Over the past year, a series of events has shifted the attention of both experts and laypersons to the arcane processes that support trading and settlement in the U.S. securities markets. The massive volume of U.S. Treasury sales in March 2020 at the start of the COVID crisis boosted liquidity needs at precisely the time when resources were scarce, overwhelming the over-the-counter trading system and compelling unprecedented Fed interventions (see our earlier post). Similarly, the late-January 2021 episode involving extraordinary activity in GameStop, in large part through Robinhood (the broker-dealer), highlighted how a surge in equities trading volume can concentrate counterparty risk and trigger a jump in liquidity needs to settle those trades (see our earlier post). After filling the news for weeks, the equity market turmoil triggered Congressional hearings (see here and here).
In an effort to reduce both counterparty risk and liquidity needs, a number of observers are focusing on shortening the settlement period. Officials at the Depository Trust and Clearing Corporation (DTCC) are calling on the industry to halve the equities settlement period from two days (T+2) to one (T+1) by 2023. Others have called for far faster clearing, including nearly instant settlement (see here).
Times like these lead us to ask: how can we improve the efficiency and safety of the financial plumbing? We see plenty of room for progress in speeding settlement, thereby reducing both risk and liquidity needs during periods of stress. However, we also think that things can go too far (or too fast). In particular, we are deeply skeptical of calls for real-time settlement (T+0) for securities or foreign exchange transactions. In this post, we suggest why the optimal settlement period for some financial transactions is not zero….
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