# Securities Transaction Settlement Cycle

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/fr%3A2017-06037

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** March 29, 2017
- **Citation:** 82 FR 15564

## Text

SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-80295; File No. S7-22-16]
RIN 3235-AL86
Securities Transaction Settlement Cycle

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

The Securities and Exchange Commission (“Commission”) is adopting an amendment to the Settlement cycle Rule (Rule 15c6-1(a)) under the Securities Exchange Act of 1934 (“Exchange Act”) to shorten the standard settlement cycle for most broker-dealer transactions from three business days after the trade date (“T+3”) to two business days after the trade date (“T+2”).

DATES:

Effective Date:
May 30, 2017.

Compliance Date:
September 5, 2017.

FOR FURTHER INFORMATION CONTACT:

Jeffrey Mooney, Assistant Director; Elizabeth Fitzgerald, Branch Chief; Susan Petersen, Special Counsel; Andrew Shanbrom, Special Counsel; Jesse Capelle, Special Counsel, Office of Market Infrastructure, Office of Clearance and Settlement; and Justin Pica, Senior Policy Advisor, Office of Market Supervision, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-7010, at 202-551-5550.

SUPPLEMENTARY INFORMATION:

The Commission is amending Rule 15c6-1 of the Exchange Act under the Commission's rulemaking authority set forth in Sections 15(c)(6), 17A and 23(a) of the Exchange Act (15 U.S.C. 78o(c)(6), 78q-1, and 78w(a) respectively).

Table of Contents

I. Introduction

II. Background

A. Statutory Framework

B. Regulatory Framework

C. Overview of Market Participants Affected by the Settlement Cycle

1. FMUs

2. Market Participants—Investors, Broker-Dealers, and Custodians

III. Discussion of Amendment to Exchange Act Rule 15C6-1

A. Amendment to Rule 15c6-1

1. Reduction in Risk to CCPs in the Clearance and Settlement Process

2. Reduction in Risk to CCP Members

3. Benefits to Other Market Participants From a Shortened Settlement Cycle

4. Cross-Border Harmonization

5. Reduction in Systemic Risk

6. Leveraging and Advancement of Existing Technology, Operations, and Market Infrastructure

B. Paragraphs (b), (c), and (d) of Rule 15c6-1

C. Impact on Other Commission Rules and Guidance; Relevant No-Action and Exemptive Relief

1. Regulation SHO

2. Financial Responsibility Rules Under the Exchange Act

3. Exchange Act Rule 10b-10

4. Prime-Broker No-Action Letter

5. Prospectus Delivery

D. Exemptive Orders Excluding Certain Products From the Requirements of Rule 15c6-1(a)

IV. Compliance Date

V. Further Reductions in the Settlement Cycle

VI. Economic Analysis

A. Background

B. Baseline

1. Central Counterparties

2. Market Participants—Investors, Broker-Dealers, and Custodians

3. Investment Companies

4. The Current Market for Clearance and Settlement Services

C. Analysis of Benefits, Costs, and Impact on Efficiency, Competition, and Capital Formation

1. Benefits

2. Costs

3. Economic Implications Through Other Commission Rules

4. Effect on Efficiency, Competition, and Capital Formation

5. Quantification of Direct and Indirect Effects of a T+2 Settlement Cycle

D. Consideration of Alternatives

1. Shift to a T+1 Standard Settlement Cycle

2. Straight-Through Processing Requirement

VII. Final Regulatory Flexibility Analysis

A. Need for the Rule

B. Summary of Significant Issues Raised by Public Comment

C. Description and Estimation of Number of Small Entities Subject to the Rule

D. Projected Reporting, Recordkeeping, or Other Compliance Requirements

E. Description of Commission Actions To Minimize Effect on Small Entities

VIII. Statutory Authority

I. Introduction

On September 28, 2016, the Commission proposed an amendment to Exchange Act Rule 15c6-1(a) to shorten the standard settlement cycle from T+3 to T+2.
1

After consideration of the comments received in response to the T+2 Proposing Release, the Commission is adopting the amendment to Rule 15c6-1(a), as proposed.
2

As discussed in greater detail below, the Commission believes that shortening the standard settlement cycle to T+2 at this time will lead to a reduction in credit, market, and liquidity risk, and as a result, a reduction in systemic risk for U.S. market participants.
3

These benefits, as discussed below, will be distributed across the financial system.

1

See
Exchange Act Release No. 78962 (Sep. 28, 2016), 81 FR 69240 (Oct. 5, 2016) (“T+2 Proposing Release”).

2
If any of the provisions of these rules, or the application thereof to any person or circumstance, is held to be invalid, such invalidity shall not affect other provisions or application of such provisions to other persons or circumstances that can be given effect without the invalid provisions or application.

3
Credit risk refers to the risk that the credit quality of one party will deteriorate to the extent that it is unable to fulfill its obligations to its counterparty on settlement date. Market risk refers to the risk that the value of securities bought and sold will change between trade execution and settlement such that the completion of the trade would result in a financial loss. Liquidity risk describes the risk that an entity will be unable to meet financial obligations on time due to an inability to deliver funds or securities in the form required though it may possess sufficient financial resources in other forms. T+2 Proposing Release,
supra
note 1, 81 FR at 69241 n.3.

