Securities Settlement Revolution
JGB T+1 & the dawn of a new Repo Market...
This series of reports on the so-called “securities settlement revolution” will focus on key trends and changes in Japan‘s securities settlement market while exploring legacy systems and ecosystem migration, as well as the related possibilities of innovation and emerging technologies in this context.
The first effort in the securities settlement revolution involves shortening the settlement cycle for JGBs, planned for the spring of 2018. In April 2012, the market successfully introduced a settlement cycle that was shortened to two business days (T+2) for outright JGB transactions and special collateral (SC) repurchase transactions (repos) and one business day (T+1) for general collateral (GC) repos (together collectively regarded as T+2). The upcoming “revolution” hopes to shorten this settlement cycle to T+1, one business day after a trade.
Market participants should take this event as an opportunity to modernize their business processes and systems:
- Initiatives to shorten the settlement cycle for JGBs and securities.
- Efforts to enhance the functions, and expand the use, linkages, and integration of the CCP.
- Enhanced functions of the central securities depository (CSD).
- Accelerated adoption and use of straight-through processing by market participants.
- Facilitating smoother cross-border securities settlement. The revolution in the works will go beyond mere cosmetic reforms to the market system.
This new market, envisioned to reach a scale of 20 trillion to 30 trillion yen, could cause structural change.
- The coming watershed in repo trading is an opportunity to create a new repo market.
This is because of the shift from Japan’s unique “gentan” repo (securities-lending
approach) to the “gensaki” approach, which is the international norm.
- With the advent of this new system, a same-day settlement market will emerge in
Japan’s money market.
Technology continues to evolve. It advances without waiting for the financial industry or its players to come to grips with it or to develop pertinent applications. The securities settlement revolution in Japan has unfolded slowly, requiring more than 15 years all told. The coming financial infrastructure revolution should not take place at such a glacial pace.
Financial institutions find themselves at a point where they should reconsider their approaches to financial infrastructure management. System reform will need to be tackled. Loosely coupling (or unbundling) connections with the financial infrastructure (exchanges, clearing houses, and settlement infrastructure) can increase the available options in business and IT sourcing models, contributing to strategic flexibility.Chapter 2
The second chapter in the securities settlement revolution is the shortening of the equities settlement cycle planned for 2019. Japan has worked to raise the bar for its securities settlement system, with examples including implementing delivery versus payment (DVP) for securities settlement in 2007, and taking equities paperless in 2009, however, the settlement cycle remains at T+3 (four business days from trade). As such, the next step and chapter in this ongoing story in the settlement revolution is to fully migrate this to T+2.
Shortening the settlement cycle has the direct benefit of reducing settlement risk. In addition, the resulting increase in liquidity can also be expected to indirectly contribute to maintaining and strengthening the market’s competitiveness internationally. Japan Securities Dealers Association (JSDA) and the Working Group on Shortening of the Stock Settlement Cycle have sought to forge a consensus among market participants on how to address the following three points.
- Reducing settlement risk.
- Enhancing efficiency, stability, and liquidity of the equities market and the financial market.
- Maintaining and strengthening international competitiveness (bring operations in line with international standards and orchestrating globalization of the equities market).
The European market migrated to T+2 securities settlement in October 2014, ahead of Japan. In coming to grips with the market reform witnessed in Europe, Asia-Pacific market participants have struggled with process changes and compliance measures accompanying settlement cycle shortening. Addressing challenges from the investment that would be required to risk points proved to be issues that could not be tackled lightly. Meanwhile, in the post-reform European market with the shortened settlement cycle the “settlement revolution” continues to play out.
The simultaneous implementation of integrating the securities settlement infrastructure (central securities depository (CSD) integration in Europe due to T2S (TARGET2-Securities) clearing settlement system) in tandem with market system reform (implementation of common European CSD regulations) ushered in a major turning point in infrastructure and great advances in the post-trade processing ecosystem for the first time in 20 years in the European market.
European market participants significantly expanded investment in the sectors of technology, operations, and systems, however, this has been taking place at the same time, that the entire securities industry is facing intense pressure to cut costs. This growth in IT spending coupled with cost-cutting pressures has spurred an evolution in post-trade operation models that has seen them move from being in-house, closed, and integrated to more innovative, open, and linked.Changes in Europe Following the T+2 Revolution
What actual changes transpired in the European market following the shift to T+2 conducted in parallel with market infrastructure system integration? Here we will draw on the changes seen in the wake of the European securities to explore responses in Japan’s market as it moves to follow suit.
Post-trade Market Changes
The simultaneous pursuit of securities settlement infrastructure integration (integration of CSDs across Europe via the T2S platform) and securities settlement system reform (implementation of CSD regulations common across Europe) marked a major turning point as they brought about the first major rethinking of the post-trade ecosystem and infrastructure in the European market in 20 years.
Although market participants have greatly expanded spending on technology, operations, and systems, they still face intense pressure to reduce costs. This growth on IT spending coupled with cost-cutting pressures has spurred an evolution in post-trading operation models that has seen them move from being in-house, closed, and integrated to more innovative, open, and collaborative.
Participants in the post-trade market not only face the need to improve the efficiency of routine operations, but also to reduce costs through shared and mutual use of operations and systems, devise new business models through business alliances and partnerships, and convert post-trade operations from a cost center to a profit center. The pursuit of heightened efficiency in operations as a means of cutting costs is spurring new initiatives—such as through streamlining operations, pooling collateral, and reducing intermediaries—that are in the processes of redefining the structure of the industry.
Structural Change in the Securities Settlement Industry
For individual financial institutions seeking to trim costs by simplifying and standardizing operations, business process outsourcing (BPO) was a good first step. However, the introduction and proliferation of utility services has generated secondary added value and cost reductions on a scale greatly transcending that possible through individual, company-based BPO initiatives.
For instance, new asset management services created via partnerships between small and medium-sized local custodians and large CSDs and efforts to parlay post-trading operation centers into new profit centers are typical examples. The viewpoint of improving the efficiency of securities settlement infrastructure can serve as a chance to reevaluate efficiency, optimization, and added value through comparing cost savings possible through mutual or shared use of operations and systems versus the merits of simple BPO with outsourcing use.
In particular, firms do not need to worry unnecessarily about excessive dependence on other firms, but rather medium- and small-sized market participants will find business alliances and introducing utility services as indispensable to bolstering their bottom lines. This move toward alliances and use of utility services is driving a shift toward the vertical integration of operation flows and partnerships and integration among smaller CSDs.