by Cydney Posner
At an open meeting this morning, the SEC voted to propose shortening the standard settlement cycle for most broker-dealer transactions from three business days after the trade date to two business days after the trade date, i.e., T+2. The SEC’s mandatory settlement cycle (Rule 15c6-1) was first established in 1993 and, since that time, there have been numerous developments in technology and processes, in particular, according to SEC Chair Mary Jo White, “further immobilization and dematerialization of securities, and enhanced institutional trade matching utilities, that have laid the foundation for a shorter settlement cycle.” Notably, the UK and a significant number of European countries already use T+2. The commissioners believe that shortening the cycle will reduce credit, market and liquidity risk exposure, encourage greater efficiency in the clearance and settlement process, and reduce systemic risk. Although it was acknowledged that even the current proposal will require a significant undertaking, the proposing release also requests comment on alternatively migrating to T+1 or T+0. Here is the SEC’s press release and the proposing release.
SideBar: Notably, the SEC’s Investor Advisory Committee has “strongly” recommended the implementation of a T+1 settlement period at least for U.S. securities as soon as possible: “The compelling justification for reducing the settlement period is to reduce the overall level of systemic risk in the financial system. Each day a purchaser of securities owes a seller money, the seller is exposed to the credit risk of the purchaser. In volatile periods when the market price of securities may change rapidly, the ability of a seller to recoup losses from a failed sale becomes more uncertain. Reducing the number of days of credit, liquidity, and counterparty risk in the system greatly benefits market participants collectively and the overall financial system generally, as well as investors that utilize the services of intermediaries or that are exposed to counterparty risk directly. These risks materializing in volatile times can become a serious contagion resulting in potentially enormous overall and systemic risk. Mitigating that risk should be a very high priority of the Commission. We have seen the results of this risk and fear of contagion at the beginning of the recent Great Recession – we believe there is no reason for letting it recur.”
At the same meeting, the SEC also adopted rules to establish enhanced standards for the operation and governance of covered clearing agencies pursuant to Section 17A of the Exchange Act and Title VIII of Dodd-Frank and proposed changes to the definition of “Covered Clearing Agency” in Rule 17Ad-22. Clearing agencies manage the “back office” processes for clearing securities transactions. Here is the SEC’s press release, the final release and proposing release.
As explained by Commissioner Kara Stein, during the financial crisis of 2008,
“financial markets seized up as firms sought to minimize their counterparty risk exposure. In response to this crisis, Congress… passed [Dodd-Frank,] Title VII and VIII of [which] were designed to improve and enhance our markets’ clearance and settlement systems. To address concerns about counterparty risk, these two sections of the Act sought to increase the use and effectiveness of clearing agencies that stand in the middle of financial transactions. However, while clearing agencies can help mitigate concerns about the solvency of individual counterparties, they can also potentially concentrate risk. As a result, Congress directed in Title VII that the Commission establish standards for security-based swap clearing agencies. And Title VIII directed the Commission to adopt risk management standards governing systemically important clearing agencies. Much like building codes, these standards are supposed to prevent or mitigate the spread of a fire. Congress did not want clearing agencies to be nodes of risk that could cause a new financial conflagration.”
Although she supported the rules, she viewed them as only marginal improvements that “simply fall short. There is too much wiggle room.”
According to Chair White, the proposal would “require covered clearing agencies to establish comprehensive policies and procedures related to governance and comprehensive risk management, with specific requirements addressing, among other things, the management of financial, liquidity, credit, operational, and general business risks [and] will render [the clearing agencies] better able to withstand adverse events that may arise in stressed market conditions.” She believes the changes will represent “robust enhancements,” noting that there are many more arrows in the SEC’s supervisory quiver, such as review of any changes submitted by the clearing agencies (as SROs) to the SEC and regular supervisory reviews and examinations.
In his statement at the open meeting, Commissioner Michael Piwowar indicated that one of the things that keeps him awake at night is the “current state of central counterparty clearing agency (“CCP”) regulation,” which he believes have, under Dodd-Frank, “become an entirely new class of too-big-to-fail entities with the power to bring down the entire financial system.” Although he approved the rules adopted and proposed as the best approach currently available, he observed that “this entire effort has the eerie feeling of re-arranging deck chairs on the Titanic.”