Specifically, the Commission believes that the shortened standard settlement cycle will reduce certain risks inherent in the clearance and settlement process for all clearing agencies, such as a central counterparty's (“CCP's”)
4

credit, market, and liquidity risk exposure to its members, because there will be fewer unsettled trades and a reduced time period of exposure to such trades.
5

The Commission believes that shortening the standard settlement cycle to T+2 will also result in related reductions in liquidity risks for broker-dealers that are CCP members and, by extension, introducing broker-dealers that clear their trades through CCP members. As a result of the transition to the T+2 standard settlement cycle, a CCP may require less financial resources (
i.e.,
collateral) from its members, and the CCP's members may, in turn, reduce margin charges and other fees that they may pass down to other market participants, including introducing broker-dealers, institutional investors, and retail investors, thereby reducing trading costs. In addition, the Commission believes that a shortened standard settlement cycle will enable market participants to gain quicker access to funds and securities following trade execution, which should further reduce liquidity risks and financing costs incurred by market participants. The Commission also believes that

shortening the standard settlement cycle will more closely align and harmonize the U.S. standard settlement cycle with those foreign markets that have already moved to a shorter settlement cycle. Finally, the Commission believes that shortening the standard settlement cycle will promote technological innovation and changes in market infrastructures and operations that will incentivize market participants to further pursue more operationally and technologically efficient processes, which may lead to further shortening of the standard settlement cycle.

4
As defined in Exchange Act Rule 17Ad-22(a)(2), “CCP means a clearing agency that interposes itself between the counterparties to securities transactions, acting functionally as the buyer to every seller and the seller to every buyer.” 17 CFR 240.17Ad-22(a)(2).

5
Credit and liquidity risk may also be relevant to the functioning of a central securities depository (“CSD”), given that the CSD will rely on incoming payments or deliveries of securities from certain participants to make payments or deliveries to other participants.

The Commission has also considered the costs attendant to shortening the standard settlement cycle to T+2 and believes that the amendment to Rule 15c6-1(a) will yield benefits that justify the associated costs. The Commission also believes that shortening the standard settlement cycle is supported by significant changes in technology, operations, and infrastructure that have occurred in the financial markets since the Commission's adoption of Rule 15c6-1 in 1993, as well as the investments already undertaken by market participants in recent years to support a migration to a T+2 standard settlement cycle.

II. Background

A. Statutory Framework

Congress amended the Exchange Act in 1975 to, among other things, (i) direct the Commission to facilitate the establishment of a national system for the prompt and accurate clearance and settlement of transactions in securities, and (ii) provide the Commission with the authority to regulate those entities critical to the clearance and settlement process.
6

At the same time, Congress provided the Commission with direct rulemaking authority over broker and dealer activity in making settlements, payments, transfers, and deliveries of securities.
7

Taken together, these provisions provide the Commission with the authority to regulate entities that are critical to the national clearance and settlement system.
8

6
15 U.S.C. 78q-1(a)(2)(A);
see also
S. Rep. No. 94-75 (1975),
reprinted
in 1975 U.S.C.C.A.N. 179, 183; Securities and Exchange Commission, Study of Unsafe and Unsound Practices of Brokers and Dealers, H.R. Doc. No. 92-231 (1971); 15 U.S.C. 78q-1(a)(1)(A)-(D) (setting forth the Congressional findings for Section 17A of the Exchange Act). “Clearance and settlement” refers generally to the activities that occur following the execution of a trade. These post-trade processes are critical to ensuring that a buyer receives securities and a seller receives proceeds in accordance with the agreed-upon terms of the trade by settlement date.

7
S. Rep. No. 94-75,
supra
note 6, at 111. Specifically, Section 15(c)(6) of the Exchange Act prohibits broker-dealers from engaging in or inducing securities transactions in contravention of such rules and regulations as the Commission shall prescribe as necessary or appropriate in the public interest and for the protection of investors or to perfect or remove impediments to a national system for the prompt and accurate clearance and settlement of securities transactions, with respect to the time and method of, and the form and format of documents used in connection with, making settlements of and payments for transactions in securities, making transfers and deliveries of securities, and closing accounts. 15 U.S.C. 78o(c)(6).

8

See
15 U.S.C. 78q-1(b)-(c); 15 U.S.C. 78o(c).

.

Congress reaffirmed its view of the importance of a strong clearance and settlement system in 2010 with the enactment of the Payment, Clearing and Settlement Supervision Act (“Clearing Supervision Act”).
9

Specifically, Congress found that the “proper functioning of the financial markets is dependent upon safe and efficient arrangements for the clearing and settlement of payments, securities, and other financial transactions.”
10

Under the Clearing Supervision Act, registered clearing agencies
11

providing CCP and CSD services
12

are financial market utilities (“FMUs”).
13

FMUs centralize clearance and settlement activities and enable market participants to reduce costs, increase operational efficiency, and manage risks more effectively. While an FMU can provide many risk management benefits to market participants, the concentration of clearance and settlement activity at an FMU has the potential to disrupt the securities markets if the FMU does not effectively manage the risk in its activities.
14

9

See
12 U.S.C. 5461-5472.

10
12 U.S.C. 5461(a)(1).

