By William Watts
That’s where Robinhood says it ran into trouble. As customers swarmed into one-way wagers on GameStop and other popular meme stocks, collateral requirements soared. That left Robinhood no choice but to temporarily halt buy orders as it raised billions in cash, Tenev, the CEO, testified.
The SEC, in a long-awaited report released on Oct. 18, noted that the NSCC “made intraday margin calls from 26 clearing members totaling $6.9 billion,” or a 37% increase in total required margin among its members. The SEC report noted that Robinhood and other brokers have maintained that these margin requirements were the sole reason for restricting purchases of GameStop, but senior officials at the agency told reporters on an Oct. 18 call that they can’t rule out other reasons.
Shortening the settlement period won’t do away with margin requirements, but it would reduce the amount of capital required in the margin process and, of course, how long it is tied up. That makes capital free for other purposes and, most important, reduces the risk of something going wrong before a trade is settled.
The DTCC has previously noted that in 2020, more than $13 billion was, on average, deposited on margin with the National Securities Clearing Corp. The DTCC has estimated that shortening the cycle by a day would reduce the volatility component of NSCC’s margin requirements by around 41% .
Moving to T+1 “benefits investors,” Tom Price, managing director of operations at Sifma, told MarketWatch. “It puts less risk in the market. No. 2, if I sell a security, I wait two days for that security to settle; now, I can get those funds a day earlier.”
For brokerage firms, having less capital tied up in margins could mean additional investment in their platforms, the proponents argued, which would also benefit retail investors.
But it’s a complicated and slow-moving process.
“If moving from T+3 to T+2 was no small undertaking, moving from T+2 to T+1 is a bit more challenging,” Price said.
In a letter to Securities and Exchange Commission Chairman Gary Gensler, Sifma, the ICI and DTCC said the industry could move to a shorter settlement process, while outlining a number of logistical hurdles that must be cleared to shorten the process by 24 hours. The SEC would have to approve rule changes for the industry to implement a shorter settlement process.
Paxos contends its approach would help open up the settlement process to competition and innovation. Its platform allows buyers and sellers to settle transactions the same day they occur, while also supporting T+1 and T+2 settlement. Rather than using a central clearinghouse, the Paxos system would allow two parties to bilaterally settle securities trades directly with each other.
“The method of settling [Wall] Street-side equity clearing hasn’t changed in 30 years … but market structure has changed significantly,” said Greg Lee, Paxos’ managing director for securities, in an interview.
Lee said the Paxos system would significantly reduce margin requirements. Margin requirements would still rise during periods of duress, but when volatility leaves the market, margin requirements return to normal, allowing capital to return to the market, he said.
The DTCC favors maintaining the central clearing party structure, which allows “netting.” Under netting, firms track their wins and losses and pay or collect just the net amount due at the end of each settlement period. That creates a much more predictable financing requirement, said Murray Pozmanter, head of clearing agency services and global business operations at DTCC, in an interview.
Blockchain technology speeds up the process
The DTCC is taking other steps. In parallel with its efforts alongside ICI and Sifma to speed the existing equity settlement process by a day. The organization in September outlined a path to launching what it has dubbed Project Ion, which would use distributed-ledger technology modeled around a netted same-day settlement process that would allow for one-day, two-day or extended settlement periods.
Paxos’ Lee, in a statement, said that the structure of DTCC’s project “is extremely similar to the Paxos Settlement System and what we’ve built that we believe it validates our strategy for a new approach to clearing,” but argued that the use of a central clearing party model would continue to impose a huge cost burden on the industry.
The DTCC declined to comment.
Adding competition to the clearing and settlement process is appealing, said Luke Mauro, global head of operations at Instinet, a participant in the Paxos project. He imagines an eventual scenario in which much of the industry uses at T+1 settlement, while a subset of the industry operates on T+0.
“The biggest thing is that competition is good and giving clients choices is great,” he said in an interview. Instinet opted to participate in the pilot project with an eye toward how the settlement process could change in coming years.
“What I said to a lot of our clients and senior management is, if this is something we want to do in a year or two, we can’t start in a year or two,” he said.