Beyond the ongoing move from T+2 to T+1 standard settlement cycles in the securities market, how close should we optimally seek to set the deadline, as an end goal? Balancing the reduced counterparty exposures that come with faster settlement, against the loss of trading flexibility and netting possibilities, industry senior Dennis McLaughlin presents a research paper seeing 90 percent of the netting benefits being possible to capture in the first ten minutes.
Outstanding trades cause counterparty risk, and distributed ledger technology has put instant settlement – which would do away with it – on the list of technically feasible options when it comes to the future infrastructure of financial markets. However, with the need it would create for pre-funding the money and pre-allocating the securities, and the lost possibility for netting out the dominant number of trades before settling them, the big market players pretty much refute the instant-settlements idea.
So if zero is too little but two days is too much – exactly how large would a golden time frame be?
Not very long, reckons Dennis McLaughlin, former Head of Financial Risk at LSEG, in a paper picked up and discussed by news site Ledger Insights. The abstract of the scientific article itself, titled “The Trade-off Between Shorter Settlement Times and Multilateral Netting Benefits in Deferred Net Settlement”, is available here. Posted there just before New Year, it presents the work as forthcoming in the Journal of Financial Market Infrastructures.
“The author acknowledges that intuitively, the longer the netting period, the greater the benefit. However, he had a surprising result using NSCC statistics for the U.S. equity markets. ‘For the network as a whole, there is no theoretical loss of the multilateral netting benefit for a settlement window of length no less than 1 hour,’ he wrote. In fact, after ten minutes, it’s possible to achieve 90% of the potential netting benefits,” Ledger Insights reports, having read the abstract.
For some background, the news article also references an older post on the New York Federal Reserve’s insights blog Liberty Street Economics, suggesting that the frequent use of the term “atomic” in connection with DLT-based delivery-versus-payment settlement be replaced by either “instant” or “simultaneous” – or both – depending on which of the two dimensions is actually in play.