Yesterday, the SEC adopted a number of new rule amendments intended to reduce risks in the clearance and settlement processes. Most significantly for this audience, the changes will reduce the standard settlement cycle for most broker-dealer transactions in securities from T+2 to T+1, that is, from two business days after the trade date to one business day after. According to the press release, the final rule is “designed to benefit investors and reduce the credit, market, and liquidity risks in securities transactions faced by market participants.” The rule changes also shorten the settlement cycle for firm commitment public offerings priced after 4:30 p.m. Eastern Time from T+4 to T+2, unless the parties expressly agree otherwise at the time of the transaction. The final rules will become effective 60 days following publication of the adopting release in the Federal Register; the compliance date is May 28, 2024, which turned out to be the most controversial aspect of the proposal, leading to two dissents. According to SEC Chair Gary Gensler, “[a]s they say, time is money. Halving these settlement cycles will reduce the amount of margin that counterparties need to place with the clearinghouse. This lowers risk in the system and frees up liquidity elsewhere in the market.”
The remaining rule changes, according to the fact sheet, are designed (1) “to improve the processing of institutional trades through new requirements for broker-dealers and registered investment advisers related to same-day affirmations,” and (2) “to facilitate straight-through processing through new requirements applicable to clearing agencies that are central matching service providers (CMSPs).”
But we can’t overlook the other remarks by Gensler, the self-confessed rom-com fanboy: “Yesterday was Valentine’s Day. Thinking about today’s recommendation brings me to that classic 1987 film ‘Moonstruck,’ starring Nicolas Cage and Cher. Cher plays Loretta, whose father is a plumber named Cosmo. In one scene, Cosmo examines a family’s broken pipes, turns to the homeowners, and just shakes his head. There are three kinds of pipe, Cosmo tells them. There’s garbage, which is what they own. There’s bronze, ‘which is very good unless something goes wrong.’ Then there’s the only pipe that Cosmo uses: copper.” Cosmo, he continued, “might say this adoption will take our plumbing from bronze to copper. I say that, taken together, these amendments will make our market plumbing more resilient, timely, orderly, and efficient. ‘Moonstruck’ opens with Dean Martin’s ‘That’s Amore.’ Keeping in the Valentine’s Day theme, one might say this rule brings A-more benefits to investors and markets alike.” Hmmm. Did you hear a groan?
As described in the fact sheet, “[r]educing time between the execution of a securities transaction and its settlement reduces risk, promotes investor protection, and increases operational and capital efficiency. 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 stocks—highlighted potential vulnerabilities in the U.S. securities market that shortening the standard settlement cycle and improving institutional trade processing can mitigate.”
That was a reference to the 2021 meme stock trading frenzy. 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.
It’s worth noting that there were a number of comments advocating that the SEC move to T+0. And, in the adopting release, the SEC recognized “that shortening the settlement cycle further than T+1 could ultimately produce considerable additional benefits to investors compared with shortening the settlement cycle to T+1.” Nevertheless, the SEC “continues to believe that shortening the settlement cycle to T+0 would require the industry to develop solutions to the many challenges identified by market participants as impediments to such a move….Given the operational and technological challenges associated with moving to a T+0 settlement cycle, the Commission believes that a successful move to T+0 would take longer to design and implement, and cost more than, a successful move to a T+1 settlement cycle.” Still, the SEC viewed the transition to a T+1 settlement cycle as a potential “useful step in identifying potential paths to T+0 settlement.” So stay tuned on that one. As Gensler once suggested, could we soon be looking at “T+evening”?
