On February 15, 2023, the SEC adopted several changes to shorten the standard settlement cycle for securities transactions to T+1 effective May 28, 2024:
The final rule can be found at the SEC website: “Shortening the Securities Transaction Settlement Cycle”.
With a view to protect investors, reduce risk, and increase operational efficiency, the SEC has continually over the last three decades made efforts to shorten the standard settlement cycle for transactions in securities, most recently in 2017, which resulted in today’s T+2 settlement cycle.
The SEC believes that a further shortening of the settlement cycle would promote investor protection, reduce risk, and increase operational efficiency. The agency’s view has been informed by two recent episodes of increased market volatility—in March 2020 following the outbreak of the COVID-19 pandemic, and in January 2021 following heightened interest in certain “meme” stocks. The SEC believes that these episodes highlighted potential vulnerabilities in the U.S. securities market that shortening the standard settlement cycle could help mitigate.
Rule 15c6-1(a) currently requires the standard settlement cycle for most broker-dealer transactions in securities to settle within two business days after the trade date (T+2), unless otherwise expressly agreed by the parties at the time of the transaction.
Amended Rule 15c6-1(a) will require most broker-dealer transactions in securities to settle within one business day after the trade date (T+1), unless otherwise expressly agreed by the parties at the time of the transaction. However, transactions involving an exempted security, a government security, a municipal security, commercial paper, bankers’ acceptances or commercial bills will remain exempt from the amended
Rule 15c6-1(a). In addition, under amended Rule 15c6-1(b), security-based swaps, non-listed limited partnership interests and other securities by SEC order will also be exempt from the standard settlement cycle.
Rule 15c6-1(c) currently permits firm commitment underwritten offerings priced after
4:30 p.m. ET to settle with a longer T+4 settlement cycle. Today’s SEC’s changes will amend Rule 15c6-1(c) to shorten the standard settlement cycle for these offerings from T+4 to T+2, including most equity and equity-linked offerings which typically price after market close.
While the SEC had originally proposed eliminating the longer permitted settlement cycle for firm commitment underwritten offerings altogether, it was persuaded by comments from SIFMA, the trade association for broker-dealers, investment banks and asset managers, that a T+1 standard settlement (and relying on the parties’ express agreement for an extended settlement date) would be insufficient to prevent transactions for securities priced after 4:30 p.m. ET from failing to settle, since it is not unusual to face unanticipated issues relating to transfer agents, legend removal, local law matters (including local court approval), medallion guarantees or non-U.S. parties. The SEC noted that most equity offerings already settle on a T+2 basis today, which should limit the practical effects that the shortening of the period under Rule 15c6-1(c) may have on those offerings.
Rule 15c6-1(d) will continue to allow issuers and managing underwriters in firm commitment underwritten offerings to agree to settlement on a timeframe other than T+2 for all securities sold in the offering, and investors in the offering will then be deemed to have expressly agreed to that other settlement date, unless they have expressly agreed to a different date. We expect that this this override provision will continue to be widely used in offerings of debt securities or preferred stock, which are often more document intensive compared to equity offerings and therefore require a longer time period after pricing to prepare for closing and settlement.
While the use of same-day affirmations is currently best market practice, the SEC believes that regulatory action in the form of new Rule 15c6-2(a) will increase the current rates of same-day affirmations, and improve the accuracy and efficiency of institutional trade processing, because same-day affirmations will require broker-dealers and their institutional customers to review and reconcile trade data earlier in the settlement process—all of which will help ensure timely settlement in a T+1 standard settlement cycle environment.
Under new Rule 15c6-2(a), broker-dealers will be required to either (i) enter into written agreements with the relevant parties (such as investment managers and bank custodians, as agents of a broker-dealer’s customer), or (ii) establish, maintain and enforce written policies and procedures reasonably designed, in each case to ensure completion of allocations, confirmations and affirmations as soon as technologically practicable and no later than the end of the day on trade date.
For a broker-dealer that choses to establish, maintain and enforce written policies and procedures pursuant to new Rule 15c6-2(a), such policies and procedures must follow certain standards and include, among other things, descriptions of the relevant technology systems, operations and processes, and measure the rates of allocations, confirmations, and affirmations completed.
Amended Rule 204-2(a)(7)(iii) under the Investment Advisers Act of 1940 will require advisers to maintain records of each confirmation received, and any allocation and each affirmation sent or received, with a date and time stamp for each allocation and affirmation for transactions subject to new Rule 15c6-2(a). The proposed time and date stamp for these communications will need to indicate when they were sent or received. As with other records required under Rule 204-2(a)(7), advisers are required to keep originals of confirmations, and copies of allocations and affirmations, but may maintain copies of the records electronically, provided that the storage complies with certain conditions.
CMSPs such as DTCC, Clearstream, Euroclear, Bloomberg and SS&C will be required to establish, implement, maintain and enforce reasonably designed policies and procedures to facilitate “straight-through processing” for transactions involving broker-dealers and their customers. Straight-through processing refers to processes that allow for automation of the entire trade process from trade execution through settlement without manual intervention. CMSPs will also need to annually report on its progress in facilitating straight-through processing and related matters.
The amendments and new rules will be effective 60 days after publication in the Federal Register, and compliance with the T+1 standard settlement cycle and the other new or amended rules is required by Tuesday, May 28, 2024 (with the exception of the express exclusion of security-based swaps from the scope of Rule 15c6-1(a), which becomes operational immediately on the effective date).
The SEC chose the May 28, 2024 compliance date because it follows a federal holiday for which both securities markets and banks will be closed, providing market participants with a three-day weekend to facilitate the transition to a T+1 standard settlement cycle. This compliance date is later than the March 31, 2024 compliance date that the SEC had originally proposed, but sooner than the first trading day after Labor Day in September of 2024 for which some industry participants had advocated.
The new rules related to shortening of the settlement cycle to T+1 were adopted by the SEC in a 3-2 vote, with the two dissenting Commissioners generally supporting the changes but preferring a later compliance date to address concerns raised by market participants.
To ensure a smooth transition to a T+1 settlement cycle and the other new or amended rules before May 28, 2024, market participants (including, among others, clearing houses, broker-dealers and investment advisors) will need to start taking action as soon as possible.
The SEC took into account issues raised in the comment process and did not reduce the standard settlement cycle for firm commitment underwritten offerings priced after 4:30 p.m. ET from T+4 to T+1 as initially proposed. Instead, the final rule reflects a slightly longer T+2 settlement. While most equity offerings today settle on a shorter timeframe than the current T+4 rule, shortening the standard settlement cycle for these offerings to T+2 means there will be less time to address unforeseen circumstances. This will require increased focus earlier in the transaction process with respect to preparations for a timely settlement. In addition, this means less time to prepare and file the final prospectus with the SEC. To the extent the market moves to further shortening the typical settlement cycle for equity offerings and align more closely with the new T+1 standard settlement cycle for trades in the secondary market, this will further shorten the preparation time for settlement.
In addition to shortening the standard settlement cycle to T+1, the SEC is expected to continue its efforts to move beyond a T+1 settlement cycle and assess the feasibility of a T+0 settlement cycle (or a netted settlement at the end of the trade date rather than real-time or rolling settlement). While noting challenges to implementing a same-day settlement cycle in the near-term, the SEC believes that a T+0 standard settlement cycle would have similar benefits of market, credit, and liquidity risk reduction that were realized in the shortening of the settlement cycle from T+3 to T+2, and that are expected as a result of moving from a T+2 to a T+1 standard settlement cycle.