Converting to one-day trade settlement will take at least 31/2 years -- far longer than the original goal of June 2002, according to a new study.
The study, prepared by Andersen Consulting and The Capital Markets Co., both in New York, was commissioned by the Securities Industry Association, Washington, to serve as the industry's master plan in transitioning to T+1 from the current three-day cycle.
The 2002 target date set by the Securities and Exchange Commission was too aggressive and was established several months ago as a "straw-man date to get the industry focused on what needs to be done," said Joseph Anastasio, partner at Capital Markets.
And there is a lot to be done, nothing short of redesigning the securities trading and settlement process.
"T+1 requires all parties to streamline and implement significant real-time processing to meet the compressed settlement timeframe . . . a `one-stop shop' for matching and transaction consolidation," the study said.
Even though in many cases large-scale revamping of systems and processes will be necessary, the shortened trading cycle will enhance the efficiency of U.S. markets in the long run. The study estimates the $8 billion preparation effort will result in a system that saves the industry $2.7 billion per year.
The study identifies 10 "building blocks" the industry must set up to prepare for T+1. Assuming a fourth quarter 2000 start on those building blocks, most should be completed by the first quarter of 2003. The next 15 months would be spent on full industry testing and stabilization, which would result in T+1 going live in June 2004.
The building blocks -- changes in existing processing methods that must be implemented to move to T+1 from T+3 -- include: modification of firms' internal trade processes to comply with compressed settlement deadlines; submission of near-real-time trade information by the exchanges and institutions; and the development of industry matching utilities and linkages for all asset classes.
Andersen Consulting and Capital Markets interviewed 56 major firms, representing retail and institutional broker/dealers, custodians and asset managers, via a web-based survey. The major securities exchanges, key regulators and the Depository Trust & Clearing Corp. also provided input.
The task of implementing near-real-time trade processing appears daunting. One of the critical needs identified by the study is industry agreement on the major steps that need to be taken to meet the shortened trade cycle.
"Recent trends in processing efficiency and capacity utilization have called into question the ability of the U.S. clearance and settlement system," according to the study. ". . . Asset managers and broker/dealers have, in some instances, indicated that capacity is a critical issue. Significant investment in new systems will be required to manage anticipated trade volume."
Changing steps
Currently, the institutional trade process consists of sequential and repetitive steps among trade participants. The cycle "is hampered by manual processes, a lack of cross-industry messaging standards, and difficulties of obtaining and properly utilizing customer, security and settlement data," the study says. These difficulties create "many potential break points" in the trade cycle, resulting in "multiple opportunities for failure."
T+1 will result in seamless communications among all trading parties and involve a single electronic process. Centralized trade processing will be the "cornerstone" of the revised institutional trade process, the study says, and will replace the current confirmation and affirmation process.
"In addition to greatly reducing the systemic risks inherent in today's trade process," the study says, "the proposed model will significantly reduce cycle times -- a critical success factor for moving to T+1 -- and dramatically increase capacity through automation, standards, and the streamlining of processes."
The adoption of communications standards among all parties in institutional trading is also a "key concern," according to the study. Asset managers "will need to adopt communication and messaging standards that enable seamless interoperability within and outside their organizational boundaries."
Asset managers currently use a variety of standards for communication with broker/dealers and custodians. "The lack of consistent standards forces a significant amount of human intervention and rework and introduces errors in the process," the study says.
"Some large asset managers maintain links with over 30 to 50 custodians, each link frequently requiring its own type of connectivity and interaction."
As a result, 47% of asset managers indicated that connectivity and interaction with custodians and broker/dealers will require improvement to comply with T+1, the study says.
The shortened trade cycle will have "one of the most dramatic effects" on the operations of custodians, the study says, despite their "considerable progress" toward straight-through processing.
"To ensure successful operation in the T+1 environment, custodians will have to ensure real-time or near-real-time processing of all trade instructions, and develop the ability to link seamlessly with the new utilities," the study says. "This will require re-engineering the current workflow, and eliminating batch processing cycles. The ability to measure risk on a real-time basis will be critical."
Costs vary
The cost of becoming T+1 compliant will require different levels of investment from each category of participants in the trading process, the study said.
"Most of this cost is associated with enhancing or replacing existing systems to enable real-time generation and processing."
Asset managers will be required to spend a total of $1.7 billion: $790 million to comply with the compressed settlement cycle; $195 million to establish interfaces with the new utilities; and $675 million to standardize reference data, the study says. Most of the cost to money managers is associated with "enhancing or replacing existing systems . . . and to automate and streamline the flow of transactions between front/middle and back office systems," the study says.
Institutional brokers will need to invest $1.5 billion to meet the new requirements, the study says. Retail broker/dealers are expected to spend $1.2 billion.
Achieving industrywide implementation of T+1 will require coordination among all participants, the study notes. "Without coordination, the pace toward implementing T+1 building blocks could vary across the industry," the study says. Fortunately, "the movement toward T+1 has already begun. Many of the building blocks are under way and firms are making investments that will enable T+1. . . . Subsequently, implementation of the individual building blocks and T+1 as a whole will be dependent on the timely publication of industry standards, specifications and testing plans."