Originally, the SEC had proposed eliminating the T+4 settlement cycle in paragraph (c) for underwritten offerings altogether, with the result that firm commitment offerings would have been subject to a T+1 settlement date generally applicable to most securities transactions. (That change was proposed in light of the availability of “access equals delivery,” which had presumably eliminated the basis for this separate settlement cycle.) However, a 2021 industry report on accelerating the settlement cycle and a comment letter from the Securities Industry and Financial Markets Association, SIFMA, persuaded the SEC otherwise. SIFMA recommended that the separate treatment for firm commitment offerings in paragraph (c) be continued but modified to allow parties to settle on T+2, rather than T+1 or T+4. To SIFMA, “Rule 15c6-1(c) would provide a ‘fallback’ to parties without an explicit agreement at the time of the transaction to settle on T+2 if unforeseen circumstances interfere with either party’s ability to conform to a T+1 settlement date.” SIFMA contended that unanticipated issues, such as problems relating to “transfer agents, legend removal, local law matters (including local court approval), medallion guarantees or non-U.S. parties,” could arise and that a move to T+1 “would lead to increased failures to settle trades with respect to firm commitment underwritings,” given the “limited timeframe that would be available ‘to resolve issues’ prior to settlement on T+1.” Reading these comments, the SEC became convinced that a T+1 settlement cycle was “not long enough to prevent firm commitment offerings priced after 4:30 p.m. ET from failing to settle on time” and amended “paragraph (c) to establish a T+2 settlement cycle for these offerings, rather than deleting paragraph (c) as the Commission proposed.” As the release noted, most firm commitment equity offerings currently settle on a T+2 basis anyway, so the change is unlikely to have a significant impact. The SEC also retained paragraph (d) unchanged, which allows the managing underwriter and the issuer to expressly agree to an alternate settlement date at the time of the transaction. The paragraph was viewed as particularly important for debt and preferred equity offerings.
Commissioner Hester Peirce supported a move to T+1, but disagreed with the timeline for implementation. She thought that May 28, 2024 was too early, but that a three-month delay to September 3 (post-Labor Day) would be much better and agreed to change her dissenting vote to support the rule, but only if that change were made.
Commissioner Caroline Crenshaw favored the rule change, observing that “a shorter settlement cycle should reduce the number of outstanding unsettled trades, reduce clearing agency margin requirements, and allow investors quicker access to their securities and funds. Longer settlement periods, on the other hand, are associated with increased counterparty default risk, market risk, liquidity risk, credit risk, and overall systemic risk.” She also viewed a possible longer term move to T+0 as “both desirable and feasible in the future.” She noted that, in response to concerns raised about the timeline, the final implementation date “was extended by several months from the proposed date to facilitate a smooth transition. The new compliance date would provide market participants more than fifteen months to prepare for the transition.”
Commissioner Mark Uyeda also disagreed with the implementation date and voted against adoption. While he recognized that the rule change would provide many benefits, it could also “potentially increase some operational risks,” including less time to address errors and fraud. Although these risks did “not ultimately weigh against shortening the settlement cycle,…they provide reason for ensuring readiness among market participants. This speaks to the implementation date. Ensuring a smooth transition will take significant investment and systems changes as well as operational and computational testing among broker-dealers, clearing firms, investment advisers, custodians, payment systems, and so on. Detailed planning is required, as is process adjustment, organizational change, and changes in the relationships among market participants.” In his view, the SEC was “in an imprudent rush away from a sensible transition date” and, accordingly, he was “unable to support the final rule.”
Commissioner Jaime Lizárraga supported the rule, contending that it would advance the SEC’s mission and also “help reduce market volatility, foster broad-based capital formation, and strengthen investor protections.” Referencing the meme stock debacle, Lizárraga asserted that the “risks of longer settlement times are not just theoretical. In January 2021, unprecedented price volatility in so-called ‘meme stocks’ challenged many retail investors’ faith in our in financial markets.” The SEC has proposed a number of reforms “to prevent another meme stock-type event from impacting the markets,” he observed, and a move to T+1 “complements these reforms and helps mitigate some of the risks that drove stock price volatility and significant margin calls during the meme stock event.” With regard to the squabble over the implementation date, he noted that DTCC, the “market utility most central to the T+1 transition, recognized May 28, 2024—after the three-day Memorial Day weekend—as a feasible compliance date.” He also advocated that the SEC continue to explore the possibility of moving to T+0.
At the same meeting, the SEC also proposed to amend a rule under the Investment Advisers Act of 1940 “to enhance investor protections relating to advisory client assets.” (See the related fact sheet.) The WSJ suggests it may have wider consequences for crypto.