11
Section 17A(b) of the Exchange Act requires any clearing agency performing the functions of a clearing agency with respect to any security (other than an exempted security) to be registered with the Commission, unless the Commission has exempted such entity from the registration requirements. 15 U.S.C. 78q-1(b)(1). The term “clearing agency” is defined broadly to include any person who: (1) Acts as an intermediary in making payments or deliveries or both in connection with transactions in securities; (2) provides facilities for comparison of data respecting the terms of settlement of securities transactions, to reduce the number of settlements of securities transactions, or for the allocation of securities settlement responsibilities; (3) acts as a custodian of securities in connection with a system for the central handling of securities whereby all securities of a particular class or series of any issuer deposited within the system are treated as fungible and may be transferred, loaned, or pledged by bookkeeping entry, without physical delivery of securities certificates (such as a securities depository); or (4) otherwise permits or facilitates the settlement of securities transactions or the hypothecation or lending of securities without physical delivery of securities certificates (such as a securities depository). 15 U.S.C. 78c(a)(23). A clearing agency may provide, among other things, CCP services and CSD services.

12
As defined in Exchange Act Rule 17Ad-22(a)(3), “central securities depository services” means the services of a clearing agency that is a central securities depository as described in Section 3(a)(23)(A) of the Exchange Act (15 U.S.C. 78c(a)(23)(A)). 17 CFR 240.17Ad-22(a)(3).

13
The Clearing Supervision Act defines “financial market utility” or “FMU” as any person that manages or operates a multilateral system for the purpose of transferring, clearing, or settling payments, securities, or other financial transactions among financial institutions or between financial institutions and the person. 12 U.S.C. 5462(6)(A). This definition contains a number of exclusions that include, but are not limited to, certain designated contract markets, registered futures associations, swap or security-based swap data repositories, swap execution facilities, national securities exchanges, alternative trading systems, brokers, dealers, transfer agents, investment companies, and futures commission merchants. 12 U.S.C. 5462(6)(B)(i).

14

See
Standards for Covered Clearing Agencies, Exchange Act Release No. 78961 (Sept. 28, 2016), 81 FR 70786, 70849 (Oct. 13, 2016) (“CCA Standards Adopting Release”);
see also
Risk Management Supervision of Designated Clearing Agencies, Joint Report to Senate Committees on Banking, Housing, and Urban Affairs and Agriculture, Nutrition, and Forestry, and the House Committees on Financial Services and Agriculture, from the Board of Governors of the Federal Reserve System, Securities and Exchange Commission, and Commodity Futures Trading Commission (July 2011), available at
https://www.federalreserve.gov/publications/other-reports/files/risk-management-supervision-report-201107.pdf
.

B. Regulatory Framework

The Commission adopted Exchange Act Rule 15c6-1 in 1993 to establish T+3 as the standard settlement cycle for broker-dealer transactions, and in so doing, effectively shortened the prevailing settlement cycle for most securities transactions (with certain exceptions), which was generally five business days after the trade date (“T+5”).
15

At that time, the Commission cited a number of reasons for standardizing and shortening the settlement cycle, including reducing credit and market risk exposure related to unsettled trades, reducing liquidity risk among derivatives and cash markets, encouraging greater efficiency in the clearance and settlement process, and reducing systemic risk for the U.S. markets.
16

15
Securities Transactions Settlement, Exchange Act Release No. 33023 (Oct. 6, 1993), 58 FR 52891, 52893 (Oct. 13, 1993) (“T+3 Adopting Release”). Rule 15c6-1 of the Exchange Act prohibits broker-dealers from effecting or entering into a contract for the purchase or sale of a security (other than an exempted security, government security, municipal security, commercial paper, bankers' acceptances, or commercial bills) that provides for payment of funds and delivery of securities later than the third business day after the date of the contract unless otherwise expressly agreed to by the parties at the time of the transaction. 17 CFR 240.15c6-1.

16
T+3 Adopting Release,
supra
note 15, 58 FR at 52893.

Since the adoption of Rule 15c6-1, the financial markets have expanded and evolved significantly.
17

Over that time, the Commission has continued to focus on further mitigating and

managing risks in the clearance and settlement process, including risks associated with the U.S. standard settlement cycle. For example, in 2004, the Commission published a concept release
18

seeking comment on, among other things, the benefits and costs of moving to a standard settlement cycle shorter than T+3, and possible methods to help the U.S. securities industry achieve straight-through processing (“STP”).
19

17

See generally
Concept Release on Equity Market Structure, Exchange Act Release No. 61358 (Jan. 14, 2010), 75 FR 3594 (Jan. 21, 2010).

18
Securities Transactions Settlements, Exchange Act Release No. 49405 (Mar. 11, 2004), 69 FR 12922 (Mar. 18, 2004). Specifically, the Commission sought comment on, among other things, (i) the benefits and costs of shortening the settlement cycle to a timeframe less than T+3; (ii) whether the Commission should adopt a new rule or the SROs should be required to amend their existing rules to require the completion of the confirmation/affirmation process on trade date (“T+0”); and (iii) reducing the use of physical securities.

