What Is Failed to Deliver?
A "failed to deliver" (FTD) occurs in financial markets when a seller of securities does not deliver the purchased assets to the buyer by the agreed-upon settlement date. This non-delivery can involve a range of financial instruments, but it is most commonly discussed in the context of equities. The concept of failed to deliver is a critical component of [securities settlement] and falls under the broader category of market regulation. When a transaction results in a failed to deliver, it means that one side of the trade has fulfilled its obligation (e.g., the buyer has paid), but the other side (the seller) has not provided the assets.
History and Origin
The concept of "failed to deliver" is as old as organized securities trading itself, emerging from the practical challenges of exchanging money for assets. Historically, physical certificates had to be moved and verified, making delays and failures more common. With the advent of electronic trading and the standardization of settlement cycles, such as T+3 (trade date plus three business days) and more recently T+2, the process became more efficient. However, fails continued to occur.
A significant moment in addressing delivery failures in the U.S. markets was the implementation of Regulation SHO by the Securities and Exchange Commission (SEC) in 2005. This regulation aimed to combat abusive short selling practices that could lead to persistent fails. Regulation SHO introduced "locate" and "close-out" requirements, mandating that broker-dealers must have a reasonable belief that a security can be borrowed and delivered before a short sale can occur, and that persistent failed to deliver positions must be closed out within specific timeframes. The SEC provides detailed information on SEC Regulation SHO.
Key Takeaways
- A failed to deliver occurs when a seller does not provide the promised securities by the settlement date.
- FTDs can result from various reasons, including operational errors, administrative delays, or strategic decisions.
- They are tracked and reported by regulatory bodies, notably the SEC, for transparency.
- Persistent failed to deliver positions can raise concerns about market integrity and efficiency.
- Regulatory frameworks, like Regulation SHO, are in place to mitigate and address failed to deliver issues.
Interpreting the Failed to Deliver
Interpreting failed to deliver data involves understanding that an FTD figure represents the aggregate net balance of shares that were not delivered as of a particular settlement date. It is a cumulative figure that includes both new fails and existing, unresolved fails. Higher numbers of failed to deliver for a particular security can sometimes signal underlying issues, such as difficulty in borrowing the shares, or can be a byproduct of complex trading strategies, including certain types of market makers activities.
While FTD data is publicly available, it's important to note that a failed to deliver does not automatically imply illicit activity like "naked" short selling. FTDs can arise from legitimate reasons within the clearinghouse and settlement process, such as administrative delays or technical glitches. Market participants often rely on central utilities like the Depository Trust & Clearing Corporation (DTCC), which provides essential services for the clearing and settlement of trades. Understanding how transactions are processed through institutions like those described in the DTCC Learning Center helps clarify the environment in which FTDs occur.
Hypothetical Example
Imagine an investor, Sarah, sells 1,000 shares of XYZ Corp. stock on Monday. The current settlement cycle for equities in her market is T+2, meaning the trade is expected to settle two business days after the trade date, which would be Wednesday. On Wednesday, the buyer's broker-dealer is ready to receive the shares, and the buyer's account has been debited. However, Sarah's own broker, due to an internal system error, fails to deliver the 1,000 shares to the buyer's broker by the end of Wednesday.
At the close of business on Wednesday, this transaction would be recorded as a "failed to deliver." Sarah's broker now has a failed to deliver position for 1,000 shares of XYZ Corp. They must work to resolve this, which might involve borrowing shares or executing a buy-in to acquire the necessary shares to complete the delivery to the buyer. Until the shares are delivered, the transaction remains an outstanding FTD, affecting the overall order flow and settlement efficiency.
Practical Applications
Failed to deliver data is a key metric in assessing market efficiency and can be relevant in several areas:
- Market Surveillance: Regulators and exchanges monitor FTD data to identify potential systemic issues, instances of abusive trading practices, or unusual activity in specific equities.
- Risk Management: Clearinghouses and broker-dealers manage counterparty risk associated with FTDs. They implement procedures like mandatory buy-ins to enforce delivery and mitigate potential losses for the receiving party.
