The essence of the settlement issue can be summed up as -- nothing good can happen between trade date and settlement, only bad things can happen. And the longer the settlement cycle, the greater the risk. In 1993, the Federal Reserve Board noted that settlement systems for securities were a potential source of “systemic disturbance” to financial markets and the economy. In the Board’s view, the ideal scenario was settlement immediately after execution and payment in same-day funds. The longer the period from trade execution to settlement, the greater the risk that one of the parties may default on the trade. In addition, the larger the number of unsettled trades, the greater the opportunity for prices of the securities to move away from the contract price – thereby increasing the risk that non-defaulting parties will incur a loss when replacing unsettled contracts. The biggest concern of the Commission is systemic risk – or the inability of one market participant to meet its obligations when due, which will cause others to fail to meet their obligations. And while the Commission believes that the threat of a serious systemic disruption to the US financial markets from a settlement failure is small, it is still a serious concern. It was this type of concern – propelled by the 1987 Market Break and the 1990 bankruptcy of Drexel Burnham – that caused the Commission to adopt rule 15c6-1 – shortening the settlement time frame from T+5 to T+3.

http://www.fisd.net/referencedata/20040512SECRelease.pdf

2004-09-21