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(Article from Registered Funds Regulatory Update, July 2022)

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On February 9, 2022, the SEC proposed to shorten the standard settlement cycle for securities transactions from two business days after trade date (“T+2”) to one business day after trade date (“T+1”). Proposed Rule 15c6-2 under the Exchange Act is part of a broader response by the SEC to mitigate systemic vulnerabilities to the financial markets posed by the COVID-19 pandemic along with the “meme” stock trading frenzy that occurred last year. The release also notes that, while not currently proposed, the SEC is “actively assessing” a future movement to a same-day standard settlement cycle (“T+0”). The following highlights the direct impacts to settlements that will result if Rule 15c6-2 is adopted as proposed:

1. The SEC is proposing to reduce the settlement timeline for most broker-dealer transactions from T+2 to T+1.
2. Under the existing rule, firm commitment offerings priced after 4:30 p.m. ET are permitted to be considered as made on the next trading day and then allowed to settle on a three business day (“T+3”) timeline (effectively four business days, or “T+4,” from the time of the trade). The current proposal would now require these offerings to close the next day—shortening what was effectively a settlement cycle of T+4 to T+1.
3. Under what is commonly known as the “override provision,” the existing rule provided for important flexibility allowing for parties to expressly consent at the time of the trade that the settlement date would occur later than T+2. The SEC is not proposing to remove this flexibility, which will still provide an important carve-out for instances that a T+1 settlement would be impracticable. However, the SEC noted that the override provision was intended to apply only to unusual transactions, such as option trades that typically settle 60 days after execution, although in practice, the override provision has been used broadly in debt offerings.
4. Investment advisers that effect block-trades for the accounts of several customers simultaneously have been required to provide post-trade underlying account allocation instructions to the broker or custodian before these transactions are allowed to settle. Certain other transactions, primarily involving institutional trades, require post-trade exchange of confirmations and affirmations, in order for the parties to compare trade details and facilitate settlement with third-party custodians. While these processes are often completed on the trade date, that is not always the case. Under Rule 15c6-2, to facilitate next-day settlement (T+1), all broker-dealers and their institutional customers will now also be required to agree to allocate, confirm, and affirm the trade details by the end of the trade date.
5. The proposal also seeks to amend the books and records rule under the Advisers Act to require advisers who are parties to a contract under Rule 15c6-2 to maintain the records of each confirmation received and any allocation and each affirmation sent. Advisers would be required to keep the original documentation of confirmations along with copies of allocations and affirmations, however, such records are permitted to be maintained electronically if certain conditions are satisfied.
6. In connection with proposed Rule 15c6-2, the SEC has also proposed new Rule 17Ad-27 under the Exchange Act for central matching service providers (“CMSPs”). CMSPs are providers that electronically facilitate communication among a broker-dealer, an institutional investor or its investment adviser, and the institutional investor’s custodian to reach agreement on the details of a securities trade. Rule 15c6-2 would require CMSPs to establish, implement, maintain and enforce policies and procedures to facilitate “straight-through processing” for transactions involving broker-dealers and their customers. Straight-through processing generally refers to processes that allow for the automation of the entire trade process—from trade execution through settlement—without manual intervention. The new proposal would require CMSPs to implement holistic policies and procedures that minimize or eliminate, to the greatest extent technologically feasible, the need for any manual input of trade details or other manual intervention to resolve errors that can prevent delays in trade-settlement.

Shortening the standard settlement cycle to T+1 will also have certain follow-on effects on a number of other rules and market practices that are themselves intertwined with the standard settlement cycle, such as various self-regulatory organization (SRO) requirements and other rules that reference the settlement time period.

While the proposal is a progression of the broader historical push by the SEC towards a shortened settlement cycle, a shift to a next-day settlement cycle under proposed Rule 15c6-2 is likely to impose substantial technological and logistical hurdles for the entire financial and securities industries. Comments on the proposal were due on April 11, 2022.

Shortening the Securities Transaction Settlement Cycle, SEC Release No. 34-94196, available at: https://www.sec.gov/rules/proposed/2022/34-94196.pdf.