New SEC Rules and Amendments Shorten the Standard Securities Transaction Settlement Cycle to T+1

This alert was also published in Insights, The Corporate & Securities Law Advisor, Volume 37, Number 5.

On February 15, 2023, the U.S. Securities and Exchange Commission (SEC) adopted rules and amendments to shorten the standard settlement cycle for transactions in most securities from two business days after the trade date (T+2) to one business day after the trade date (T+1).[1] The rules and amendments will directly apply to registered broker-dealers and will also impact the trading-related responsibilities of investment advisers registered with the SEC under the Investment Advisers Act of 1940 (Advisers Act). The principal purpose of the new rules is to increase market efficiency and reduce the risk of failed transactions. Compliance with the new rules will require significant adjustments to current business practices by broker-dealers, clearing agencies, and investment advisers. The compliance date is May 28, 2024. 

Background and SEC Goals in the Progression to T+0

On February 9, 2022, the SEC proposed amendments to Rule 15c6-1 and new Rule 15c6-2 under the Securities Exchange Act of 1934, as amended (Exchange Act), to reduce the standard settlement cycle to T+1 for transactions in certain securities.[2] In adopting final rules based substantially on this proposal, the SEC has taken its most recent step in a series of initiatives that have dramatically shortened the standard settlement cycle over the past two decades. 

In 1993, the SEC first shortened the standard settlement cycle under Rule 15c6-1 from T+5 to T+3, and did so again in 2017 from T+3 to T+2. Each amendment came as a response to changes in markets, technology, operations, and infrastructure. In the Adopting Release, the SEC notes that, informed in part by increased market volatility resulting from the COVID-19 pandemic and heightened interest in certain “meme” stocks, the SEC believes that “shortening the settlement cycle from T+2 to T+1 can promote investor protection, reduce risk and increase operational and capital efficiency.” The SEC also asserts in the Adopting Release that it believes that the transition to a T+1 settlement cycle can be a useful step in identifying paths to a T+0 settlement cycle in the future.[3]

The SEC believes that shortening the standard settlement cycle will result in a reduction in the number and total value of unsettled trades that exist at any point in time and decrease the total market value of all unsettled trades in the U.S. clearance and settlement system. This would also reduce a market participant’s overall exposure to market and credit risk arising from open transactions. Further, a shorter settlement cycle aims to reduce central counterparties’ exposure to credit, market, and liquidity risks arising from its obligations to participants. The SEC notes that shortening the settlement cycle to T+1 will enable investors to access the proceeds of their securities transaction sooner than they are able to in the current T+2 environment.

Amendments to Rule 15c6-1 – Standard Settlement Cycle

Rule 15c6-1(a) establishes the standard settlement cycle for the purchase or sale of a security effected by a broker-dealer. As amended, Rule 15c6-1(a) now prohibits broker-dealers 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, banker’s acceptances, or commercial bills) that provides for payment of funds or 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.[4]

The SEC amended Rule 15c6-1(b) to exclude security-based swaps from the T+1 standard settlement cycle under Rule 15c6-1(a), noting the key differences between security-based swaps and other types of securities. Most security-based swap contracts include contract terms that specify the timing of contractual obligations, and, for that reason, there is no need for a rule‑based “default” contract term that provides for the timing of such obligations.

The SEC also amended Rule 15c6-1(c) to shorten the standard settlement cycle for firm commitment offerings for securities that are priced after 4:30 p.m. ET, unless otherwise expressly agreed to by the parties at the time of the transaction. The amendment to Rule 15c6‑1(c) will shorten the standard settlement cycle for those transactions from T+4 to T+2. The SEC proposed to remove paragraph (c) from Rule 15c6-1 based on the belief that the expanded application of the “access equals delivery” standard for prospectus delivery supported such a change, but was persuaded that the standard settlement cycle for such transactions should be shortened to T+2 rather than T+1 to prevent firm commitment offerings priced after 4:30 p.m. ET from failing to settle on time due to unforeseen circumstances at the time of pricing.

