At long last, the SEC has proposed amendments to its rules that would shorten the standard settlement period for securities transactions from three business days (T+3) to two business days (T+2).
The change would be accomplished by amending Exchange Act Rule 15c6-1 to prohibit a broker-dealer from entering into a contract for the purchase or sale of a security (subject to certain exceptions) that provides for payment of funds and delivery of securities later than two business days after the trade date (known as “T”), unless otherwise expressly agreed to by the parties at the time of the transaction.
You may recall that trades used to settle on a T+5 cycle until 1993, when the SEC adopted Rule 15c6-1, which mandated T+3 in order to reduce credit risk (the risk that the credit quality of one party to the transaction will deteriorate) and market risk (risk that the value of traded securities will change between trade execution and settlement). But since 1993, the settlement cycle has been stuck on three business days, despite dramatic advances in technology, multiple industry-driven recommendations to shorten the cycle and the adoption of a shorter settlement cycle in almost every other significant non-U.S. trading market. For example, according to the SEC’s release, T+2 (or less) already exists in most European markets, including Germany, France, Ireland, the Netherlands, Sweden and Switzerland, to name a few, as well as in the U.K., Israel, Saudi Arabia, China and many more. Others markets, like Australia, New Zealand, Japan and Canada, are expected to adopt T+2 in the near future.
Impact on securities offerings…
For public companies, the issue of settlement timing often arises in the context of securities offerings. Interestingly, Rule 15c6-1 expressly allows the company and the managing underwriter in a firm commitment underwritten offering for cash to agree to a settlement period other than T+3, if they prefer. This exception from the T+3 mandate usually leads the underwriters to expressly confirm with management the company’s desire to settle the offering within three business days, rather than later. (Management is sometimes surprised by this check-the-box question because it may not realize there is a choice.)
To complicate things further, Rule 15c6-1 also requires a T+4 settlement cycle for firm commitment underwritings that are priced after 4:30 p.m. Eastern time. So, for example, an underwritten offering that prices at 5 p.m. Eastern time on Monday would settle on Friday (rather than Thursday) unless otherwise expressly agreed by the company and the managing underwriter (typically reflected in the underwriting agreement).
This has sometimes led to confusion between companies and underwriters, who tend to use T+3 settlement terminology in all cases and then simply adjust “T” where T+4 would apply. There have been instances when underwriters have assumed that everyone understood that “T” was the following business day for an offering that priced after the market closed when, in fact, the company believed “T” was the day of pricing. To avoid last minute hysteria when the parties ultimately realize they have different closing dates in mind, wise issuer’s counsel will always expressly confirm everyone’s agreement on the answer to two questions: (1) What is the settlement period? and (2) Which day is “T”?
The SEC’s proposal seeks comments regarding how best to handle the special rules and exceptions applicable to firm commitment underwritten offerings, which often involve special due diligence and prospectus delivery challenges that do not exist with typical retail trading.
It is worth noting that the SEC also considered T+1 and T+0 settlement cycles in its deliberations, but rejected them as requiring more extensive changes to technology and post-trade processes that would delay the risk-reduction benefits of moving promptly to a T+2 cycle. The SEC believes that transitioning to a settlement cycle shorter than T+2 would require “near real-time capabilities” that make it impractical at this time. Given, however, that other markets have already moved to shorter settlement cycles, it would be reasonable to expect similar moves in the U.S. somewhere down the road.
In light of widespread industry support for T+2, the SEC’s proposal is likely to be approved quickly and with little controversy. The compliance date for a new rule is still up in the air, though the SEC says it wants to move rapidly while also providing sufficient time for broker-dealers, clearing agencies and other market participants to plan for, implement and test the changes necessary to allow for an orderly transition. Various industry participants have been preparing for such a transition for a while now, and some have proposed compliance dates in late 2017. The SEC says it will consider such a timeline, but has made no promises.
The SEC is currently requesting comments on its proposal within 60 days after it is published in the Federal Register. Expect a final rule shortly thereafter.