- Academic Research: Economists and financial researchers study failed to deliver patterns to understand market dynamics, the impact of short selling, and implications for liquidity and price discovery. For example, research has explored the relationship between FTDs and specific instruments like Exchange-Traded Funds, investigating whether they stem from "naked short-selling or operational shorting."1
- Investor Awareness: While complex, aggregated FTD data can sometimes provide insights into securities that may be experiencing unusual trading pressures or settlement challenges, particularly for sophisticated participants in capital markets.
Limitations and Criticisms
While necessary for market integrity, the existence of failed to deliver positions and the regulations surrounding them also face limitations and criticisms. One common critique is that some FTDs might arise from "naked" short selling, where shares are sold short without first borrowing them or confirming their availability for borrowing. Critics argue this practice can depress stock prices unfairly or create "phantom" shares. Regulatory efforts like Regulation SHO specifically target such practices.
Moreover, the process of resolving FTDs can be complex and may not always immediately rectify the underlying cause. While regulations aim to prevent persistent failures, the sheer volume of daily trades means FTDs are a continuous operational challenge. Furthermore, a "failure to deliver" can occur in broader contexts beyond securities settlement. For instance, regulatory bodies themselves might be criticized for a "failure to deliver" on their oversight responsibilities, as seen in the Review of the Federal Reserve's Supervision and Regulation of Silicon Valley Bank. Such broader institutional "failures to deliver" highlight the importance of robust financial regulations and vigilant oversight to prevent systemic risk across the financial system.
Failed to Deliver vs. Naked Short Selling
"Failed to deliver" and "naked short selling" are often discussed together and can be confused, but they are distinct concepts.
Failed to Deliver (FTD) is an outcome or a state where a seller has not delivered the securities to the buyer by the settlement date. It can result from various reasons, including operational errors, administrative delays, or a lack of shares available for delivery after a short sale. An FTD is a measurable and reportable event in the settlement process.
Naked Short Selling is a type of short sale where a seller sells shares without first borrowing them or ensuring they can be borrowed, and without having a reasonable belief that they can deliver the shares by the settlement date. If a naked short sale cannot be covered (i.e., the shares are not acquired and delivered by settlement), it will result in a failed to deliver. Therefore, naked short selling is a cause that can lead to an FTD, but not all FTDs are caused by naked short selling. The confusion often arises because naked short selling is a primary reason for strategic or abusive failed to deliver positions, leading to regulatory scrutiny and enforcement.
FAQs
What causes a failed to deliver?
A failed to deliver can be caused by various factors, including clerical errors, technical glitches in trading systems, administrative delays, or simply a seller not having the shares available to deliver by the settlement date. In the context of short selling, it can also occur if a seller is unable to borrow the shares needed to complete the delivery of a short sale.
How are failed to deliver positions resolved?
When a failed to deliver occurs, the responsible broker-dealer is typically required to resolve it by acquiring the shares and delivering them to the buyer. This might involve borrowing shares or initiating a "buy-in," where the clearinghouse or the buyer's broker purchases the shares on the open market at the seller's expense to complete the transaction. Rules like Regulation SHO specify timelines for closing out these positions.
Does a failed to deliver mean someone lost money?
Not necessarily immediately. The buyer who did not receive the shares still holds a claim to them and typically has their funds debited, essentially providing an interest-free loan to the seller for the period of the FTD. However, persistent FTDs can create uncertainty and impact liquidity. The party that fails to deliver may face penalties, fees, or be forced to cover their position at an unfavorable price, especially if a "buy-in" is triggered. This impacts their margin requirements and overall financial standing.
Is failed to deliver common?
Failed to deliver positions occur regularly in financial markets due to the sheer volume and complexity of trading. While individual FTDs are usually resolved quickly, regulators monitor the aggregate numbers and any persistent fails in specific securities to ensure market stability and prevent potential abuses. The data on FTDs is generally made public by regulatory bodies like the SEC.