At an open meeting yesterday morning, the SEC voted unanimously to propose shortening of the standard settlement cycle for most securities transactions from T+2 to T+1. The press release can be found here, the fact sheet here and the proposing release here. According to SEC Chair Gary Gensler, “[t]hese proposed amendments to the securities clearing and settling process, if adopted, could lower risk to the financial system and drive greater efficiencies in the markets….First, these amendments would shorten the standard settlement cycle. As the old saying goes, time is money. Shortening the settlement cycle should reduce the amount of margin that counterparties would need to post with clearinghouses. Second, these changes would require affirmations, confirmations, and allocations to take place as soon as technologically practicable on trade date (‘T+0’). Finally, the release would require clearing agencies that provide central matching services to have policies and procedures to facilitate straight-through processing—i.e., fully automated transactions processing.” The public comment period—using a new format following complaints that the comment period was too short—will be open for 60 days following publication of the proposing release on the SEC’s website or 30 days following publication in the Federal Register, whichever period is longer.
The SEC also took up a couple of other matters at the meeting, from the Division of Investment Management, related to fund advisors and investment managers. One proposal related to cybersecurity risk management for funds and advisors, including required disclosure of cybersecurity risks and incidents as well as confidential reporting of incidents to the SEC. (A taste of the future on the corporate side?) Here is the fact sheet. Another item originally included was a proposal to amend the whistleblower rules, but that was subsequently removed from the agenda altogether.
Why shorten the settlement cycle? The proposal was designed to “reduce the credit, market, and liquidity risks in securities transactions faced by market participants and U.S. investors.” It’s been reported that the proposal was intended to address some of the effects of market volatility emanating from the pandemic and, most prominently, from the meme stock trading frenzy last year. In that episode, the intense volatility of certain meme stocks prompted some retail brokers to restrict trading in the affected stocks. Reuters reported that the volatility “prompted the post-trade clearinghouse that guarantees trades to demand that retail brokerages pay billions of dollars in extra collateral to guarantee trades in case either party defaults. In response, several brokers restricted trading in the affected stocks.” Some have attributed the problem in part to the 2-day timeframe to settle a trade.
Why is that? It all relates to “market plumbing”: as Commissioner Caroline Crenshaw observed in her statement, “[a]s with household plumbing, it’s not highly visible, and when it’s working properly, it doesn’t get a lot of attention. However, it is crucially important to the functioning of our capital markets.” Gensler explained a bit of the history and mechanics in his statement at the meeting: “Clearinghouses—intermediaries that help ensure that buyers and sellers in our markets get their securities or cash—have lowered risk for the public and fostered competition in the securities markets since the late 19th century. Clearinghouses act as the middle counterparty between the buyer and the seller of a securities contract, guaranteeing the obligations of those parties. Clearinghouses value positions on a daily basis and require both parties to post collateral to ensure that there is sufficient cushion in the event that any party defaults.” As Crenshaw explained it, during the recent meme stock volatility, “[c]learing agencies issued margin calls and additional capital charges on broker-dealers to manage the risk associated with the unusual trading activity. Some retail brokers reacted by restricting buying activity by their customers in certain stocks.” Unsettled transactions, she said, “carry risks, and the longer the settlement process, the greater the risks. Longer settlement periods are associated with increased counterparty default risk, market risk, liquidity risk, credit risk and overall systemic risk.”
Accordingly, the SEC is proposing to shorten the settlement cycle to T+1 and is seeking comment on whether, in the future, to consider shortening the cycle to same-day settlement—T+0. According to Gensler, back in the 1920s, there was a one-day settlement cycle, but it was later “extended because messengers were getting too tired to make all their runs on Wall Street in the given time! Over the decades, the length of the settlement cycle has ebbed and flowed….from T+5 to T+3 in 1993 and from T+3 to T+2 in 2017. These changes were made possible by new technologies that made the settling process more efficient.”
As described in the fact sheet, the proposal would:
- “Shorten the standard settlement cycle for securities transactions from two business days after trade date (T+2) to one business day after trade date (T+1);
- Eliminate the separate T+4 settlement cycle for firm commitment offerings priced after 4:30 p.m.;
- Improve the processing of institutional trades by proposing new requirements for broker-dealers and registered investment advisers intended to improve the rate of same-day affirmations; and
- Facilitate straight-through processing by proposing new requirements applicable to clearing agencies that are central matching service providers (CMSPs).”
The proposed change to the T+4 settlement cycle (proposed deletion of Exchange Act Rule 15c6-1(c)) is intended to “promote a uniform approach to the settlement of primary and secondary offerings.” Originally, the T+4 settlement cycle was intended to help “market participants manage prospectus delivery obligations. Since the rule was adopted, the ‘access equals delivery’ standard for most such obligations has eliminated the basis for this separate settlement cycle. Paragraph (d) of Rule 15c6-1 would continue to provide for an extension of the settlement period when necessary.” In addition to changes to the settlement cycle, the proposed rules would “improve the processing of institutional trades by accelerating the confirmation and affirmation of such trades between broker-dealers and their institutional customer.” If the proposal were adopted, the new T+1 settlement cycle would be implemented by March 31, 2024.