The Securities and Exchange Commission this week shortened, by one business day, the standard settlement cycle for most broker-dealer securities transactions.
Currently, the standard settlement cycle for these transactions is three business days, known as T+3. The amended rule shortens the settlement cycle to two business days, T+2.
The amended rule is designed “to enhance efficiency, reduce risk, and ensure a coordinated and expeditious transition by market participants to a shortened standard settlement cycle,” an SEC statement says.
Broker-dealers will be required to comply with the amended rule beginning on Sept. 5, 2017.
The amended Rule 15c6-1(a) would prohibit a broker-dealer from effecting or entering into a contract for the purchase or sale of a security that provides for payment of funds and delivery of securities later than T+2, unless otherwise expressly agreed to by the parties at the time of the transaction. As stated in the rule, the T+2 requirement would not apply to certain categories of securities, such as exempted securities.
Generally, this change would mean that when an investor buys a security, the brokerage firm must receive payment from the investor no later than two business days after the trade is executed. When an investor sells a security, the investor must deliver to the brokerage firm the investor’s security no later than two business days after the sale. For example, if an investor sells shares of a particular stock on Monday, the transaction would settle on Wednesday.
The amended rule would apply the T+2 settlement cycle to the same securities transactions currently covered by the T+3 settlement cycle. These include transactions for stocks, bonds, municipal securities, exchange-traded funds, certain mutual funds, and limited partnerships that trade on an exchange.
To assist broker-dealers, other securities professionals and the investing public in their preparation for the implementation of a T+2 settlement cycle, the Commission has established an e-mail address (T2settlement@sec.gov) for the submission of inquiries to SEC staff.
“Rarely is an issue as commonsensical or broadly supported as this one,” said Acting SEC Chairman Michael Piwowar.
In supporting the amendment, Piwowar couldn’t resist a play on words that any fan of action movies and Arnold Schwarzenegger should appreciate.
“I am pleased that the Commission is now in a position to consider the adoption and implementation of a T+2 settlement cycle, thus terminating a long and overdue process. It is finally time to say hasta la vista to the antiquated T+3 settlement cycle,” he said.
“The financial markets have changed significantly since the Commission adopted Rule 15c6-1 in 1993,” Piwowar added. “New products have emerged, trading volumes have grown, and technology has evolved. In addition, the regulatory community and market participants have increased their respective focus on effectively managing credit, market, and liquidity risk.”
With a T+2 settlement cycle, market participants’ overall exposure to unsettled trades should decrease, as should any attendant credit, market, and liquidity risk, he added. This should improve capital efficiency and enhance the resilience of the national clearance and settlement system.
“It will be incumbent on each broker-dealer, mutual fund, self-regulatory organization, trading venue, clearing agency, transfer agent, and other affected market participant to do its respective part to ensure a collective readiness for a smooth transition to T+2,” Piwowar said.
Commissioner Kara M. Stein provided some historical perspective.
“Over 80 years ago, Wall Street was filled with ‘runners’ who carried stock certificates and other documentation back and forth between brokers and dealers, banks, and others in the securities markets,” she said. Today, advances in technology and communication have transformed the landscape of the securities marketplace. Instead of runners carrying documents, “fiber-optic cables now carry digital signals faster than the blink of an eye.”
While trading is now nearly instantaneous, the final step in the securities settlement process is not, Stein warned, describing the amended rule as “an attempt to catch up with technology developments in the world around us.” “The current settlement cycle standard of three days after a trade is woefully behind the times,” she said. “Currently, standards vary around the globe, but most are moving to shorter settlement cycles…We no longer live in an era where back office functions are handled manually by human beings. We live, work, and transact in a digitalized world.”
Elongated settlement cycles, Stein explained, have also been associated with increased counterparty default risk, market risk, liquidity risk, credit risk and overall systemic risk. Longer settlements may also contribute to inefficiencies in how capital moves from investors to companies.
That said, while movement to a T+2 standard settlement cycle is an improvement from the current T+3 standard, “more can and should be done,” Stein said, describing technological, operational, and communications improvements exist that could enable T+1 and end-of-the-day settlement cycles.
She asked SEC staff to study not only the changes resulting from a movement to a T+2 settlement cycle, but to also consider further improvements. That study is due to the Commission within three years of the compliance date for the rule amendment approved on March 22.