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T+1 Revisited: Settling On a Settlement Speed


Pacific Investment Management Company, of course, runs the world's largest mutual fund. Its Total Return Fund counts assets of nearly one-quarter of a trillion dollars.

That is a bond fund. But in late 2009, the company began moving into actively managing funds that invest in stocks.

And the move into equities has Cynthia Meyn, PIMCO's executive vice president of operations, concerned. She doesn't quite understand why her firm has to be exposed to the risk of not being able to settle on stock purchases or sales it makes for three days.

In that much time, high-speed traders run through automated trading cycles equivalent to three years, in olden days. In that much time, the price of the stock can increase or fall dramatically, potentially undermining the purpose of making the transaction in the first place.

And, oh yeah, there is "counterparty risk." Who knows? There might be another Lehman Brothers or MF Global incident lurking out there. "I'd say our largest concern leading into '08 and then thereafter, has been counterparty exposure,'' she said early this month at the Securities Industry and Financial Markets Association 2012 Operations Conference in Phoenix.

"First of all, in terms of the cash equities market, something new to PIMCO, we are concerned about the three-day settlement," she said. She's used to settling U.S. Treasury notes, other fixed-income securities and even complex, tiered swaps of interest rates or other risks in one day - or the same day the trade is made.

Why not stocks?

"The thing about the equities market is that for three days, in a market moving potentially 2% a day, we are at bay until the trade settles, there's no payoff,'' she said. "So we are looking to actively participate in any kind of movement towards (straight-through processing) and automation that can lead to a shorter settlement date cycle.''

Enter The Depository Trust and Clearing Corporation, the non-profit industry utility for clearing and settlement that is the world's largest post-trade financial services company.

The industry utility last week embarked on an industry-wide study of interest in and difficulties of speeding up the time it takes to settle transactions.

The study will capture comment from brokers to institutions to asset managers to clearing organizations to transfer agencies.

It's planning to conduct interviews on the feasibility and desirability of moving to two-, one- or same-day settlement with 30 to 40 individuals at different firms in the securities trading industry and with working groups. It also plans to conduct electronic surveys across 200 to 250 firms. The services firm will look not just at stock trades, but transactions involving corporate bonds and municipal bonds, as well.

Accelerating the cycle, according to DTCC chief operating officer Michael C. Bodson, could reduce financial risks as well as lower the capital requirements and margin requirements involved in trading.

"We're looking for business case," Bodson said, at the SIFMA Ops conference.

Europe already has committed itself to "T+2" settlement, meaning Trade Date plus Two Days. The DTCC study will look at three alternatives: T+2, T+1 and T+0, which translates to same-day settlement.

The industry last looked at moving to T+1 settlement in 2001, but the introspection and planning was shelved in the wake of the September 11 attacks. Meyn said many sophisticated individuals in the fund industry don't understand why it takes days to settle transactions such as stock trades, while orders get matched in millionths of seconds.

A shorter settlement time might not be met with universal acclaim in the industry. Transfer agents, who have gotten used to using the float on funds involved in the three days of moving cash from one party to another and the associated security back, will now have to give up that use of funds, Meyn said.

Similarly, custodial banks will have a reduced ability to lend out securities and earn returns for their owners, if settlement times are shortend.

But in a show of hands at Bodson's request, the majority of votes in the audience at this conference of the nation's top operations managers went not to T+2 settlement, but T+1.

But, he noted, there are lots of repercussions on different parts of the financial industry, from a change of this stature. Institutions and fund managers typically use money in money market funds to pay for their transactions, not checks from banks. A significant tightening of settlement times could have a ripple effect on the health of that part of the financial industry, for instance.

Which means that, whatever comes out of this study, nothing will take place immediately.

The efficiencies needed have to be defined first, he said. And he estimated moving to T+2 settlement could be a "three- to five-year undertaking." Getting to T+1 might take more like a decade, he indicated.