The Securities and Exchange Commission, on February 15, 2023, adopted amendments to Rule 15c6-1 under the Securities Exchange Act of 1934 to shorten the standard settlement cycle for most broker-dealer securities transactions from two business days following the trade date (T+2) to one business day following the trade date (T+1), and adopted other related amendments affecting how broker-dealers, investment advisers and certain clearing agencies process institutional trades (collectively, Amendments).1 The Amendments are a response to changes in markets, technology, operations and infrastructure since T+2 settlement was implemented in 2017. The Amendments are intended to: reduce credit, market and liquidity risk (thereby reducing systemic risks); and encourage technological development (to further reduce settlement times in the future).
Background
In the 1990s, the SEC determined that significant counterparty risk was created by the then-prevailing T+5 settlement cycle and reasoned that resiliency and efficiency in the clearance and settlement system for securities transactions could be enhanced by reducing settlement time. In 1993, the SEC first acted to establish a mandatory settlement cycle by adopting Rule 15c6-1; this rule shortened the settlement cycle to three business days after the trade date (T+3). In 2017, in response to changes in markets, technology, operations and infrastructure since the T+3 requirement was instituted, the SEC adopted amendments to Rule 15c6-1(a) to shorten the standard settlement cycle for securities transactions by broker-dealers from T+3 to T+2.2 In February 2022, citing the increased market volatility in March 2020 that resulted from the outbreak of COVID-19, and in January 2021 attributed to “meme” stock spikes, the SEC proposed amendments that would shorten the standard settlement cycle to T+1 and improve institutional trade processing to mitigate these vulnerabilities in the securities market (Proposed Amendments).3 On February 15, 2023, the SEC adopted the Amendments, which largely mirror the Proposed Amendments, with certain modifications.
Settlement Cycle Changes
Consistent with the Proposed Amendments, the Amendments reduce Rule 15c6-1(a)’s current T+2 settlement cycle to T+1. Accordingly, amended Rule 15c6-1 will prohibit a broker-dealer from “effecting or entering into a contract for the purchase or sale of a security (other than an exempted security, a government security, a municipal security, commercial paper, bankers’ acceptances, or commercial bills) that provides for payment of funds and delivery of securities later than the first business day after the date of the contract unless otherwise expressly agreed to by the parties at the time of the transaction.” As such, the Amendments will not expand the types of securities subject to T+1 settlement, nor will they eliminate or revise the “override provision” of paragraph (d) of Rule 15c6-1, which permits the parties to a transaction to agree contractually to an alternative settlement date in unusual circumstances. The SEC is also amending paragraph (b) of Rule 15c6-1 to exclude security-based swaps from the requirements of paragraph (a) of the rule. The SEC expressed the view that characteristics of security-based swaps make such transactions inconsistent with the purpose of Rule 15c6-1 because, among other reasons, security-based swap transactions generally include contractual terms that specify timing.4
Finally, the SEC decided to retain paragraph (c) of Rule 15c6-1, but voted to amend it to establish a T+2 settlement cycle for firm commitment offerings priced after 4:30 p.m. ET, which will decrease the current T+4 settlement cycle by two business days. Paragraph (c) originally was adopted to help market participants manage prospectus delivery requirements, however, the SEC noted that the “access equals delivery” standard for prospectuses makes a four business day settlement period no longer necessary, and determined that a T+2 standard would provide sufficient flexibility. In the Adopting Release, the SEC noted that most “firm commitment offering” transactions currently settle on a T+2 basis.
Observing that the 2017 move to a T+2 standard settlement cycle resulted in meaningful improvements in the functions of the securities market, the SEC expressed its expectation that a move to T+1 for most transactions will produce similar results. The SEC acknowledged that despite the expected benefits of the Amendments, there will be technological and operational costs resulting from the settlement-cycle changes.
Same-Day Affirmations
To facilitate the shortened settlement cycle, the SEC also adopted new Rule 15c6-2 under the Exchange Act. Rule 15c6-2(a) will require a broker-dealer who engages in an allocation, confirmation, or affirmation process with another party or parties to facilitate settlement of a securities transaction that is subject to Rule 15c6-1(a) to enter into a written agreement to ensure that allocation, confirmation or affirmation is completed as soon as technologically practicable (and no later than the end of the day on the trade date in order to complete settlement on T+1). Alternatively, new Rule 15c6-2(a)(2) permits broker-dealers, in lieu of written agreements, to establish, maintain, and enforce written policies and procedures reasonably designed to ensure the completion of the allocation, confirmation and affirmation of a transaction as soon as technologically practicable and no later than the end of the day on trade date. As adopted, Rule 15c6-2 differs from the proposal by using the term “relevant parties” in lieu of “customer” with the SEC stating their belief that this language better reflects the market dynamics that currently exist between broker-dealers, their customers, and their customers’ use of advisers, custodians, and other third party agents. As with the Proposed Amendments, the SEC did not include definitions of “allocation,” “confirmation” or “affirmation” in final Rule 15c6-2, pointing to its continued belief that these terms have commonly understood meanings.
