> A substantial amount of trades in the market are executed by liquidity providers that provide efficient two-sided
markets. These important trading firms trade on both sides of the market and are largely risk flat at the end of the
day. Real-time settlement would require these liquidity providers to have significant sums of capital and securities
on hand to make trade-for-trade deliveries.
The current infrastructure relies on the efficiencies of trade netting to accommodate substantial amounts of trades.
Wholesale market-making is important to the infrastructure as it provides the capital and balance sheets to back
customer trading. Significantly increasing those capital requirements by requiring pre-funding of all trades without the
benefit of recognizing the offsetting trades would substantially increase the costs of trade execution to the end user.
Real-time settlement could also introduce operational inefficiencies. In a typical low-volatility trading day, NSCC
and DTC process over one million shares per second on average, valued at over $16 million. During peak trading
hours, such as market open and close, this number spikes to over 300 million shares per second, valued at over
$25 billion. Settling these amounts throughout the day in real-time would introduce substantial financial and
operational risks to the equity markets.
Accelerated settlement that abandons the significant capital and operational efficiencies gained through
centralized multilateral netting would be a step backward for the world’s most liquid markets. Striking a balance
between the capital efficiencies of netting and the risk mitigation benefits of moving settlement closer to trade date
should be the goal of the industry.
Thanks! Replacing market makers seems difficult.
Edit: Why the downvotes? I'm quoting the article for easy access.
> Significantly increasing those capital requirements by requiring pre-funding of all trades without the benefit of recognizing the offsetting trades would substantially increase the costs of trade execution to the end user.
I don't see how this follows, if the trades are settled faster? Wouldn't you have to keep less capital on hand at any given time if you're settling trades faster? I'm clearly missing something, not sure what.
You aren't, there are netting, batching, and matching algorithms that have been developed for larger systems. The Feds, who process $2Tn.+/day, BoE, ECB etc have found these systems to hold up through trials, simulations, and implementations. DTCC, on the other hand, handles $500Bn.
I'm not an expert but how I read it is: market makers currently can sell a stock without owning it. All is well as long as they buy it back by the end of the day as settlement takes 2 more days.
If settlement was instantaneous then the market makers would have to already own a bunch of the stock in order to sell any. Owning stock requires capital. Similarly if they wanted to buy more stock they'd need cash on hand.
Would they though? If settlement was instantaneous for market makers, then obviously settlement with the brokerages would also have to be instantaneous. Then it's no longer an issue of verifying anything, the risk of proving ownership would fall squarely on the brokerages or whoever is initiating the trade with the market maker in the first place.
Thanks! Replacing market makers seems difficult.
Edit: Why the downvotes? I'm quoting the article for easy access.