T+1 Settlement Reduces NSCC Clearing Fund by $3.1 Billion

T+1 Settlement Reduces NSCC Clearing Fund by $3.1 Billion

The transition to T+1 settlement in the US capital markets has successfully decreased the National Securities Clearing Corporation’s Clearing Fund by $3.1 billion to $9.1 billion, significantly cutting counterparty credit risk. Despite this improvement, the operational costs for faster settlements are estimated at $8 billion annually. The move aims to enhance financial system security and has also led to a decrease in trade settlement failures, with recent data showing lower fail rates than under the previous T+2 regime. However, the need for clearing margin remains, indicating that while risks are reduced, they are not eliminated.

Key Takeaways

• The National Securities Clearing Corporation’s Clearing Fund decreased by $3.1 billion, now at $9.1 billion, post T+1 transition.
• T+1 settlement cycle has successfully reduced counterparty credit risk, a primary goal of the switch.
• Operational costs for faster settlements under T+1 are estimated at $8 billion annually.
• Trade settlement failures have decreased, with key fail rates dropping below T+2 averages.
• The transition to T+1 was partly motivated by the 2021 "meme stock" trading frenzy, highlighting the need for reduced settlement times.

Analysis

The shift to T+1 settlement in US capital markets has notably reduced counterparty credit risk and settlement failures, aligning with post-2021 market volatility concerns. This transition, while costly at $8 billion annually, enhances financial system security. However, the persistent need for clearing margin suggests ongoing risk. Short-term, firms face increased operational expenses; long-term, benefits include improved market stability and potentially lower systemic risk. This change impacts financial institutions, traders, and regulators, influencing operational strategies and regulatory frameworks.

Did You Know?

• T+1 Settlement: Refers to the process in which securities transactions are settled one business day after the transaction is executed. This is a faster settlement cycle compared to T+2, which required two business days for settlement. The shift to T+1 aims to enhance financial system security by reducing the time between trade execution and settlement, thereby decreasing the exposure to counterparty risk and potential market disruptions.
• Counterparty Credit Risk: This risk arises when two parties enter into a financial transaction and one party is at risk of default by the other party before the transaction is completed. In the context of securities trading, reducing this risk is crucial as it can lead to significant financial losses. The transition to T+1 settlement has been effective in mitigating this risk by shortening the time between trade execution and settlement, thus reducing the likelihood of default.
• National Securities Clearing Corporation (NSCC): A subsidiary of the Depository Trust & Clearing Corporation (DTCC), the NSCC provides clearing, settlement, and risk management for equities, corporate and municipal bonds, unit investment trusts, mutual funds, and exchange-traded funds in the US. The NSCC’s Clearing Fund is used to cover potential losses from member defaults. The reduction in the Clearing Fund size post-T+1 transition indicates a lower perceived risk due to the faster settlement times.