Marut Hobtahob
introduce
Clearing and settlement must have higher priority than trading.
To stabilize the securities market, clearing and settlement must become a priority. T+1 Security is second only to trading volume among the market’s priorities.Failure to liquidate will cost more resources system rather than changing liquidation priorities to ensure market health. In this way, T+1 will only increase the cost of failure. It may even inadvertently increase market instability.
The accelerated pace of modernization has exposed the securities market’s erroneous attitude towards risk, and market instability factors are increasing day by day. The pace of world events is inevitably accelerating. The appropriate response to the resulting market instability is to be prepared – ensuring security before trading – rather than spending more money on half-measures such as T+1.
In today’s financial markets, settlement is an afterthought.pouring Devoting more resources to an ill-conceived resolution process without raising its priority will fail to stabilize the market. Financial markets must prepare clearing and transfer mechanisms for changes in valuations before prices move.
The time limit between trade and settlement is zero. However, in a world of unlimited speed, safety depends on preparation, not reaction. Only when the securities market puts safety first will it be ready.
T+0 settlement has been the rule for futures trading for decades, spending far fewer resources on clearing and settlement but achieving greater success. Success is not the result of advanced technology in the futures market. Instead, futures exchanges decided from the outset that secure settlement would be a top priority.
What is the T+1 challenge?
At the end of May, the U.S. securities market will shift to T+1 settlement – transaction settlement time will be one day earlier than now. This has been the case for years, but it didn’t gain momentum until the Meme Disaster in January 2021 when Robinhood blew up the stock market.
The difficulty of T+1 in an era when businesses can instantly transfer millions of dollars from their bank accounts is prima facie evidence of the continued global disregard for market security. Financial market stability gets a lot of lip service. The pace of legislation aimed at creating safer financial markets has only been outpaced by the intensification of market destabilizing events.
Lipstick treatments like T+1 will never reduce instability because they ignore the underlying issue—that the priority of volume must be subordinated to the priority of safety. If a transaction is more important to the securities market than immediate security, then the transaction will be made before its implied wealth transfer is determined to be considered. No system built on this priority can survive in modern society. A secure system will ensure that transactions are cleared before proceeding.
Is preparation for liquidation difficult or something new?
No. This problem was solved decades ago, when markets were high-risk, trading volumes were high, and collateral protection was scarce. The Chicago futures market is designed to handle this situation.
How do futures markets achieve greater stability than securities markets with far less collateral protection?
The Chicago Board of Exchange puts safety first.
They do this by making clearing houses the arbiters of trade access. The clearinghouse is a seller to every buyer and a buyer to every seller. Clearing houses require clearing members to limit new positions to positions that are less than those covered by existing customers’ excess margin funds. Therefore, sufficient margin needs to be provided before entering a new position. The second effect of an exchange-controlled clearing house is that there is much less chance of trading errors. If you are buying or selling, collateral issues are not part of the transaction and will not affect the transaction. In other words, the clearing house only guarantees exchange transactions. Ancillary issues such as changing the margin funding currency must be managed before entering a trade.
Another issue where futures exchanges are managed differently than stock exchanges is the transfer of ownership. Futures exchanges are not directly involved in the transfer of ownership. This is an important distinction because title transfer is the most expensive and time-consuming part of settlement. More generally, the specifications of the transaction are limited by the customer’s interest. If the client does not seek title, it is not part of the settlement.
The most fundamental difference between futures trading and securities trading is that futures exchanges have clearing as their core. Stock exchanges, on the other hand, have new company offerings as their core component.
The market’s concerns about T+1 are well-founded
recent article The Financial Times described market concerns about the impact of the T+1 measures. As the article reports, in theory simply shortening the time between trade and settlement could reduce the risk of subsequent market failure because price changes between trade and settlement are smaller.
But the article lists several possible reasons why the change could increase instability.
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Work schedules will be compressed. These steps must be completed in less time.
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Fund transfers must be made as quickly as possible.
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Systems that are inherently slow (fax wired instructions?) must be replaced.
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Failure rates will inevitably increase.
But all this only illustrates the shortcomings of a plan that treats margin payments associated with trades as an afterthought. If the funds are already there before the trade, the entire process is a single transfer from a single bank clearing the exchange itself.
Changing your priorities instead of spending more money not only works, it’s cheaper.
Will safety first reduce transaction volume?
The reason trades have higher priority than clearing and settlement is that trades can occur even before an exchange is involved. The exchange exists to facilitate trading in the high-volume U.S. securities markets. As markets mature in a competitive environment, market practices accommodate more participants by increasing the assurance that participants will fulfill their obligations. But when the incentive to add new deals first arises, the seeds of instability are sown.
Since stock exchanges never took direct responsibility for the security of their own trades, clearing and settlement became a market utility – all exchanges used the same system, leaving traders with no chance of choosing a stable trading venue over an unstable one place. Predictably, all venues have become equally unstable.
If an exchange were to be responsible for the clearing and settlement of their trades, investors would choose safety first, especially when they find that the security provided by the exchange is cheaper than the current costly ex-post liquidation process.
Eventually, trading volume will move to cheaper and safer venues, while stability will increase trading volume.
in conclusion
The uproar caused by T+1 is understandable. After the change, investors’ transaction costs will be higher. Furthermore, there is no guarantee that T+1 will be able to achieve its intended goal of stabilizing the market. This article identifies reasons why people believe market stability may even be declining.
The face of clearing and settlement in U.S. securities markets is ugly, especially when compared to the cheaper, lower-margin, and safer futures versions of the same financial markets. T+1 is lipstick on a pig.
The difference between stable futures markets and unstable securities markets is simple. Futures exchanges put safety first. Stock exchanges consider security to be a problem for other parts of the trading system. Although settlement and clearing are secondary factors in securities markets, excess spending on settlement does not improve market stability.
