On February 15, 2023, the Securities and Exchange Commission (SEC or the Commission) voted to adopt rule changes to shorten the standard settlement cycle for broker-dealer transactions in securities from two business days after the trade date (T+2) to one business day after the trade date (T+1). The Commission believes that the move to T+1 will “promote investor protection, reduce risk, and increase operational and capital efficiency.”1 The Commission also noted in the adopting release that it believes a successful transition to T+1 can be a “useful step in identifying potential paths to T+0 settlement.”2
The final rules become effective on May 5, 2023, but are subject to a transition period. While the amended rules’ exclusion for security-based swaps will become effective on the effective date, broker-dealers will not have to comply with the new rules until May 28, 2024.
Rule 15c6-1(a) establishes the standard settlement cycle for the purchase or sale of a security by a broker-dealer. As amended, the rule now prohibits broker-dealers from entering into a contract for the purchase or sale of a security that provides for payment of funds or delivery of securities later than the first business day after the date of the contract, unless otherwise agreed to by the parties. This prohibition does not apply to exempted securities, government securities, municipal securities, commercial paper, banker’s acceptances or commercial bills. The prohibition also does not apply to security-based swaps, since the SEC amended Rule 15c6-1(b) to exclude them from the requirement, citing the key differences between security-based swaps and other types of securities, including the fact that most security-based swaps specify the timing of contractual obligations for the parties.
Rule 15c6-1(c) establishes the standard settlement cycle for firm commitment offerings for securities that are priced after 4:30 p.m. ET. As amended, the rule now shortens the standard settlement cycle for these offerings from T+4 to T+2. The Commission does not believe that a T+1 settlement is long enough to prevent firm commitment offerings priced after 4:30 p.m. ET from failing to settle on time but believes that a T+2 settlement will provide sufficient time and flexibility for parties to complete documentation and address any other issues that may arise. The Commission also notes that under the current T+4 settlement cycle, most firm commitment offerings settle in T+2.
Rule 15c6-1(d) 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 as specified in Rules 15c6-1(a) and (c). The SEC did not amend this provision of the rule, and also noted that all existing exemptive orders issued pursuant to Rule 15c6-1 will remain in effect.
The move to T+1 could lead to increased costs for broker-dealers as a result of the mismatch in settlement cycles between the United States and foreign markets, since broker-dealers will have to finance that mismatch. Similar issues could exist for ADRs where the underlying foreign securities settle on T+2 while the ADR will now be required to settle on T+1, as will US-listed Exchange-Traded Funds (ETFs) with baskets that contain foreign securities and ADRs. The Commission declined to exempt ADRs and ETFs from Rule 15c6-1(a) in response to these concerns, stating its belief that the move to T+1 will reduce costs in other areas, increase capital efficiency and reduce risk in the clearance and settlement system.
In addition to the amendments to Rule 15c6-1, the SEC adopted new Rule 15c6-2, which requires that, where parties have agreed to engage in an allocation, confirmation or affirmation process, a broker-dealer is prohibited from effecting or entering into a contract for the purchase or sale of a security on behalf of a customer unless the broker-dealer has either (i) entered into a written agreement with the relevant parties that requires that the allocation, confirmation or affirmation, or any combination thereof, be completed as soon as technologically possible and no later than the end of the day on the trade date in such form as necessary to achieve settlement of the transaction, or (ii) established, maintained and enforced 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 the trade date in such form as may be necessary to achieve settlement of the transaction. The rule applies to transactions in securities that are subject to Rule 15c6-1(a). The Commission believes that the move to T+1 requires “significant improvements” in the current rate of same-day affirmations in order to ensure timely settlement in a T+1 environment.
The Commission notes that the term “confirmation” in Rule 15c6-2 refers to “the operational message that includes trade details provided to the broker-dealer by the customer to verify trade information so that a trade can be prepared for settlement on the timeline established in Rule 15c6-1(a).”3 The Commission distinguishes this from confirmation under Rule 10b-10, which concerns disclosures that broker-dealers are required to provide to customers in writing at or before completion of a transaction.
The SEC notes that Rule 15c6-2 will not require that a broker-dealer enter into written agreements with parties that do not have a role in the allocation, confirmation and affirmation process. For example, if a broker-dealer is acting as an executing broker on behalf of a customer and another broker-dealer will act as a clearing broker and take responsibility for completing the allocation, confirmation and affirmation process with the relevant parties to settle the transaction, then the executing broker is subject to Rule 15c6-2 only to the extent that it participates in the allocation, confirmation and affirmation process. An executing broker that does not participate in the process would not face any obligations under Rule 15c6-2.
With respect to the policies and procedures option for compliance, the Commission notes that it believes that “maintaining and enforcing” such policies and procedures means that a broker-dealer “generally should ensure that it has designed its own systems and operations, and deployed sufficient resources to address any potential systemic failures within its own process.”4With respect to enforcing the policies and procedures, the Commission states that a broker-dealer is required to “design its systems and commit the necessary resources to ensure that it can comply with its own policies and procedures.”5 The policies and procedures should, among other things, provide a mechanism for tracking progress over time. The adopting release also provides that when transacting with an investment adviser, a broker-dealer may have policies and procedures to provide that it “generally should seek written assurances from the adviser that its policies and procedures are sufficient to ensure compliance with obligations requested by the broker-dealer.”6 A similar suggestion is made regarding where a custodian participates in the allocation, confirmation or affirmation process.
Rule 15c6-2(b) sets out the requirements for the policies and procedures. Among other things, the policies and procedures must describe the procedures that the broker-dealer will follow to ensure the prompt communication of trade information, investigate discrepancies in trade information, and adjust trade information to ensure that the allocation, confirmation and affirmation can be completed by the target time frames on the trade date. The Commission states that this requirement relates to the need for a broker-dealer to ensure that an action fully within its own control does not prevent the completion of the allocation, confirmation or affirmation for a transaction. The rule also requires a broker-dealer to have policies reasonably designed to describe how it will address delays caused by another party. The Commission suggests with respect to this requirement that a broker-dealer should consider including policies and procedures that explain the efforts it would take to resolve recurring problems; this is especially relevant for problems that recur with respect to one particular counterparty, customer or custodian.
The SEC also adopted amendments to Advisers Act Rule 204-2 to require that, in the event an adviser is a party to a contract under Rule 15c6-2, the adviser make and keep records of each confirmation received and of any allocation and each affirmation sent or received. An allocation or affirmation must have a date and time stamp that indicates when it was sent or received. The Commission is not adopting requirements for the time and date stamp format, and the time and date stamp requirement does not apply to confirmations.
Finally, the SEC adopted new Rule 17Ad-27, which will apply to clearing agencies acting as central matching service providers (CMSPs). The rule requires CMSPs to (i) establish, implement, maintain and enforce policies and procedures to facilitate straight-through processing (STP) for transactions at the clearing agency, and (ii) submit to the Commission every 12 months a report that describes the CMSP’s current policies and procedures for facilitating STP, the CMSP’s progress in facilitating STP in the period covered by the report, and the steps the CMSP intends to take to further facilitate and promote STP in the next 12 months.
The rule reflects a move away from manual processing, which the SEC believes will reduce both risk and costs in conjunction with the move to T+1 settlement. The Commission notes that the policies and procedures under this rule should disincentivize the use of manual systems or automated systems that do not facilitate STP, and encourages CMSPs to “consider developing incentives or requirements in their policies and procedures to encourage or compel the use of [standardized settlement instructions].”7The Commission also states that the policies and procedures should establish a timeline for transitioning away from electronic trade confirmation services that impede the development of STP.