The SEC did not amend Rule 15c6-1(d), which enables underwriters and the parties to a transaction to agree, in advance of the transaction, to a settlement cycle other than the standard settlement cycle specified in paragraphs (a) and (c) of Rule 15c6-1. The SEC notes that market participants in firm commitment offerings of certain debt and preferred securities commonly rely on paragraph (d) of Rule 15c6-1 to extend the settlement date for such transactions to allow time for the completion of the extensive documentation associated with those offerings.

The SEC solicited comment regarding its existing exemptive orders issued pursuant to Rule 15c6-1 and determined that the existing exemptive orders will remain in effect without modifications, because no changes are needed to facilitate and orderly transition to a T+1 standard settlement cycle.

New Rule 15c6-2 – Same-Day Affirmation

The SEC adopted new Rule 15c6-2 under the Exchange Act to require that any broker or dealer engaging in the allocation, confirmation, or affirmation process with another party (e.g., an investment adviser or other market participant acting as an agent for the broker or dealer’s customers) to achieve the settlement of a securities transaction that is subject to the requirements of Rule 15c6-1(a) shall take one of the following two actions:

• Enter into a written agreement with the relevant parties to ensure completion of the allocation, confirmation, affirmation, or any combination thereof for the transactions as soon as technologically practicable and no later than the end of the day on trade date in such form as necessary to achieve settlement of the transaction; or
• Establish, maintain, and enforce written policies and procedures reasonably designed to ensure completion of the allocation, confirmation or affirmation, or any combination thereof for the transaction as soon as technologically practicable and no later than the end of the day on trade date in such form as may be necessary to achieve settlement of the transaction.

In providing broker-dealers with discretion to select either of these two options, the Adopting Release affirms that broker-dealers will be able to choose which approach “aligns best with their business practices and customer relationships, and to consider the approach that best enables the broker-dealer to ensure the completion of allocations, confirmations, and affirmations as soon as technologically practicable and no later than the end of the trade date.” Notably, both of these options will necessarily involve the implementation of a coordinated effort by broker-dealers, investment advisers, and other industry participants to achieve same-day deadlines for buy-side functions such as trade allocations among customer accounts, as well as the acceleration of various middle and back-office trade affirmation and reconciliation processes conducted by investment advisers and other institutional investors.

When a broker-dealer elects to pursue the second option noted above, it becomes subject to additional requirements established in paragraph (b) of Rule 15c6-2, which states that, to ensure completion of the allocation, confirmation, affirmation, or any combination thereof for the transaction as soon as technologically practicable and no later than the end of the day on trade date, the reasonably designed written policies and procedures shall:

• Identify and describe any technology systems, operations, and processes that the broker or dealer uses to coordinate with other relevant parties, including investment advisers and custodians, to ensure completion of the allocation, confirmation, or affirmation process for the transaction;
• Set target time frames on trade date for completing the allocation, confirmation, and affirmation for the transaction;
• Describe the procedures that the broker or dealer will follow to ensure the prompt communication of trade information, investigate any discrepancies in trade information, and adjust trade information to help ensure that the allocation, confirmation, and affirmation can be completed by the target time frames on trade date;
• Describe how the broker or dealer plans to identify and address delays if another party, including an investment adviser or a custodian, is not promptly completing the allocation or affirmation for the transaction, or if the broker or dealer experiences delays in promptly completing the confirmation; and
• Measure, monitor, and document the rates of allocations, confirmations, and affirmations completed as soon as technologically practicable and no later than the end of the day on trade date.

The terms “allocation,” “confirmation,” and “affirmation” are not defined in Rule 15c6-2, but the SEC explained in the Proposing Release that “allocation” refers to the process by which an institutional investor (often an investment adviser) allocates a large trade among various client accounts or determines how to apportion securities trades ordered contemporaneously on behalf of multiple funds or non-fund clients. Further, the SEC explained that “confirmation” and “affirmation” refer to the transmission of messages among broker-dealers, institutional investors, and custodian banks to confirm the terms of a trade executed for an institutional investor. The SEC believes that these terms are widely used and generally understood by market participants who engage in institutional trade processing.

