Journal of Financial Market Infrastructures

The trade-off between shorter settlement times and multilateral netting benefits in deferred net settlement

Dennis McLaughlin

  • We find there is no loss of multilateral netting benefits for a settlement window of at least one hour when our model is applied to the US equity markets.
  • The hubs in the system reach their maximum potential netting benefits in about half an hour.
  • Hubs can be expected to achieve 90% of their maximum potential netting benefit in about 10 minutes.
  • The approach also demonstrates the complete loss of multilateral netting benefits as the horizon shortens to arrive at instantaneous settlement and a real-time gross settlement system.

In a deferred net settlement (DNS) system, market participants trade with each other over some predetermined time window and then all trades are netted down at the end of the window through a central clearing function. This process is known as multilateral netting. It is intuitively clear that the longer the time window (also known as the settlement horizon) is, the greater the potential for multilateral netting, as there are more counterparties and trades available to net down. Conversely, the shorter the settlement window, the smaller the potential for multilateral netting. Understanding this trade-off between the length of the settlement horizon and the benefit of multilateral netting is now very important, particularly in light of efforts underway globally to shorten settlement times in securities markets. This paper finds that a priori in the US equity markets, there is no material loss of multilateral netting benefits for a settlement window of at least one hour. This is a surprisingly short time. The same approach can be applied to any deferred netting system.

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