19
The Securities Industry Association (which in 2006 merged with The Bond Markets Association to form the Securities Industry Financial Markets Association) has described STP “as the seamless integration of systems and processes to automate the trade process from end-to-end—trade execution, confirmation, and settlement—without manual intervention or the re-keying of data.” Securities Industry Association, Glossary of Terms,
reprinted in part in
Kyle L. Brandon,
Prime Brokerage: Of Prime Importance to the Securities Industry
(SIA Res. Rep., Vol. VI, No. 4, New York, NY), Apr. 28, 2005, at 25-26,
http://www.sifma.org/WorkArea/linkit.aspx?LinkIdentifier=id&ItemID=21718&libID=5884
.

The Commission's efforts to facilitate further shortening of the standard settlement cycle are consistent with its broader focus on enhancing the resilience and efficiency of the national clearance and settlement system and the role that certain FMUs, particularly CCPs and CSDs, play in concentrating and managing risk.
20

To address these risks, the Commission has used its authority under the Exchange Act, as supplemented by the authority under the Clearing Supervision Act, to promulgate rules designed to, among other things, establish enhanced risk, operational, and governance standards for FMUs registered as clearing agencies with the Commission to help ensure that FMUs under its supervision are subject to sufficiently robust regulatory standards.
21

These entities are also subject to inspections and examinations under both the Exchange Act and the Clearing Supervision Act, and the Commission also monitors these entities to assess and evaluate the risks posed.
22

20

See
Clearing Agency Standards, Exchange Act Release No. 68080 (Oct. 22, 2012), 77 FR 66220 (Nov. 2, 2012) (“Clearing Agency Standards Adopting Release”).

21

See, e.g.,
CCA Standards Adopting Release,
supra
note 14; Clearing Agency Standards Adopting Release,
supra
note 20, 77 FR at 66221-22.

22
CCA Standards Adopting Release,
supra
note 14, 81 FR at 70794.

C. Overview of Market Participants Affected by the Settlement Cycle

The clearance and settlement process for transactions involving securities that currently settle on a T+3 standard settlement cycle involves a number of market participants whose role and functions will be impacted significantly by a change in the standard settlement cycle.
23

As a starting point, there are a number of market participants that operate as financial market infrastructures facilitating the national clearance and settlement system, including two FMUs that provide CCP and CSD services, respectively, and three matching and electronic trade confirmation service providers (collectively “Matching/ETC Providers”).
24

In addition, there is the diverse population of market participants that depend on the clearance and settlement services facilitated by the FMUs and Matching/ETC Providers that also will be affected by the shortened settlement cycle. These market participants include, but are not limited to, institutional and retail investors, broker-dealers, and custodians.

23
This release focuses on securities that currently settle on a T+3 standard settlement cycle. The definition of the term “security” in Section 3(a)(10) of the Exchange Act covers, among others, stocks, corporate bonds, unit investment trusts (“UITs”), mutual funds, exchange-traded funds (“ETFs”), American depository receipts (“ADRs”), and options. 15 U.S.C. 78c(a)(10). Although current Rule 15c6-1 establishes a standard settlement timeframe of no more than T+3, in today's environment certain types of transactions routinely settle on a settlement cycle shorter than T+3, which is permissible under the rule. For example, open-end funds (
i.e.,
mutual funds) generally settle on a T+1 basis, except for certain retail funds which typically settle on T+3, and options generally settle on a settlement cycle less than T+3. Therefore, such transactions that already settle on a shorter settlement cycle will not be impacted by the amendment shortening the standard settlement cycle to T+2.

In addition, Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010), amended, among other things, the definition of “security” under the Exchange Act to encompass security-based swaps. The Commission granted temporary exemptive relief from compliance with certain provisions of the Exchange Act, including Rule 15c6-1, in connection with the revision of the Exchange Act definition of “security” to encompass security-based swaps in July 2011.
See
Order Granting Temporary Exemptions Under the Securities Exchange Act of 1934 In Connection With the Pending Revision of the Definition of “Security” To Encompass Security-Based Swaps, Exchange Act Release No. 64795 (July 1, 2011), 76 FR 39927 (July 7, 2011), and Order Extending Temporary Exemptions Under the Securities Exchange Act of 1934 In Connection With the Revision of the Definition of “Security” To Encompass Security-Based Swaps, Exchange Act Release No. 71485 (Feb. 5, 2014), 79 FR 7731 (Feb. 10, 2014). The Commission then extended the exemption for Rule 15c6-1, along with certain other exemptions, to February 5, 2018.
See
Order Extending Certain Temporary Exemptions under the Securities Exchange Act of 1934 In Connection with the Revision of the Definition of “Security” to Encompass Security-Based Swaps, Exchange Act Release No. 79833 (Jan. 18, 2017), 82 FR 8467 (Jan. 25, 2017).

24

See
Order Granting Exemption from Registration as a Clearing Agency for Global Joint Venture Matching Services-U.S., LLC, Exchange Act Release No. 44188 (Apr. 17, 2001), 66 FR 20494, 20501 (Apr. 23, 2001) (“Omgeo Order”); Order Approving Applications for an Exemption from Registration as a Clearing Agency for Bloomberg STP LLC and SS&C Techs., Inc., Exchange Act Release No. 76514 (Nov. 24, 2015), 80 FR 75388, 75413 (Dec. 1, 2015) (“Bloomberg/SS&C Order”).