As a rationale for adopting the new rule, the SEC explained that the implementation of a T+1 settlement cycle would require “significant improvement in the current rates of same-day affirmations to help ensure timely settlement,” and noted that same-day affirmations accelerate the completion of the trade on the required date. Further, the SEC expressed the view that such affirmations would improve the “accuracy and efficiency of institutional trade processing” by resolving errors more quickly and reducing risks. The SEC stated that the availability of a policies and procedures compliance option will relieve the parties to an institutional contract from the burden of negotiating a written agreement where one does not exist and will enable broker-dealers to comply with the alternative that they believe is best suited to their existing operations. The SEC noted that Rule 15c6-2 is targeted at broker-dealers, because they are the parties that the SEC views as in the best position to ensure such affirmations are completed.
Recordkeeping Rule Amendment for Investment Advisers
In conjunction with shortening the settlement-cycle, the SEC adopted amendments to the recordkeeping requirements of Rule 204-2 under the Investment Advisers Act of 1940. The changes to Rule 204-2 add a requirement in paragraph (a)(7)(iii) for registered investment advisers to create and maintain records of “each confirmation received, and any allocations and each affirmation sent or received” for any contract that is subject to the requirements of Rule 15c6-2(a).
Specifically, the changes to Rule 204-2 will require investment advisers to time-and-date stamp records of all allocations and affirmations as of the time, to the minute, that the allocations and affirmations are sent or received by a broker-dealer. The amendments to Rule 204-2, as adopted, differ from the Proposed Amendments, which would have required investment advisers to make and keep copies of allocations and affirmations sent with a date and time stamp (if applicable). The SEC noted in the Adopting Release that part of the motivation behind the changes to Rule 204-2 stemmed from the SEC’s belief that investment advisers might not maintain such affirmation and allocation records. The SEC believes that the changes to Rule 204-2 would assist in the move to the T+1 settlement cycle.
Requirements for Certain Clearing Agencies
The SEC further adopted Rule 17Ad-27 under the Exchange Act, a new rule applicable to clearing agencies that are central matching service providers (CMSPs). Rule 17Ad-27(a) will require a CMSP to create, implement, maintain, and enforce written policies and procedures reasonably designed to facilitate straight-through processing. By adding the terms “reasonably designed” and “written,” the SEC sought to provide clarity regarding its the expectations of the policies that CMSPs are expected to implement. Among other requirements, Rule 17Ad-27(b), as adopted, requires a CMSP to submit annual reports to the SEC that, among other information, describe its current policies and procedures and progress during the prior 12 months to facilitate straight through processing, various quantitative data, and a narrative discussion of the steps it intends to take to facilitate straight-through processing of trades. Pursuant to paragraph (c) of Rule 17Ad-27, a CMSP must file its annual report within 60 days of the end of the twelve-month period covered by its annual report. The SEC affirmed its view that the shortening of the settlement cycle could lead to a rise in the use of CMSPs, and its belief that Rule 17Ad-27 will assist with the efficacy of trade processing. The annual reports will need to be tagged for XBRL and will be made available on EDGAR by the SEC.
Conclusion
The Amendments are a long-awaited step forward in modernizing settlement cycles to reflect technological advances and reduce credit, market, liquidity and overall systemic risks. Nevertheless, in addition to the direct compliance obligations on broker-dealers, and to a lesser extent CMSPs and investments advisers, market participants will want to review their operational and risk controls in light of the move to a T+1 settlement cycle. It also will be important to review account agreements as well as agreements relating to securities lending, repurchase agreements, margin and swaps and other derivatives transactions to make any needed adjustments for mismatched settlement cycles.
The Amendments will become effective May 5, 2023, with a compliance date of May 28, 2024, however, industry participants and at least two commissioners have called for a post-Labor Day 2024 compliance date.
Footnotes
1) Shortening the Securities Transaction Settlement Cycle, 88 Fed. Reg. 13872 (Mar. 6, 2023) (Adopting Release). At times, this Dechert OnPoint tracks the Adopting Release without the use of quotation marks.
2) Securities Transaction Settlement Cycle, 82 Fed. Reg. 15564 (Mar. 29, 2017).
3) Shortening the Securities Transaction Settlement Cycle, 87 Fed. Reg. 10436 (Feb. 24, 2022) (Proposing Release).
4) The SEC’s existing exemptive orders issued pursuant to Rule 15c6-1(b) under the Exchange Act for certain insurance products as well as for foreign securities that do not have facilities for transfer or delivery in the U.S. will remain in effect without modification. See Adopting Release, supra note 1, at 13885; Securities Transactions Settlement, 60 Fed. Reg. 27994, 27995 (May 26, 1995) (granting an exemption from Rule 15c6-1 for certain transactions in foreign securities); Securities Transactions Settlement, 60 Fed. Reg. 30906, 30907 (June 12, 1995) (granting an exemption from Rule 15c6-1 for transactions involving certain insurance contracts).
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