In his testimony to the House Financial Services Committee over the GameStop trading frenzy, Robinhood chief executive Vlad Tenev called for an industry-wide change to the trade settlement process. Hedge fund billionaire Ken Griffith echoed Tenev’s plea calling for ”shortened settlement cycles and transparent capital models.” The congressional hearing focused on the events of the last week of January, when Robinhood suspended the trading of GameStop and a few other stocks after a mob of retail investors drove up the price of those securities in an attempt to “short squeeze” Wall Street hedge funds. But Tenev and Griffith’s calls for an overhaul of the securities industry’s settlement system could open an opportunity for new blockchain-based improvements already in the works.
Tenev called for the need to shift from the current two-day trade settlement period, known as T+2, to settling trades in real time. He claimed that “real-time settlement would have allowed Robinhood Securities to better react to periods of increased volatility in the markets without restricting the purchasing of securities,” essentially shifting the blame for service interruptions to an often overlooked trade settlement mechanism. Citadel CEO Ken Griffin also advocated for a shortened trade cycle, albeit a less extreme one-day model, in his testimony.
The T+2, shorthanded for trade plus two business days, settlement cycle was adopted by the SEC in March 2017 as a revision to the previous three-days model. It simply means that the trade is considered final two business days after the day the order is executed in the market.
“There is no reason why the greatest financial system the world has ever seen cannot settle trades in real time. Doing so would greatly mitigate the risk that such processing poses, said Tenev. The clearinghouse deposit requirements are designed to mitigate risk, but last week’s wild market activity showed that these requirements, coupled with an unnecessarily long settlement cycle, can have unintended consequences that introduce new risks.”
Tenev’s thesis largely repeats his blog post from February 2nd boldly titled “It’s Time for Real-Time Settlement.”
In fact, blockchain technology has already opened the gates not only to real-time settlement but, perhaps more importantly, the world where traders wouldn’t have to depend on intermediaries like DTCC. PayPal’s crypto partner Paxos, New York-based fintech company specializing in blockchain, is at the forefront of this innovation. Last February, the company launched Paxos Settlement service, pioneering settlement of U.S. listed equity trades without a central counterparty. The service enables participants to pick virtually any cycle, including same-day settlement. Its clients include Credit Suisse, Nomura Instinet and one of France’s largest banks Societe Generale. The service has already settled 15,000 trades worth approximately $75 million.
Paxos CEO and co-founder Charles Cascarilla believes decentralization is the future of securities settlement. “Decentralised systems are just more resilient. They use up less capital, they cost less. And that’s what we are offering – a settlement system that has expanded capabilities. We’re not prescribing the market exactly what to do.”
Someone who certainly does not shy away from openly criticizing the current system is Overstock’s former CEO Patrick Byrne, who called the separation of trading and settlement “the original sin.” By unifying the two through real-time settlement, “you’re eliminating systemic risk and all kinds of mischief. You’re also making the market totally transparent for regulators,” said Byrne in an interview to Forbes in 2019. Earlier that year, Overstock’s blockchain technology firm tZERO launched a security token trading platform. As the name suggests, the company sees its mission in bringing efficiency and transparency to capital markets.
The opportunity the blockchain technology can bring to financial markets is recognized globally.
Australia’s primary securities exchange ASX has been developing a blockchain-based post-trade clearing and settlement system, which will replace its quarter-century old platform called Clearing House Electronic Subregister System (CHESS). ASX’s partners include Digital Asset, New-York-based technology company behind the open-source smart contract language DAML, and software company VMware, famous for developing the technology behind Facebook’s cryptocurrency Diem. ASX’s representative was not immediately available for comment.
Even outside the blockchain community, the Depository Trust & Clearing Corporation (DTCC), which settles the vast majority of U.S. securities transactions and is the parent company of the National Securities Clearing Corporation (NSCC), the clearing house at the center of the GameStop-Robinhood story, expressed support for accelerating the current settlement cycle.
In a post published on February 18, DTCC managing director and general manager of equity clearing and DTC settlement services Michael McClain addressed the question in detail. “The reality is that we already have the capability to clear and settle in T+1 or even the same day using existing technology, and in fact, we clear a number of T+1 trades every day. In our discussions with the industry, many firms appear ready to start revising their processes to accelerate settlement. They realize it’s in their best interest: Shortened settlement times reduce market risk and margin requirements, which would allow firms to use those resources in other ways.”
If there’s demand and technological capability, why are we still on T+2?
The simple answer is such change would require regulatory engagement. The more intricate argument is that under the current system the NSCC “nets”, or “reduces the total amount of cash and securities that have to go back and forth throughout the day. This eliminates a material amount of operational and market risk, said DTCC’s Managing Director Michael McClain. In a real-time settlement scenario, netting is not possible, meaning trillions of dollars in cash and securities would be moving through the financial system on a continual basis throughout the trading day, creating massive market and capital inefficiencies, increasing credit and operational risks, and increasing costs between trading parties, possibly undermining the stability of the markets.”
Even with blockchain-enabled faster settlement, brokers hesitate to take advantage of the opportunity. Paxos CEO Cascarilla attributes this to the potential difficulty of keeping trades with different timeframes in sync. Though he is hopeful that the markets will eventually warm up to instantaneous trade settlement: “That frees up capital. The faster you settle, the less chance you have that someone fails. The less risks you have, therefore, the less capital you need to hold.”