Why it matters when trades settle


NSHE PAEANS It follows a recent retirement KKR Founders Henry Kravis and George Roberts (formerly private-equity barbarians) remind us that the Wall Street story is a big deal, a bold deal, and one of the people behind it. .. The “back office” of banks, brokers and buyout companies behind it has rarely been investigated. Not surprisingly, their world is colorless compliance and “post-transaction” processes such as clearing and settlement. They are financial plumbers and struggle behind the scenes to ensure that plumbers work well. But from time to time, there is a gargling noise that is so loud that even the Cockshua colleague in front of him is anxious.

The system for closing stock transactions, where the buyer gets her security and the seller gets cash reliably, became tense during the volatility of covid in March 2020. In the frenzy of meme trading on GameStop stock, I squeaked again earlier this year. A regulatory report to the episode, published on October 18, enthusiastically pointed out that the post-transaction process was “usually in the background and entered into public debate.” Retail broker Robin Hood restricted trading on GameStop shares and caused the turmoil because of soaring margin claims and settlement risk due to volatility.

Risk is a function of time. The longer the transaction takes from execution to completion, the more “counterparty” risk, or one or the other, so that anyone can prove that they were caught in the middle of a transaction when Lehman Brothers or Arquegos Capital collapsed. There is a greater chance that the pony-up will fail. Therefore, the margin payments that brokers and investors have to post to the clearinghouse are high.

Therefore, a long-term promotion to reduce trade processing time from 14 days (“NS+14 inches in term) When the certificate was shipped on a horse in the 18th century. Within a week of reforms triggered by the tight paperwork on Wall Street in 1968, the trading boom closed the exchange one day a week for several months, and the boys in the back room. Was able to catch up.NS NS+5, then NS+3, and 4 years ago, NS+2.

Still, so much can happen on Wall Street in two days, so why stop there? Spurring last year’s market turmoil, a group of banks, investors and liquidators NS+1 and expected within a few weeks to uncover plans for how to get there. The symptom is that the Securities and Exchange Commission will congratulate it. If so, half of the settlement time could start as early as 2023. Europe will probably follow.

It should be pointed out that they are not pushing this solely for the sake of greater profit, so that no one thinks the financial giants are weakening. They are as interested in reducing their costs as systemic risk. During last year’s market turmoil DTCC, US stock clearing institutions have jumped five-fold to over $ 30 billion per day. Over hundreds of billions of years are bound by “delivery failures”, delays due to settlement failures, ranging from typos to more sinister practices such as deliberate failures to manipulate stock prices. It has been. .. Releasing this capital will leave more for making profitable investments in financial companies.

So why does it stop after one day’s payment? The evangelist of so-called distributed ledger technology NS+0, known as “atomic” payments. This looks technically feasible.Certainly, some broker-to-broker transactions DTCC It has already been resolved almost instantly.

But is it desirable? There is a big difference between reducing and eliminating payment times. In the latter case, the buyer needs to raise funds in advance and the seller needs to be ready to exchange immediately. All bits of a complex process need to be synchronized and there is no room for error. It may also require a rigorous restructuring of the huge securities lending market designed to accommodate time-lag payments.

“Luddite!” Signal However, Buttonwood has a good relationship in advocating maintaining process redundancy. Ken Griffin, the boss of Citadel, one of America’s largest market makers, and without techno slouch, describes real-time gross settlement as “an overkill bridge” because “everything is needed.” [to] It works perfectly in a world where people are still involved. The message is clear. Overdoing things can replace one risk set with another, more frightening risk. In this case, a small number of unsuccessful transactions cause a chain reaction between back offices around the world. Certainly an atom.

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This article was published in the printed version of the Treasury and Economy section under the heading “When the Pipe Squeaks”.

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