Last September, the SEC proposed rules that would shorten the standard settlement period for securities transactions from three business days (T+3) to two business days (T+2). As predicted, the rules have now been finalized in short order and without controversy.
This is the latest, though probably not the last, step in the evolution of trade settlements. Trades actually settled on a T+5 cycle until 1993, when the adoption of Rule 15c6-1 mandated T+3 in an effort 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).
Since then, 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, T+2 (or less) already exists in most European markets, the U.K, Israel, Saudi Arabia and China, while others markets, like Australia, New Zealand, Japan and Canada, are expected to adopt T+2 in the near future.
The SEC actually 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 benefits of moving to a T+2 cycle. Nevertheless, it would be reasonable to expect movement toward shorter trade settlements in the U.S. in the future.
The amended rule
Exchange Act Rule 15c6-1(a) has been amended 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.
The T+2 requirement generally will apply to the same securities transactions currently covered by the T+3 settlement period. The T+2 will not apply to certain specified categories of securities, including, for example, exempted, government and municipal securities.
The shift from T+3 to T+2 will be effective on September 5, 2017, which the SEC noted was sufficient time to plan for, implement and test changes to the various systems, policies and procedures necessary for an orderly transition. One commenter on the proposed rules also helpfully noted that September 5th effectiveness has the advantage of letting everyone work through the Labor Day weekend to deal with last-minute bugs.
Impact on securities offerings
Rule 15c6-1 continues to expressly allow the company and the managing underwriter in a firm commitment underwriting for cash to agree to a settlement period other than T+2, if they prefer. For that reason, underwriters will, no doubt, continue their practice of asking management to confirm its desire to settle the offering within two business days, rather than some other date. (Management may be surprised by this question if it does not realize there is a choice.)
The issue is further complicated by the Rule 15c6-1 requirement for a T+3 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 Thursday (rather than Wednesday) unless otherwise expressly agreed by the company and the managing underwriter (typically reflected in the underwriting agreement).
To avoid last-minute confusion, or worse, it is important to always expressly confirm everyone’s agreement on the answer to two questions:
- What is the settlement period?
- Which day is “T”?
Questions for the staff
The SEC wisely anticipated that the amended rules may generate a lot of questions as traders and companies prepare for the new settlement cycle. Therefore, it has established a separate email address for submitting inquires to the staff: T2settlement@sec.gov.