Hillery, General Manager of Equity Clearing and DTC Settlement Service at the DTCC

However, a shift to T+1 would require significant regulatory, technological and behavioural changes to be implemented across the industry. In a letter to the SEC, SIFMA says a move towards T+1 would have an impact across corporate actions; securities issuances; allocation, affirmation and disaffirmation processes; CCP processing timeframes; and securities lending. SIFMA also adds that activities such as prime brokerage, delivery of investor documentation; global movement of securities and currencies; foreign exchange (FX), batch cycle timing and exchange traded fund (ETF) creation and redemptions - would all need to undergo major structural changes were a T+1 cycle to be introduced.

T+0 – too hot to handle?

While there is broad market support for a T+1 settlement cycle in the US, the DTCC acknowledges a move to T+0 – while technically possible – is not warranted. In its report, the DTCC notes that a number of market participants would not be able to leverage a T+0 settlement cycle due to legacy business and operational issues. The DTCC says that T+1 – in contrast to T+0 – would enable the industry to continue taking advantage of netting benefits, before adding it will give brokers sufficient time to arrange for the financing that allows people to buy securities on margin. “Introducing T+0 as the new standard settlement cycle for all US securities transactions would be a far more complex undertaking than a move to T+1 and would require foundational changes to how securities trade and settle today, including large scale redesigns of areas such as global settlements, margin investing, financing, FX and securities lending”, says Hillery. Despite these short-term challenges, the DTCC stresses that it will explore ways in which to achieve a T+0 settlement cycle. “While the industry is now focused on a move to T+1, key stakeholders will continue to analyse how a wholesale move to T+0 could be achieved in the future, and will incorporate enabling functionality where applicable”, explains Hillery.

Introducing T+0 as the new standard settlement cycle for all US securities transactions would be a far more complex undertaking than a move to T+1 and would require foundational changes to how securities trade and settle today"

Michele Hillery, General Manager of Equity Clearing and DTC Settlement Service at the DTCC.

Many within the industry argue T+0 is logistically difficult to achieve if leveraging existing technology systems and processes. These thoughts are echoed by Colin Brooks, Chairman of the advisory board at Hex Trust, a digital asset custodian in Hong Kong. “Achieving T+0 in today’s capital markets and using existing systems and technology is unachievable. The sheer levels of intermediation and sequential nature of today’s settlement processing would make it too difficult”, he says. There are other barriers which need to be overcome. Marsh says that data would have to be shared between intermediaries in the settlement chain much faster in order to facilitate T+0. Marsh continues that structural issues – such as different time zones and market opening hours could also inhibit the adoption of T+0. If these impediments can be successfully solved, then the roll-out of T+0 could become a possibility.

Achieving T+0 in today’s capital markets and using existing systems and technology is unachievable. The sheer levels of intermediation and sequential nature of today’s settlement processing would make it too difficult"

Colin Brooks, Chairman of the advisory board at Hex Trust

Technology could make T+0 a reality

The introduction and growing adoption of new technologies such as DLT, CBDCs and smart contracts could help with the industry’s transition to T+0, or even atomic settlement. “DLT allows market users to share data across the financial ecosystem in real-time, meaning all participants in the trading and settlement process would have access to a trusted and golden source of data”, says Marsh. The real-time dissemination of data is an enabler for T+0. In the case of smart contracts, Brooks highlights that clauses can be embedded into self-executing agreements to ensure the simultaneous exchange of title to securities. If the terms and conditions within the smart contract are not met for whatever reason, then the trade will not settle. On CBDCs, Brooks concedes that many of these initiatives are still in their early proof-of-concept stages, but adds the ability to potentially move digital fiat cash internationally in real-time could help the market with its eventual move to T+0.

Nonetheless, many believe the shift to T+0 will take time, at least in traditional markets. “I anticipate some of these disruptive technologies will be used to support settlement of digital assets initially - such as digital bonds – before being introduced into the more conventional markets like equities”, comments Brooks. If there is little progress in the way of standardising the underlying technologies supporting T+0, then its adoption will face challenges. Right now, there are a number of different DLT protocols in the market hampering interoperability and with it, T+0. If T+0 is to be more than just a pipe-dream, it is vital that the industry doubles down on its efforts to develop technology standards.

I anticipate some of these disruptive technologies will be used to support settlement of digital assets initially - such as digital bonds – before being introduced into the more conventional markets like equities"

Colin Brooks, Chairman of the advisory board at Hex Trust