1. FMUs

a. CCP

A CCP eliminates bilateral risk between individual counterparties by becoming the buyer to each seller and the seller to each buyer, thereby assuming a central role in ensuring the performance of open contracts and the facilitation of the clearance and settlement of the trade. In the U.S. financial system, NSCC is the only CCP for trades involving securities that currently settle on a T+3 standard settlement cycle.
25

NSCC facilitates the management of risk among its members using a number of tools, which primarily include: (1) Novating and guaranteeing trades to assume the credit risk of the original counterparties; (2) netting to reduce NSCC's overall exposure to its counterparties; and (3) collecting clearing fund contributions from members to help ensure that NSCC has sufficient financial resources in the event that one of the counterparties defaults on its obligations.
26

25
In addition to providing CCP services, NSCC provides a number of other non-CCP services to market participants, including, for example, services that support mutual funds, alternative investments, and insurance products.

26
NSCC's rules provide for several categories of membership with different levels of access to NSCC's services. This release uses the term “member” when referring to an NSCC member that has full access to NSCC's CCP services.
See
NSCC Rules and Procedures, Rule 1 (providing definitions of the various membership categories) (“NSCC Rules and Procedures”),
www.dtcc.com/legal/rule-and-procedures
.

In novation, when a CCP member presents a contract to the CCP for clearing, the original contract between the buyer and seller is discharged and two new contracts are created, one between the CCP and the buyer, and the other between the CCP and the seller. The CCP thereby assumes the original parties' contractual obligations to each other. Historically, NSCC has attached its trade guaranty to its novated transactions at midnight on T+1; however, the Commission recently approved a rule change proposed by NSCC that will accelerate the NSCC trade guaranty from midnight of T+1 to

the point of trade comparison and validation for bilateral submissions, or to the point of trade validation for locked-in submissions.
27

Through novation and the trade guaranty, the two original trading counterparties to the transaction replace their bilateral credit, market, and liquidity risk exposure to each other with risk exposure to NSCC.

27

See
Self-Regulatory Organizations; National Securities Clearing Corporation; Order Granting Approval of Proposed Rule Change to Accelerate its Trade Guaranty, Add New Clearing Fund Components, Enhance its Intraday Risk Management, Provide for Loss Allocation of “Off-the-Market Transactions,” and Make Other Changes, Exchange Act Release No. 79598 (Dec. 19, 2016), 81 FR 94462 (Dec. 23, 2016). NSCC has not yet implemented these rule changes.

Netting is the process of automatically offsetting a member's buy orders of an individual security against its corresponding sell orders for that security, thereby allowing NSCC to reduce the number and value of the transactions that must be cleared between members to settle their trades. Through the use of NSCC's netting and accounting system, the Continuous Net Settlement System (“CNS”), NSCC accepts trades into CNS for clearing from exchanges and other trading venues.
28

It also uses CNS to net each NSCC member's trades in each security traded that day to a single receive or deliver position for such securities.
29

Throughout the day, cash debit and credit data generated by NSCC's members' activities are recorded, and at the end of the processing day, the debits and credits are netted for each security to produce one aggregate cash debit or credit for each member.
30

28
NSCC accepts CNS-eligible securities. To be CNS-eligible, a security must be eligible for book-entry transfer on the books of DTC, and must be capable of being processed in the CNS system. For example, securities may be ineligible for CNS processing due to certain transfer restrictions (
e.g.,
144A securities) or due to the pendency of certain corporate actions.
See
NSCC Rules and Procedures,
supra
note 26, Rules 1 (defining CNS-eligible securities) and 3 (listing CNS-eligible securities).

29
In CNS, compared and recorded transactions in CNS-eligible securities that are scheduled to settle on a common settlement date are netted by specific security issue into one net long (
i.e.,
buy) or net short (
i.e.,
sell) position. CNS then nets those positions further with positions of the same specific security issue that remain open after their originally scheduled settlement date, which are generally referred to as “Fail Positions.” The result of the netting process is a single deliver or receive obligation for each NSCC member for each specific security issue in which the member has activity on a given day.
See
NSCC Rules and Procedures,
supra
note 26, Rule 11 and Procedures VII and X.

30

See
NSCC, Disclosures under the Principles for Financial Market Infrastructures, at 9 (Dec. 2015) (“NSCC PFMI Disclosure Framework”),
http://www.dtcc.com/legal/policy-and-compliance
.

To mitigate default risk, NSCC collects clearing fund deposits from its members to maintain sufficient financial resources in the event a member or members default on their obligations to NSCC.
31

NSCC's rules allow NSCC to adjust and collect additional clearing fund deposits as needed to cover the risks present while a member's trades are unsettled. Each member's required clearing fund deposit is calculated at least once daily pursuant to a formula set forth in NSCC's rules,
32

and is designed to provide sufficient funds to cover NSCC's exposure to the member.
33

31
NSCC's clearing fund is comprised of cash, securities, and letters of credit posted by NSCC members to provide NSCC the necessary resources to cover member defaults. The amount and timing of contributions to the clearing fund are determined pursuant to NSCC's rules.
See
NSCC Rules and Procedures,
supra
note 26, Rules 1 and 4.

32

See
NSCC Rules and Procedures,
supra
note 26, Rule 4 and Procedure XV.

