Image credit: source

T+2 is catchy Wall Street jargon for “trade date + two.” In layman’s terms, shares or money hit your account two days after you buy or sell. So why, in a world in which I can video call someone on the other side of the planet from my watch, does my trade take two days to settle?

Trade settlement has a long, interesting and misunderstood history, but it’s only now, thanks to distributed ledger technology (DLT), that we stand on the verge of making instant trade settlement a possibility.

When the Buttonwood Agreement, which eventually gave rise to the New York Stock Exchange, was famously signed into existence beneath the — likely apocryphal — buttonwood tree outside 68 Wall Street in 1792, trade settlement was established as T+1. This gave buyers and sellers one full day to find each other, confirm trade details and exchange money or stock certificates.

Imagine you sell $50,000 worth of shares, and financial calamity strikes before settlement. A few banks are wiped out.

As trading volumes increased and brokerage firms multiplied, armies of messengers were hired to scramble around the city and settle trades. But by 1933 trading volume was prodigious, and more time was needed to reduce the costly mistakes and fraud that were starting to plague the system, forcing the NYSE to adopt T+2.

After World War II, the U.S.’ role of global creditor boosted its economy, further fueling trading activity, and in 1946 the NYSE moved to T+3; in 1952 to T+4; and by 1968 the amount of paper produced by trade settlements was so overwhelming the NYSE moved to T+5 and for a few months restricted trading to four days a week (closing Wednesdays). The “Paperwork Crisis” of 1968 had reached its zenith.

Fortunately, around this time computers started becoming smaller, powerful and affordable. Robert W. Haack, who became NYSE president in 1967, led the effort to integrate high-speed communications and computers into the exchange. Instead of messengers, computers would communicate with each other to confirm trades, reducing human error and fraud. Amazingly, it wasn’t until 1995 that technological prowess caught up with trading volumes, and on June 7 of that year the Securities and Exchange Commission mandated trade settlements be officially reduced to T+3. Then, on Sept. 5, 2017, the SEC mandated trade settlements be reduced to T+2. But we’re still one day shy from where we started in 1792. Can technology get us back to T+1 or even T+0? Does it even matter?

It matters — a lot.

Over 1 billion shares are traded daily on the NYSE, and billions more around the globe — billions that are “unsettled” for 48 hours. Imagine you sell $50,000 worth of shares, and financial calamity strikes before settlement, a few banks are wiped out and things spiral from there. Are you ever going to see your money?

Granted, there are entities and mechanisms that mitigate these risks such as the Federal Deposit Insurance Corp. (FDIC) and the Depository Trust & Clearing Corp (DTCC). Still, the amount of counterparty, operational and systemic risk that exists because of T+2 remains substantial, as we learned in 2008. Many counterparties that traded with Bear Stearns and Lehman Brothers a few days before they failed never received their money.

The DTCC has made great strides using existing technology to compress the time it takes to settle trades. On June 22, 2018, Murray Pozmanter, DTCC’s head of clearing services, wrote a newsletter titled “Is the Industry Ready for T+0 Settlement?” in which he said the body was “exploring several ways to optimize settlement and further shorten the trade settlement cycle beyond T+2, reducing risk and costs for clients.” He cited cybersecurity and compliance as hurdles in achieving goals of T+1 or T+0, and emphasized that the DTCC hopes to “extract as much risk and as much time out of the settlement cycle as possible without having to do a radical reengineering.”

But radical reengineering is likely what’s needed to achieve T+0; and the answer, it turns out, could be the technology that gave rise to bitcoin: DLT, aka blockchain. Blockchain allows entities to establish a digital network where trade details are simultaneously broadcast to, confirmed and recorded by all users of the network. The network can count on all details being unequivocally agreed to by all parties and can rely on all users being made aware of these details simultaneously. Finally, because every user in the network records the transaction independently, it’s nearly impossible for a hacker to alter the record.

There are signs this process is underway. Take for example R3, an enterprise blockchain software firm. According to its website, in May 2018, HSBC and ING executed “the world’s first live letter of credit conducted on a blockchain platform.” Execution of letters of credit involves numerous parties that review numerous documents to guarantee and facilitate the exchange of vast sums of money and goods. Because of this complexity, letters of credit can take up to 10 days to execute and settle, but R3’s blockchain network reduced HSBC and ING’s execution to 24 hours.

From settle-it-yourself to armies of messengers to enormous computers to smaller computers to blockchain. For the first time in history, technology holds the potential to efficiently deal with the volume, complexity and safety issues that loom over global trade settlement systems. Who knows, maybe one day you’ll be able to sell shares and have the cash settle into your account while you are waiting for that conference call on your watch to begin.

(Excerpt) Read more Here | 2019-04-23 04:01:47

LEAVE A REPLY

Please enter your comment!
Please enter your name here