Paxos has built a clearing agency platform able to support settlement on any cycle – from “regular way” T+2 to intraday T+0, all with multilateral netting. This is an amazing feat of engineering and perseverance, but one that isn’t well understood by many in the industry. Let’s talk about why we built this, and why the legacy infrastructure can’t deliver the fast & flexible platform that the industry needs.
US Equities Settlement has been more hotly discussed and analyzed this year than in any of the prior three decades combined. Perhaps you came to understand the topic because of the in-depth coverage of the meme-stock trading frenzy in early 2021. Or, maybe you’ve read how this crucial infrastructure is clinically neglected. Either way, it’s an important component of market structure that’s often misunderstood. I’ve spent my entire career specializing in trading and settlement and the decades of no competition and little flexibility in clearing have led to significant misunderstanding of the paths available to improve settlement.
On October 23, 2021, The Economist published an article that called into question the merits of the market striving towards T+0 settlement cycles. Specifically, the article states, “Why then stop at one-day settlement? Evangelists for so-called distributed-ledger technology are touting the possibility of going to t+0, known as ‘atomic’ settlement.”
This conflation in many people’s minds of T+0, Real-Time Gross Settlement (RTGS), and atomic settlement demonstrates just how misunderstood this topic really is. To be clear, T+0 simply means settlement on the same day as the trade, RTGS means settlement at the time of trading, and atomic settlement is the transfer of securities against cash (ie: delivery vs payment) at any settlement time. All of these should be embraced as opportunities that can create efficiencies, cut costs and protect our system from future market failures.
We need a much more granular view of the alternatives and what the clearing platforms of the future should provide.These options include – from the longest settlement duration to the shortest:
- T+2 (where we are now);
- T+1 (proposed reduction in 2024);
- T+0 end of day net settlement (not available today; NSCC netting cutoff is 11:30am)
- T+0 intraday net settlement (no clearing agency can provide today); and
- T+0 real time gross settlement (how the crypto markets work).
The current T+2 settlement and proposed T+1 settlement both require overnight risks to be managed after the trading day. The move to T+1 settlement would offer a reduction in the margin required from the industry due to the shortened duration from trading to settlement. This margin reduction could be as large as 40% in some estimates, but this still requires the industry to put up billions of dollars in margin. While an improvement, there are still better options available.
All T+0 options remove overnight risk and have the ability to reduce the margin requirements completely. With T+0 real-time gross settlement, traders can potentially remove settlement risks from the system as trades settle in (near) real-time. While this is a huge benefit and could revolutionize the business of securities trading, the downside of RTGS settlement is it requires all transactions to be pre-funded and settled on a gross basis so the benefits of netting are lost.
What’s left is the T+0 end of day and intraday net settlement options. The current COBOL based batch processing of the legacy infrastructure can not provide the intraday netting required for either intraday batches or a full day of trading to be netted and settled quickly. Nor can they support gross settlement of today’s US equities volumes. This is why we built the Paxos Settlement Service.
The Paxos Settlement Service solves these challenges. As a new, technologically advanced clearing agency for the US market, Paxos Settlement Service will enable flexibility in clearing cycles through the advent of sophisticated real time netting and settlement capabilities. Never before has the US market had a clearing agency able to Net settle a full day’s trading on the trade date as well as handle regular way (T+2 or T+1) trading. With this flexibility in the clearing platform and choice between clearing models across the legacy and new Paxos platforms, the industry will be enabled to create innovative products to drive the market forward. By creating the capabilities needed in the future, as well as supporting today’s needs, we can help create a path to the future. The bottom line is this: the world’s most valuable market needs to be protected and the legacy settlement system is not cutting it. We need competition and new technology today.