SEC shortens settlement cycle to T+1: Benefits, risks, T+0, and Canada

The Securities and Exchange Commission has announced rule changes to shorten the standard settlement cycle for most broker-dealer transactions in securities from two business days after the trade date (T+2) to one (T+1).

The final rules aim to benefit investors and reduce the credit, market, and liquidity risks in securities transactions faced by market participants.

The final rules not only shorten the standard settlement cycle, but the final rules will also improve the processing of institutional trades:

• A broker-dealer will be required to either enter into written agreements or establish, maintain, and enforce written policies and procedures reasonably designed to ensure the completion of allocations, confirmations, and affirmations as soon as technologically practicable and no later than the end of trade date.
• Registered investment advisers will be required to make and keep records of the allocations, confirmations, and affirmations for certain securities transactions.
• Central matching service providers will be required to establish, implement, maintain, and enforce new policies and procedures reasonably designed to facilitate straight-through processing. They must also submit an annual report to the Commission that describes and quantifies progress with respect to straight-through processing.

The final rules will become effective 60 days after publication in the Federal Register. The compliance date for the final rules is May 28, 2024.

SEC Chair Gary Gensler commented on the changes:

“First, the amendments will shorten the standard settlement cycle by half, from two business days (“T+2”) to one business day (“T+1”). The amendments also will halve the settlement cycle for trades relating to initial public offerings, from T+4 to T+2. As 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.

“Now, that’s not to say this change will be new; in fact, this change simply brings us back to the T+1 settlement cycle our markets used up until the 1920s. It also aligns with the T+1 cycle used in the $24 trillion Treasury market.

“Second, the amendments will lower the risk of the clearing process associated with allocation, confirmation, and affirmation. Under the adoption, brokers will be required to complete same-day allocation, confirmation, and allocation as soon as technologically practical and no later than the end of the trade date. This will increase resiliency and efficiency in our plumbing. The adoption will allow brokers to achieve these enhancements either through written agreements or through policies and procedures.

“Third, the proposal will require clearinghouses to facilitate the straight-through processing of securities transactions. Straight-through processing refers to the process for automating the entire trade process, from execution to clearing and settling. Such automation, benefitting from technological advancements, will make our market plumbing more efficient.

“Today’s adoption addresses one of the four areas the staff recommended the Commission address in response to the meme stock events of 2021. Further, the implementation for these amendments will be set to after Memorial Day weekend (May 28, 2024). This implementation comes more than three years after key industry members first proposed shortening the settlement cycle, and a year and a quarter from now, providing sufficient time in my view for the transition. Further easing the transition, the implementation date will occur during a three-day holiday weekend.”

Industry reacts to T+1 settlement cycle

The whole industry, including regulatory agencies and officials as well as fintechs and market participants, are reacting to the SEC’s decision. Here we cover a few comments.

David Smith, Managing Director and Capital Markets Practice Lead at Broadridge, said: 

“It’s not surprising the SEC didn’t want to delay achieving the benefits of T+1 much further than the original proposal date of March 2024. Those in the US who were planning for a transition date in the second half of 2024, will have to increase their implementation efforts quickly. The final ruling has greater implications for cross border transactions between the US and Canadian marketplace. The earlier T+1 date now intersects with Canada’s own post trade modernization project timeline. If Canada is not able to meet the earlier US timeline, you create a mismatched settlement cycle. Creating a risk between two countries that have been historically frictionless in terms of their settlement process.”

SIFMA and SEC’s Peirce disagree with implementation date of May 2024

“I support the plan to move to T+1, but do not support the proposed timeline for making this change. Shortening the settlement cycle is a way to remove some risk from our markets. Mandating that the change occur in May 2024, however, could pose risks of its own by forcing the transition before market participants are ready. I propose instead a September 3, 2024 implementation date”, said SEC Commissioner Hester Peirce.

Kenneth E. Bentsen, Predisdent and CEO of SIFMA, commented: “The industry strongly supports the transition of securities settlement from T+2 to T+1, and in fact has been working on the project since 2020. As we know from leading the industry effort with our partners at the Investment Company Institute (ICI) and The Depository Trust & Clearing Corporation (DTCC) to move to T+2 in 2017 and T+3 in 1995, shortening the settlement cycle is multi-year effort that involves significant preparation and testing.

“We appreciate the Commission finalizing its rule to provide certainty, but we strongly disagree with the implementation date of May 2024. As we have repeatedly stated for the past two years, the industry needs ample time to execute the transition and doing so following the Labor Day weekend 2024 in coordination with Canada is the optimal date. It is the industry, and not the regulators, who will do the work to shorten the cycle and rushing the implementation for no apparent reason will only add risk when the underlying goal is to mitigate risk.

“SIFMA is, however, pleased that the SEC has supported a ‘policies and procedures’-based approach for SEC Rule 15c6-2, which will provide greater flexibility to both broker-dealers and their customers with respect to the allocation, confirmation, and affirmation process.

“As the industry moves forward in the effort to significantly reduce the current settlement cycle, we would encourage market participants to refer to The T+1 Securities Settlement Industry Implementation Playbook, developed by SIFMA, ICI, and DTCC, together with Deloitte LLP. This guide outlines a detailed approach to identifying the implementation activities, timelines, dependencies, and risk impacts that market participants should consider as they prepare for the transition to T+1 settlement.”

T+0 both desirable and feasible in the future

SEC Commissioner Caroline A. Crenshaw said: “Some commenters raised concerns regarding the proposed changes related to the processing of institutional trades, firm commitment offerings, and security-based swaps, and the final rule reflects certain changes from the proposal in response to those comments. A number of commenters also raised concerns about the implementation timeline, which has been 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.

“The proposal also included a request for comment on the possibility of settling trades by the end of the trade date, or what we call “T+0.” Some commenters highlighted challenges relating to multi-lateral netting, securities lending practices, and other issues. However, many others expressed support for an eventual move to T+0. While it is clear that T+0 will entail greater operational and technological challenges than the move to T+1, I agree with commenters that such a move may be both desirable and feasible in the future, and I look forward to working with my colleagues and stakeholders toward that important goal.

T + 1 can potentially increase some operational risks

SEC Commissioner Mark T. Uyeda noted the potential operational risks arising from the change to the T+1 settlement cycle.

“There will be less time to address errors within the process and, in some circumstances, less time to deal with trading entities that are suddenly confronting massive and unexpected trading losses within the settlement cycle timeframe. There is also less time for regulators to identify and freeze the potential proceeds from potential frauds, such as, insider trading and market manipulation, before those proceeds exit our jurisdiction. These arguments and considerations, however, do not ultimately weigh against shortening the settlement cycle, but 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. There is asymmetry in terms of costs and benefits—a smooth transition would provide net benefits for investors and U.S. markets to be accrued over the long-term in the future. On the other hand, the downside of a rough, turbulent transition could be steep, and could induce substantial harm in the short-run. That asymmetry cautions us to provide sufficient time to ensure a smooth transition.”