33
Commission Rules 17Ad-22(b)(1) through (4) and 17Ad-22(e)(4) through (6) establish standards for NSCC, as a registered clearing agency that performs CCP services and a covered clearing agency, with respect to its policies and procedures regarding margin and its financial resources. 17 CFR 240.17Ad-22(b)(1)-(4) and (e)(4)-(6).

b. CSDs

A CSD is an entity that holds securities for its participants either in certificated or uncertificated (dematerialized) form so that ownership can be easily transferred through a book entry (rather than the transfer of physical certificates), as well as providing central safekeeping and other asset services. DTC serves as the CSD and securities settlement system
34

for most equity securities and a significant number of debt securities held by U.S. market participants. In its capacity as a CSD, DTC provides custody and book-entry transfer services for the vast majority of securities transactions that are cleared through NSCC. While NSCC provides final settlement instructions to its members each day, the payment for and transfer of securities ownership occurs at DTC.
35

In accordance with its rules, DTC accepts deposits of securities from its participants
36

(primarily broker-dealers and banks), credits those securities to the depositing participants' accounts, and effects book-entry transfer of those securities. The securities deposited with DTC are registered in DTC's nominee name and are held in fungible bulk for the benefit of its participants and their customers.

34
On September 28, 2016, the Commission published a proposal to amend the definition of a covered clearing agency to add registered clearing agencies that perform the services of a securities settlement system.
See
Exchange Act Rel. No. 78962 (Sep. 28, 2016) 81 FR 70744, 70745 (Oct. 13, 2016).

35
At the conclusion of each trading day, CNS short positions (
i.e.,
obligations to deliver) at NSCC are compared against the long positions held in the NSCC members' DTC accounts to determine security availability. If securities are available, they are transferred from the NSCC member's account at DTC to NSCC's account at DTC, to cover the NSCC member's CNS short positions. CNS long positions (
i.e.,
the right to receive securities owed to the participant) are transferred from the NSCC account at DTC to the accounts of NSCC members at DTC. On settlement date, NSCC submits instructions to DTC to deliver (
i.e.,
transfer) securities positions for each security netted though CNS for each NSCC member holding a long position in such securities. Cash obligations are settled through DTC by one net payment for each NSCC member at the end of the settlement day.
See
NSCC PFMI Disclosure Framework,
supra
note 30, at 106.

36
DTC's rules provide for different categories of membership, including “participants.” This release uses the term “participant” when referring to a participant of DTC.
See
Rules, By-Laws, and Organizational Certificate of DTC, Rule 1 (providing definitions of various categories of membership).

DTC substantially reduces the number of physical securities certificates transferred in the U.S. markets by immobilizing securities, which generally means, holding and transferring ownership of securities positions in book-entry form, with DTC's nominee reflected as the registered owner on the issuer's records, and by centralizing and automating securities settlements. DTC thereby significantly improves operational efficiencies and reduces the risks and costs associated with the processing of physical securities certificates.

In addition to a securities account at DTC, each DTC participant has a settlement account at a clearing bank (
e.g.,
custodian) to record any net funds obligation for end-of-day settlement, whether payment will be due to or from the participant. During the day, debits and credits are entered into the participant's settlement account. The debits and credits arise from DVP transfers and from other events or transactions involving the transfer of funds, such as principal and interest payments distributed to a participant or intraday settlement progress payments by a participant to DTC.
37

Debits and credits in the participant's settlement account are netted intraday to calculate, at any time, a net debit balance or net credit balance, resulting in an end-of-day settlement obligation or right to receive payment. DTC nets debit and credit balances for participants who are also members of NSCC to reduce funds transfers for settlement, and acts as settlement agent for NSCC in this process. Settlement payments between DTC and DTC's participants' settlement banks are made through the National

Settlement System of the Federal Reserve System.
38

37
As noted above, a CSD operates a securities settlement system that provides for transfers of securities either free of payment or for payment. When a transfer occurs for payment, typically securities settlement systems provide “delivery versus payment” or “DVP,” whereby the delivery of the security occurs only if payment occurs. The concept of DVP is sometimes referred to as “DVP/RVP.” The term “receive versus payment” or “RVP” is from the perspective of the seller.

38

See
NSCC PFMI Disclosure Framework,
supra
note 30, at 9-10.

DTC also provides certain settlement services for trades by institutional investors (as discussed further in Part II.C.2 below) that are not otherwise cleared through NSCC. In such cases, institutional investors' transactions may be processed on a trade-for-trade basis through a prime broker
39

and settled on an RVP/DVP basis through DTC and the institutional customer's custodial bank.

39
Prime brokers provide a range of centralized services to clients, including, for example, trade execution, custodial services, clearing and settlement services, financing, securities lending, recordkeeping and reporting services, and capital introduction.

c. Matching/ETC Providers—Exempt Clearing Agencies

Matching/ETC Providers electronically facilitate communication among a broker-dealer, an institutional investor, and the institutional investor's custodian to reach agreement on the details of a securities trade.
40

Currently, there are three entities that have obtained exemptions from registration as a clearing agency from the Commission to operate as Matching/ETC Providers.
41

The existing Matching/ETC Providers use two methods, “Matching”
42

and “ETC,”
43

to facilitate agreement on the trade details among the parties. When the parties reach agreement, it is generally referred to as an “affirmed confirmation.”