When a broker-dealer is considering whether and with which entities to enter into written agreements, the broker-dealer must identify only the relevant party or parties that will have a role or roles in completing the allocation, confirmation, and affirmation process. The SEC notes in the Adopting Release that Rule 15c6-1 does not require a broker-dealer to enter into agreements with parties that do not have a role in the allocation, confirmation, and affirmation process.

The SEC notes in the Adopting Release that it is appropriate to impose obligations on the broker‑dealer under Rule 15c6-2, even though the broker-dealer is only responsible for its own actions and not the actions of others under Rule 15c6-2, because the broker-dealer has the ability, in some circumstances, to modify the conduct of other relevant parties with which the broker‑dealer may participate in the allocation, confirmation, and affirmation process to ensure its own compliance with the rule. Further, the SEC believes that Rule 15c6-2 will incentivize broker‑dealers to identify and deploy effective practices for future allocations, confirmations, and affirmations that will improve the rate of allocations, confirmations, and affirmations over time.

Amendment to Rule 204-2 for Investment Adviser Recordkeeping

Rule 204-2 under the Advisers Act prescribes the books and records that are to be maintained by investment advisers. With the move to T+1 settlement, Rule 204-2(a)(7)(iii), as amended, will now require registered investment advisers to make and keep records regarding any transaction that is subject to the requirements under Rule 15c6-2(a), specifically transactions where a broker‑dealer engages in the allocation, confirmation, or affirmation process with another party or parties to achieve settlement of a securities transaction. The required records include each confirmation received, and any allocation and each affirmation sent or received, with a date and time stamp for each allocation and affirmation that indicates when the allocation and affirmation was sent or received. As with other records required under Rule 204-2(a)(7), advisers will be required to keep originals of written confirmations received and copies of all allocations and affirmations sent or received but may maintain records electronically if they satisfy certain conditions.

The SEC has acknowledged that advisers allocate trades through various means and often rely on internal systems, portfolio management systems, and order management systems for this purpose. The Adopting Release also notes that, in many cases, affirmation is performed by the asset owner’s custodian (or its prime broker) on the asset owner’s behalf (and not directly by the adviser) and that an adviser may rely on a third party to make and keep the required records, although using a third party to make and keep records does not reduce an adviser’s obligations under Rule 204-2. The Adopting Release states that these records will be “important” to SEC’s staff for use in its regulatory and examination program and will be helpful to monitor the transition from T+2 to T+1. Accordingly, advisers should expect the SEC staff to make specific requests for these records during any examination that follows implementation.

Adoption of Rule 17Ad-27 – Requirement for CMSPs to Facilitate Straight-Through Processing

The SEC adopted Rule 17Ad-27(a) under the Exchange Act to require that central matching service providers (CMSPs) establish, implement, maintain, and enforce written policies and procedures reasonably designed to facilitate straight-through processing of securities transactions. The SEC uses the term “straight-through processing” to refer generally to the processes that allow for the automation of the entire trade process from trade execution through settlement without manual intervention. Under Rule 17Ad-27, a CMSP will facilitate straight‑through processing when its policies and procedures enable its users to minimize or eliminate, to the greatest extent that is technologically practicable, the need for manual input of trade details, the manual intervention to resolve errors and exceptions that can prevent the settlement of the trade, or the transmission of messages regarding errors, exceptions, and settlement status information among the parties to a trade and their settlement agents that impede the ability of a CMSP to achieve a straight-through processing environment.

As adopted, Rule 17Ad-27 gives CMSPs flexibility in drafting and adopting their policies and procedures reasonably designed to facilitate straight-through processing of securities transactions. The SEC notes in the Adopting Release certain factors that a CMSP may consider relevant in assessing whether any identified issues can or should be addressed, and, if so, how best to implement those changes. Such factors include:

• The significance of certain obstacles to straight-through processing as it relates to other clearance and settlement functions and objectives, including operational efficiency and operational risk management;
• The frequency and impact of a particular issue; or
• The cost of resolving the issue versus the benefit.

