More than half of all U.S. adults have money invested in stocks, mutual funds and/or some form of self-directed retirement account. And they have something else in common. Settlement for most stock purchases and sales takes place three days after the initial trade, a concept known as “T+3” settlement. With more than $15 trillion in the stock market, improving the liquidity of investments is seen by many financial professionals as an essential step toward greater efficiency and reduced risk.
In an interview with PYMNTS’ Karen Webster, Steve Stone, EVP of Operations at United Bank, shared some insights on his recommendation to use a new ACH Standard Entry Class (SEC) and Same Day ACH to provide additional volume for NACHA and a faster, more secure settlement mechanism for the securities industry — an idea that last year won the Judge’s Choice Award at NACHA’s Payments conference and the $15,000 cash prize that came with it.
As described by Stone, T+3 settlement has been the standard for most stock market and mutual fund trades since 1995 when it replaced the T+5 settlement process. As T+3 was being implemented in the early 90s, the concept of using ACH was raised, but there were two problems that, at the time, were insurmountable. Brokers/dealers were concerned about the potential for consumers to exercise their rights under Regulation E to assert that a transaction was unauthorized up to 60 days after its settlement, despite the fact that securities settlement transactions are exempt from Reg. E. Financial institutions, on the other hand, had no ready way to identify securities settlement transactions from other debits that would be subject to Reg. E, and absent Reg E, they had no mechanism to deal with customer allegations of fraud or error.
A Window Of Opportunity
With the securities industry putting the final touches on its planned move to T+2 settlement later in 2017, there seemed to Stone to be an opportunity to update the role of ACH in the securities settlement process.
“NACHA has grown considerably in the past 25 years,” said Stone. “As the NACHA Rules have evolved, so has the concept that the Standard Entry Class can be used to determine how an ACH Entry is handled.” Stone, who has worked with NACHA and ACH processing since 1980, has the historical perspective needed to make such observations. “This is the key difference in the 2016 proposal versus the early 90s version. Back then, there were a handful of SECs — the three letter identifiers used to identify various types of ACH payments — and rules were often based on the type of account that was involved, be it business or consumer. Today, there are 23 Standard Entry Classes, and the NACHA Rules are oriented around them.”
“If we were to create a new SEC for securities settlement transactions, we resolve one of the two problems from the 90s. Financial institutions would have a reliable way to identify transactions exempt from Reg. E, which, in turn, means less risk to the securities industry from consumer allegations of unauthorized transactions.”
But what about the other concern? Stone explained that the securities industry already has established mechanisms for handling customer disputes, so banking and securities professionals simply need to create a mechanism for directing security settlement disputes into those channels. That addresses the concern of financial institutions about dealing with disgruntled customers without creating significant additional work for brokers/dealers. “Add in the potential for same-day settlement on certain transactions to further accelerate the process, and this is truly a win-win scenario. This might even be the first step toward T+1 settlement in the future,” mused Stone.
He said he would like to see such a complementary relationship used as a “catalyst for a dialogue between the banking industry and the securities industry” and noted that “the opportunity is there for us to cooperate in the payments space at a level deeper than we’ve done in the past.”
“It’s time we moved beyond being a utility for money movement and started contributing as a value-added partner.”
Beyond Securities Transactions
Since the 2016 Payments conference, Stone said that his bank has been “enhancing our risk management capabilities associated with ACH processing. We have a growing Third-Party Sender portfolio that we monitor closely, and that has us focused on getting ready for the Third-Party Sender registration rule.”
Thus far, he added, Same Day ACH has proved to be, for United Bank, a relatively low-impact event. “We’ve originated a few files for emergency payroll situations, and we’ve received same-day credits as well. The challenges for us, and I think for most other financial institutions, have been getting the applications that send payments to the ACH system to upgrade their capabilities and understanding the risk implications of Same Day ACH and adjusting accordingly.”
“Financial institutions that avoid or ignore the risk implications of payments changes do so at their own peril. Ways of committing fraud are emerging constantly, and a faster payment system can amplify the potential for loss. Controls that operate after the fact, like looking for an anomalous payment in a batch of processed transactions, might occur too late in the cycle to be effective in a faster payments model.”
As a remedy, he told PYMNTS, “risk management, through enhanced forms of authentication and real-time payment profiling on the front end, must replace some traditional risk tools. We’ve seen this progression in card-based payments, and we’ll need to apply those lessons here as well.”