40
Electronic trade confirmation (“ETC”) was originally developed by DTC in the early 1970s as an alternative to the use of phone, fax, or other manual processes. To facilitate greater use of ETC by market participants to process institutional trades, the Commission approved rule changes filed by several SROs that required the use of ETC for trades involving institutional investors.
See
Exchange Act Release No. 19227 (Nov. 9, 1982), 47 FR 51658, 51664 (Nov. 18, 1982) (order approving confirmation rules for exchanges and securities association).

41
The Commission issued an interpretive release in 1998 concluding that matching constitutes comparison of data respecting the terms of settlement of securities transactions, and therefore an entity that provides matching services as an intermediary between a broker-dealer and an institutional customer is a clearing agency within the meaning of Section 3(a)(23) of the Exchange Act and is, therefore, subject to the registration requirements of Section 17A.
See
Confirmation and Affirmation of Securities Trades, Exchange Act Release No. 39829 (Apr. 6, 1998), 63 FR 17943, 17946 (Apr. 13, 1998); Clearing Agency Standards Adopting Release,
supra
note 20, 77 FR at 66220, 66228 & n.94 (noting the 1998 interpretive release);
see also
15 U.S.C. 78c(a)(23) (defining the term “clearing agency”). The Commission has provided exemptions from registering as a clearing agency to certain entities that operate matching and ETC services.
See
Omgeo Order,
supra
note 24; Bloomberg/SS&C Order,
supra
note 24.

42
Matching is a process by which the Matching/ETC Provider compares and reconciles the broker-dealer's trade details with the institutional investor's allocation instructions to determine whether the two descriptions of the trade agree. If the trade details and institutional investor's allocation instructions match, an affirmed confirmation is generated, which also is used to effect settlement of the trade. As with ETC, transmission of the affirmed confirmations by the Matching/ETC Provider to DTC facilitates automated trade settlement. Bloomberg/SS&C Order,
supra
note 24, 80 FR at 75389.

43
ETC is a process where the Matching/ETC Provider simply provides the communication facilities to enable a broker-dealer and its institutional investor to send messages back and forth that ultimately results in the agreement of the trade details or affirmed confirmation, which is in turn sent to DTC to effect settlement of the trade. Bloomberg/SS&C Order,
supra
note 24, 80 FR at 75389.

2. Market Participants—Investors, Broker-Dealers, and Custodians

As mentioned above, a variety of market participants that depend on the clearance and settlement functions provided by the FMUs and Matching/ETC Providers will be affected by a shortened standard settlement cycle. These market participants include, but are not limited to, institutional and retail investors, broker-dealers, and custodians (
e.g.,
banks).

Institutional investors are entities such as mutual funds, pension funds, hedge funds, bank trust departments, and insurance companies. Transactions involving institutional investors are often more complex than those for and with retail investors due to the volume and size of the transactions, the entities involved in facilitating the execution and settlement of the trade, including Matching/ETC Providers and custodians, and the need to manage certain regulatory or business obligations.
44

44
The distinction between “institutional investor” and “retail investor” is made only for the purpose of noting the manner in which these types of entities generally clear and settle their securities transactions. For the purposes of this release, the term “institutional investor” includes any entity that settles its trades using the facilities of a Matching/ETC Provider, and the term “retail investor” includes entities that do not use the facilities of a Matching/ETC Provider. For more information about the manner in which these entities clear and settle their securities,
see
the T+2 Proposing Release,
supra
note 1, Part II.A.3.

Trades involving retail investors are typically smaller in size than institutional trades, and the settlement of retail investor trades generally occurs directly with the investor's or their intermediary's broker-dealer and does not involve a separate custodian bank. Accordingly, retail investors do not rely upon the involvement of a Matching/ETC Provider to facilitate the settlement of their transactions.

To clear and settle securities transactions directly through a registered clearing agency, the rules of the clearing agencies provide that a broker-dealer or other type of market participant must become a direct member of that clearing agency; such broker-dealers are generally referred to as “clearing broker-dealers.”
45

Clearing broker-dealers must comply with the rules of the clearing agency, including rules relating to operational and financial requirements, such as NSCC's clearing fund deposits mentioned above. In contrast, broker-dealers that submit transactions to a clearing agency through a clearing broker-dealer are generally referred to as “introducing broker-dealers.” In general, broker-dealers executing trades on a registered securities exchange are required by the exchange's rules (as a self-regulatory organization (“SRO”)) to clear those transactions through a registered clearing agency.
46

Broker-dealers executing trades otherwise than on an exchange (
e.g.,
on an internalized basis) may clear and settle such trades through a clearing agency, may choose to settle those trades through mechanisms internal to that broker-dealer, or may settle such trades bilaterally.
47

Broker-

dealers that effect transactions in municipal and corporate debt securities generally are required to clear and settle those transactions through a registered clearing agency.
48

45
Due to the financial and operational obligations of entities submitting trades to a clearing agency, all clearing agencies have established specific requirements for initial membership and ongoing participation in the clearing agency.
See, e.g.,
NSCC Rules and Procedures,
supra
note 26, Rules 2A and 2B (discussing initial and ongoing requirements for membership).