Rule 17Ad-27(b) further requires a CMSP to submit to the SEC an annual report describing its current policies and procedures for straight-through processing, its progress in facilitating straight-through processing during the 12-month period covered by the report, and any steps the CMSP intends to take to promote straight-through processing during the following 12‑month period.

The annual report must include the following five components:

• A summary of the CMSP’s policies and procedures, current as of the last day of the twelve-month period covered by the report;
• A qualitative description of the CMSP’s progress in facilitating straight-through processing during the 12-month period covered by the report;
• A quantitative presentation of data that includes (i) the total number of trades submitted for processing, (ii) the total number of allocations submitted, (iii) the total number of confirmations submitted as well as total number of confirmations canceled by a user, (iv) the percentage of confirmations submitted that are affirmed on trade date, (v) the percentage of allocations and confirmations submitted that are matched and automatically confirmed, and (vi) metrics concerning the use of manual and automated processes by the CMSP’s users;
• The data provided must be (i) organized on a month-by-month basis, beginning with January of each year, (ii) where applicable, separated between the use of the CMSP and electronic trade confirmation services, (iii) separated, as appropriate, by asset class, (iv) separated by type of user, and (v) presented on an anonymized and aggregate basis; and
• A qualitative description of the actions the CMSP intends to take to further facilitate straight-through processing during the following 12-month period.

The report must be filed within 60 days of the end of the 12-month period, which begins on January 1 of the calendar year. Further, it must be submitted using the SEC’s EDGAR filing system and must be tagged using Inline XBRL.

The SEC believes this annual report requirement will enable an assessment of the qualitative and quantitative progress of CMSPs and its users to further straight-through processing efforts, evaluate the need for additional regulatory action, and further its oversight of, and development of, the national clearance and settlement system.

Compliance Dates

The shortened settlement cycle and each of the subsequent adopted rules and amendments will become effective 60 days following the date of publication of the Adopting Release in the Federal Register. Broker-dealers, investment advisers, CMSPs, and investors will need to comply with the new requirements beginning May 28, 2024. Certain industry organizations (e.g., SIFMA and the Investment Company Institute) and one of the SEC Commissioners, while supporting the move to T+1, believe that the compliance date may be overly ambitious and contend that it should be deferred to September 2024. The annual report required of CMSPs under Rule 17Ad-27(b) must be filed within 60 days of the end of the 12-month period covered by the report, therefore it must be filed by no later than March 1, 2025.

[1] Release No. 34-96930, Shortening the Securities Transaction Settlement Cycle (Feb. 15, 2023) (Adopting Release).

[2] Release No. 34-94196, Shortening the Securities Transaction Settlement Cycle (Feb. 9, 2022) (Proposing Release).

[3] In the Proposing Release, the SEC solicited comment on whether shortening the standard settlement cycle to T+1 is a logical step on the path to a T+0 standard settlement cycle, or if a T+1 standard settlement cycle would instead require investments or processes that would be outdated or unnecessary in the T+0 environment. In the Adopting Release, the SEC acknowledged that, while a move to a T+0 standard settlement cycle could “produce considerable additional benefits to investors compared with shortening the settlement cycle to T+1,” shortening the settlement cycle to T+0 would require the industry to develop solutions to several operational and technological challenges, and overcoming those challenges would take longer to design and implement than would be the case with a move to a T+1 standard settlement cycle. The SEC notes in the Adopting Release that market participants have already taken significant steps and made substantial progress in planning for a move to T+1 and that it continues to believe that the transition to a T+1 settlement cycle can be a useful step in identifying paths to a T+0 settlement cycle in the future.

[4] Transactions in Treasury securities already generally settle on a T+1 basis.