Settlement Latency Review
Settlement latency is the lag between the point at which a trade is made and the trade is settled. Today, startups are looking to solve settlement latency problems using technologies like blockchain.
The problem of settlement latency is as old as the markets. However, in recent years, it has become a more pressing issue.
As high frequency trading has become more and more common, market regulators have grown concerned that an elite group of hedge funds and algorithmic traders with low latency trading capabilities threaten the stability and integrity of global markets.
All markets in the world operate on settlement cycles that vary in lengths of time.
You hear a lot about how quickly trades can be executed today. What you don’t hear about is the multi-day process required to settle those trades – something that can take 2 to 3 days.
The US securities industry, for example, operates on a 3 day cycle known as T+3. The “T” stands for Trade, so that means Trade + 3 Days.
Other global capital markets, however, have shortened their settlement cycles in recent years. Germany and Hong Kong, for example, operate on T+2, while the European Union has gradually moved towards its own T+2 model.
The ultimate goal is to move towards a T+1 or a T+0 cycle – something that wasn’t feasible a few years ago.
Surprisingly, the United States security industry originally set a target date for T+1: it was 2004. However, at the time, the technology didn’t exist and the effort was abandoned.
Today, these shortened cycles are seen to be more feasible due to the existence of technologies like blockchain – the fundamental technology behind virtual currencies.
Benefits of Reducing Settlement Latency
There are enormous benefits to reducing settlement latency. These benefits can be enjoyed by firms operating within the securities industry as well as to the owners of stocks and bonds on the market.
As one writeup on settlement latency explained,
“Much of the trading volume on markets such as NASDAQ and NYSE is designed to increase the value of pension funds owned by corporations, life insurance policies held by consumers and endowments managed for charities. Every dollar of inefficiency that can be reduced from the trading settlement lifecycle is a dollar that could be reinvested in these portfolios to generate higher returns.”
Ultimately, reducing settlement latency can lead to greater profits throughout the market.
How Can Block Chain Technology Help Reduce Settlement Latency?
Blockchain technology is being seen as the savior for settlement latency. At the moment, blockchain technology is still relatively new and people aren’t totally sure how to implement it into existing financial systems.
However, here’s how blockchain works with virtual currencies like Bitcoin:
-The blockchain is like a ledger at a bank. It displays all of the completed transactions ever performed on Bitcoin. You can go all the way back to the first transaction or view a transaction that was completed just moments ago.
-The blockchain is constantly growing. Every time a new transaction is completed, a block is added onto the chain. That’s where the term “block chain” comes from.
-The blockchain is decentralized. Instead of being hosted in one place, it’s shared by every Bitcoin user.
-The blockchain is publically viewable and verifiable. One reason why blockchain is viewed as a way to enhance security and reduce risk in the markets is because it’s publically accessible. If you want to view a transaction or verify that it has taken place, then you can just look at the blockchain. All of the blocks are placed in chronological order. If someone tries to modify the blockchain, it’s instantly noticeable.
Ultimately, blockchain is viewed as the most likely way to reduce settlement latency as we move towards the future.
Digital Asset and Settlement Latency
Several banks around the world are looking at ways to reduce settlement latency using block chain technology. Swiss bank USB, for example, recently opened a financial lab in London with the goal of eliminating settlement latency through block chain technology.
Meanwhile, a private New York firm called Digital Asset is developing its own blockchain technology that could be used by financial institutions as a way to solve settlement latency.
That firm claims that the blockchain can be used to reduce settlement latency while also reducing risk for both parties. The goal of the company is to build “distributed, encrypted straight through processing tools” that improve “efficiency, security, compliance and settlement speed.”
With Digital Asset and major international banks starting to take notice of settlement latency and blockchain technology, you can expect to hear more about this in the near future.