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Fed chief in settlement warning By Stephen Fidler in Washington

Published: October 16 2000 20:36GMT | Last Updated: October 16 2000 20:41GMT

An increasing number of stock market transactions are failing to settle on time because high trading volumes are straining market infrastructure, Alan Greenspan, Federal Reserve chairman, said on Monday. yesterday.

"The potential for such problems clearly must be a significant concern for policymakers," Mr Greenspan said in a video speech shown at a financial markets conference organised by the Federal Reserve Bank of Atlanta.

"Errors and delays in settling trades imply greater operational risks and counter-party credit risks to market participants.

"Furthermore, should capacity problems emerge because of a volatility-induced spike in trading volumes, the equity markets themselves could be compromised," he said.

Mr Greenspan backed calls from the Securities Industry Association to cut the gap between trading and settlement from three business days to one.

He said electronic finance had had much less impact on the important "back office" functions of clearing and settling transactions for shares and other corporate securities than on the "front office", where the higher volumes of transactions were being generated.

More transactions were failing to settle as scheduled on the third business day after trading, he said. Many felt serious capacity problems could emerge "without a complete re-engineering of the process that uses new technology".

A shorter settlement cycle would significantly reduce counter-party credit risks by reducing the number and value of trades awaiting settlement and by reducing the potential for losses from those unsettled trades in case of a default, he said.

Mr Greenspan said efforts to reduce the settlement delay were serving as a catalyst for so-called straight-through processing under which settlements are completed with just one manual entry into an automatic system.

Without STP next-day settlement would be impossible and it would significantly reduce costs, he said. STP would also remove many, if not all, of the obstacles to the ultimate goal: same-day settlement.

http://news.ft.com/ft/gx.cgi/ftc?pagename=View&c=Article&cid=FT3S3BSKEEC&live=true&tagid=ZZZOMSJK30C&subheading=US

-- Martin Thompson (mthom1927@aol.com), October 16, 2000

Answers

With technology as far along as it is there is no reason why one day settlements should not be possible - none that I can see.

-- RogerT (rogerT@c-zone.net), October 16, 2000.

The FT story in this thread is a different version of the same Nandonews report I posted yesterday (Hey Martin, I'm not complaining, just pointing this out--don't often get to "scoop" you!!! Grin).

A clip from that other news story: "The Fed chief, whose agency is a principal regulator of banks, said that shorter time for the completion of stock sales would lower the risk of defaults on any one trade. During times of market volatility when stock prices are plunging, the Fed is always worried that large banks may be vulnerable if investors to whom they have lent money are unable to come up with more collateral for those loans as stock prices plummet... "

My question: isn't this in essence the "Herstadt risk" in banking, which I first became aware of through Gary North's old site? (Named after a bank in Europe that had this problem happen or nearly happen some decades ago, IIRC). Or is that something different?

Cheers, --Andre in southcentral Pennsylvania

-- Andre Weltman (aweltman@state.pa.us), October 17, 2000.

Hey Andre,

I sure don't mind being 'scooped'. For myself I really appreciate your great posts and informed answers. I remember the disussions on the old y2k board about the Herstadt Risk, but it kind of slipped off into the nether land of my brain. I think this could be an example of that situation. Sure wished I has saved some of that stuff. I guess we will just have to wait and see.

Martin

-- Martin Thompson (mthom1927@aol.com), October 17, 2000.

Herstatt Risk to Banks on Y2K

-- spider (spider0@usa.net), October 17, 2000.

Thank you, spider! Very helpful, and very scary.

-- Andre Weltman (aweltman@state.pa.us), October 17, 2000.