F.Ailure-to-Deliver (FTD) occurs when a party fails to meet its end of trading by failing to deliver its shares (or cash) by the settlement day, currently two days after the trade (T + 2).
We recently talked about how Reg SHO rules require it Short seller Locate stocks prior to their short sale (albeit not physically pre-borrowing) so that they can conduct their short sales. But long-term investors can also let trades fail if there is a problem with the assignment of accounts and the posting of trades to custody accounts.
What surprised us: How many trades fail?
Most of the symbols have failed trades
Surprisingly, Data from the SEC shows that 40% of all tickers had stocks that were not delivered every day (chart 1).
Our research shows that errors are very evenly distributed across market capitalization. We have assigned all NMS company stocks to quartiles based on their market capitalization and placed around 1,500 stocks in each basket. Then we looked at how many stocks were on the list of errors in each quartile. The blue quartiles in Figure 1 are very similar, although large cap and microcap fail a little more often than stocks in between.
There are also now well over 2,000 ETFs in the NMS universe, making this bucket bigger than the corporate quintiles. However, the fact that ETFs are more than double the equity quintiles seems to indicate that ETFs fail more often.
Chart 1: 40% of all tickers have stocks that were not delivered on an average day in 2020
It’s not as bad as it looks
Almost half of all symbols feel like a lot. A deeper dive into the data puts this into perspective.
What is important is that failed trades make up a relatively small fraction of the total trade.
Looking at the total number of failing stocks, the total market-wide failing stocks contribute less than 1% of the market-wide traded volume on an average day (Figure 2). The data also shows that the level was relatively constant throughout 2020, although it rose in March last year COVID-19 shutdowns started and some hedge funds closed. It then fell below average during the strong rally that this involved many new private investors.
Chart 2: Failed stocks make up a small fraction of the total market, less than 2% of total consolidated volume
If we take a closer look, we also see that the stocks that default on most tickers are very small.
Almost half of all failed tickers fail on fewer than 1,000 stocks, and many fail on fewer than 100 stocks (blue colors in Figure 2). In fact, 79% of all failed tickers were for fewer than 10,000 stocks, which, while an operational pain, poses no systemic risk.
Of the remaining stocks that fail, only 5% of the failed tickers (i.e. 2% of all tickers) fail for more than 100,000 stocks (Figure 3).
Chart 3: The majority of the symbols show a relatively insignificant number of stocks that are failing
While half of all symbols fail on any given day, the total number of stocks that failed makes up a small fraction of the total market volume. Most errors focus on a few symbols.
Which raises another question.
What kind of tickers are failing?
One thing that seems to lead to increased defaults is high levels of short selling.
We seen some time ago that only very few tickers have short-term interest on more than 25% of the shares issued (SI / SO). However, if these businesses fail to set up, they typically fail on much larger volumes (and often on consecutive days as well). These symbols have an average default of 26,000 stocks compared to 2,000 and 1,000 failed stocks for stocks that are moderately and infrequently shorted, respectively (Figure 4).
Diagram 4: Symbols with a strong brief interest tend to fail with larger dimensions
Do stocks or ETFs or stocks fail anymore?
In addition to the rules for finding stocks, there are buy-in rules for traders who are out for several days.
From the data we can see several tickers that fail for more than five days in a row in 2020. However, we don’t know if it’s the same person failing to deliver or a series of different trades.
What we find is that ETFs tend to fail on more days each year, and also on more continuous days per year. However, this is likely due to the time liquidity providers need Build baskets Complete creations for getting ETF shares for settlement can be more complicated.
Figure 5: ETFs tend to fail more often, but not necessarily continuously or by the same person
What does it all mean?
Overall, stocks that don’t deliver make up a relatively small fraction of the overall market.
Although most stocks appear on the fail list frequently, they are mostly small amounts of stocks that may be the result of technical or processing errors.
The few symbols with a significant number of failed portions make up most of the volume of failure on any given day. Usually, however, these tickers don’t last long due to buy-in rules because they don’t fail for long.
In short, while errors are common, they are usually very small and usually short-lived. They don’t seem to pose a systemic risk – as the rules suggest.