The Need for Affirmation in Settlement Matching
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A common theme in the Boston Consulting Group (BCG) white paper on shorter settlement cycles (SSC) is that efficiency, harmonization and effective communication between counterparties are key to faster settlement. Certain processing changes would, according to the BCG, need to take place before SSC can be achieved.
As discussed in my previous article, one enabler for SSC is trade-date matching─where counterparties agree on the economic details of a trade on the same day, also known as same-day affirmation or SDA. The next stage of the trade-processing lifecycle involves settlement counterparties (for instance, buy-side firms and custodian banks) affirming the settlement details of a trade, so that the trade can move to settlement. This stage was also identified in the BCG report as an important consideration and SSC enabler.
Match-to-Settle
In every major market around the world except for the US, counterparties must affirm the settlement details of trades before settlement. In other words, there has, historically, been no requirement for settlement matching in the US. However, this is changing, with the Depository Trust and Clearing Corporation (DTCC) recently introducing a settlement-matching requirement in the US market. This move will involve the US central securities depository (CSD), the Depository Trust Company (DTC), using existing financial market infrastructure to provide participants with the ability to authorize or match transactions, before it attempts to process them for settlement. Essentially, DTC will not settle trades until settlement details are matched.
It is anticipated that settlement matching will further global efforts towards shorter settlement cycles. Firstly, the development is illustrative of the push to reduce market risk─in this instance, settlement risk─by a systemically important financial market infrastructure in the US. Settlement matching will enhance intraday finality by eliminating reclaims─a process which occurs when a participant attempts to return a transaction executed earlier in the day, thereby increasing risk of trade failure. In fact, it is estimated that the number of trades that remain unaffirmed or unmatched up until the point of settlement puts around $4.1 trillion DTCC eligible trades at risk on an annual basis.
Level Playing Field
Secondly, the introduction of settlement matching in the US will increase harmonization and standardization of settlement practices worldwide. I believe this is fundamental to achieving a reduction in the overall level of risk in global financial markets because when markets settle on divergent cycles, and via different processes, the risk of trade failure is heightened. From a business perspective, if we take Europe as an example, differing practices across the European Union mean that cross-border settlement costs can be up to four times higher than domestic costs.
From a business perspective, if we take Europe as an example, differing practices across the European Union mean that cross-border settlement costs can be up to four times higher than domestic costs.
Mandates, such as the DTCC's settlement matching requirement, drive standards of behaviour that broadly benefit the financial markets. The community approach to trade processing─where counterparties are equipped with similar levels of automation and adhere to the same rules and practices─will always be the most effective. These types of mandates enable participants who want to realise benefits of best practice to not be disadvantaged by those who do not.
Finally, straight-through processing (STP) will be enhanced by settlement matching. STP has been the holy grail of operations professionals for many years, but wider industry focus on this area has tended to ebb and flow. Mandatory settlement matching is a significant step towards improving STP in the US market, which in turn, should bring the goal of SSC even closer.
Next week, I will explore the third of the middle-office enablers to SSC by looking at cross-industry standing settlement instructions.
Tony Freeman is the executive director of industry relations at Omgeo. Over the next few weeks, Tony will be contributing to Waters on the various enablers that need to be put in place in order to achieve SSC. The opinions expressed are those of the author, and do not necessarily reflect those of Waters or Omgeo.
Read the other parts of this series:
- The Road to Shorter Settlement Cycles
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