Reducing settlement time - where to draw the line?

 

PRESS RELEASE

Reducing settlement time - where to draw the line?

London, 22 May 2024 – The World Federation of Exchanges (WFE), the global industry association for exchanges and CCPs, has published novel research today that warns of the risks of adopting technologies without trusted third party oversight, such as permissionless Distributed Ledger Technology (DLT), that radically reduce settlement time at the cost of market quality. 

The research finds that:

• When adopting Bitcoin blockchain the cost of making a trade increases, and the price reaction to a trade is intensified. For example, a one-minute increase in settlement latency leads to a 1.3% increase in transaction cost and a 1.5% increase in price impact.
• This increase isn’t a rare event, and some of our findings showed that settlement latency can easily vary by over 3 minutes, equating to a 3.9% increase in transaction costs and a 4.5% increase in price impact.
• When there is uncertainty, informed traders will find it more difficult to execute their trading strategies and therefore pricing is less efficient.

 

Inherent latency in DLT settlement introduces uncertainty into the settlement process due to factors such as overall mining capacity, which affects block validation speed. The WFE finds that this uncertainty discourages investor participation, resulting in a deterioration of liquidity and an increase in transaction costs. 

The policy implications are substantial, especially in shaping the market design of cryptocurrency infrastructure and, more broadly, for exchanges that are considering different methods of speeding up trading time. DLT, with its promise of decentralized and swift settlement cycles, comes at the cost of introducing uncertainty due to the unpredictable nature of settlement time, which has negative implications for the investors trading on that venue. 

Policymakers and market operators, from regulated exchanges to crypto platforms, should carefully consider this trade-off between near-instant settlement and market quality before introducing DLT. The research reinforces the important role of CCPs and CSDs in overseeing and guaranteeing the settlement process and reducing uncertainty in the timing of settlement. Markets with less uncertainty have increased liquidity and lower trading costs.

Pedro Gurrola-Perez, Head of Research at the World Federation of Exchanges commented, “Whilst much of the finance industry has been focused on how to reduce settlement time, our research – looking at the extreme case – demonstrates the important place CCPs and CSDs have in the process, and the trade-offs that would need to be made if their roles were removed in favour of speed.”

Kaitao Lin, Senior Financial Economist at the World Federation of Exchanges commented, “Implementing DLT in settlement processes presents a dual-edged impact. Our research reveals a trade-off between near-instantaneous settlement and liquidity. Without trusted entity oversight, DLT introduces uncertainty which impedes liquidity. Policymakers must weigh these trade-offs and balance their impacts on different market participants.”

The full paper, The effect of DLT settlement latency on market liquidity, can be found here.

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About the World Federation of Exchanges (WFE)

Established in 1961, the WFE is the global industry association for exchanges and clearing houses. Headquartered in London, it represents over 250 market infrastructure providers, including standalone CCPs that are not part of exchange groups. Of our members, 36% are in Asia-Pacific, 43% in EMEA and 21% in the Americas. WFE’s 87 member CCPs and clearing services collectively ensure that risk takers post some $1.3 trillion (equivalent) of resources to back their positions, in the form of initial margin and default fund requirements. The exchanges covered by WFE data are home to 55,000 listed companies, and the market capitalization of these entities is over $111 trillion; around $124 trillion (EOB) in trading annually passes through WFE members (at end 2023).

The WFE is the definitive source for exchange-traded statistics and publishes over 350 market data indicators. Its free statistics database stretches back more than 40 years and provides information and insight into developments on global exchanges. The WFE works with standard-setters, policy makers, regulators, and government organisations around the world to support and promote the development of fair, transparent, stable and efficient markets. The WFE shares regulatory authorities’ goals of ensuring the safety and soundness of the global financial system.

With extensive experience of developing and enforcing high standards of conduct, the WFE and its members support an orderly, secure, fair and transparent environment for investors; for companies that raise capital; and for all who deal with financial risk. We seek outcomes that maximise the common good, consumer confidence and economic growth. And we engage with policy makers and regulators in an open, collaborative way, reflecting the central, public role that exchanges and CCPs play in a globally integrated financial system.

Click here to view the WFE’s website, sign up for the industry’s Focus magazine or to visit the WFE on LinkedIn. For Twitter see: @TheWFE

Media:

Cally Billimore

Manager, Communications

Email: [email protected]

Phone: +44 7391 204 007

Edelman Smithfield (PR)

Email: [email protected]

Phone: +44 7813 407 665

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