46

See, e.g.,
BATS EDGX Exchange, Inc. Rule 11.13 and NASDAQ Stock Market Rule 4618 (stating that all transactions through the facilities of the exchange shall be cleared and settled through a registered clearing agency using a continuous net settlement system; however, transactions may be settled “ex clearing” provided that both parties to the transaction agree); NYSE Rule 132 (stating that each party to a contract shall submit data regarding its side of the contract to a registered clearing agency for comparison or settlement; however, this requirement does not apply if otherwise stipulated in the bid or offer, otherwise mutually agreed upon by both parties to the contract, or a registered clearing agency refuses to act in the matter).

47

See generally
Financial Industry Regulatory Authority (“FINRA”) Rules 6350A(a) and 6350B(a) (requiring that FINRA members must clear and settle transactions in “designated securities” (
i.e.,
NMS stocks) through the facilities of a registered clearing agency that uses a continuous net settlement system).
See also
FINRA Rule 6274(a) (requiring that FINRA members must clear and settle transactions “effected on” the Alternative Display Facility in ADF-eligible securities (
i.e.,
NMS stocks) that are eligible for net settlement through the facilities of a registered clearing agency that uses a continuous net settlement system). Notwithstanding the requirements in Rules 6350A(a), 6350B(a) and 6274(a), transactions in

designated securities and transactions in ADF-eligible securities may be settled “ex-clearing” provided that both parties to the transaction agree to the same.
See
FINRA Rules 6350A(b), 6350B(b), 6274(b).

48

See
Municipal Securities Rulemaking Board (“MSRB”) Rule G-12(f) (stating that inter-dealer transactions in municipal securities shall be compared through a registered clearing agency); FINRA Rule 11900 (stating that a member or its agent that is a participant in a registered clearing agency, for the purposes of clearing over-the-counter securities transactions, shall use the facilities of a registered clearing agency for the clearance of eligible transactions between members in corporate debt securities).

Custodians handle the electronic payment or receipt of payment through the Federal Reserve's Bank's Fedwire system, which automates and streamlines the process by which broker-dealers make payments for securities transactions. Pursuant to DTC rules, DTC participants are required to select a custodial bank to facilitate payment of their transactions cleared and settled through NSCC and DTC, with a net cash payment facilitated between DTC and the DTC participant's custodial bank account. Since many broker-dealers use the same custodial bank to settle their trades, NSCC and DTC can net the total amount being handled by any one custodian for all DTC participants using that bank.

Often, due to regulatory or business obligations, an institutional investor will not use its executing broker-dealer to custody the institutional investor's securities at DTC, but rather will use a custodian bank for the safekeeping and administration of both their securities and cash.
49

49
Section 17(f) of the Investment Company Act of 1940 (the “Investment Company Act”) and the rules thereunder govern the safekeeping of a registered investment company's assets, and generally provide that a registered investment company must place and maintain its securities and similar instruments only with certain qualified custodians. Section 17(f)(1)(A) of the Investment Company Act permits certain banks to maintain custody of registered investment company assets subject to Commission rules.
See
15 U.S.C. 80a-17(f).

III. Discussion of Amendment to Exchange Act Rule 15c6-1

A. Amendment to Rule 15c6-1

In the T+2 Proposing Release, the Commission proposed to amend Rule 15c6-1(a) to shorten the standard settlement cycle from T+3 to T+2 and articulated several reasons supporting this proposal. The Commission received a number of comment letters in response.
50

As described in Parts III.A.1 through III.A.6 below, commenters generally supported the reasoning in the T+2 Proposing Release for shortening the standard settlement cycle. The comments received are addressed in detail below.

50

See
letters from Michael C. Parker (Sep. 29, 2016) (“Parker”); Eugene W. Guinn (Oct. 14, 2016) (“Guinn”); Sally J. Gellert (Oct. 20, 2016) (“Gellert”); Randy Spydell (Nov. 14, 2016) (“Spydell”); Todd J. May, President, The Securities Transfer Association, Inc. (Nov. 28, 2016) (“STA”); Keith Evans, Executive Director, Canadian Capital Markets Association (Nov. 1, 2016) (“CCMA”); Stephen E. Roth, Sutherland Asbill & Brennan LLP for the Committee of Annuity Insurers (Nov. 29, 2016) (“CAI”); Paul Kim (Dec. 4, 2016) (“Kim”); Greg Babyak, Head, Global Regulatory and Policy Group, Bloomberg L.P. (Dec. 5, 2016) (“Bloomberg”); Mike Nicholas, CEO, Bond Dealers Association (December. 5, 2016) (“BDA”); Micah Hauptman, Financial Services Counsel, Consumer Federation of America (Dec. 5, 2016) (“CFA”); William A. Jacobson, Esq., Clinical Professor of Law, Director, Cornell Securities Law Clinic, and Nandy Millette, and Arjun A. Ajjegowda (“CSLC”); Larry E. Thompson, Vice Chairman & General Counsel, Depository Trust and Clearing Corporation (Dec. 5, 2016) (“DTCC Letter”); Marc. R. Bryant, Senior Vice President, Deputy General Counsel, Fidelity Investments (Dec. 5, 2016) (“Fidelity”); Christopher W. Bok, Financial Information Forum (Dec. 5, 2016) (“FIF”); David T. Bellaire, Esq., Executive Vice President & General Counsel, Financial Services Institute (Dec. 5, 2016) (“FSI”); Richard Foster, Senior Vice President and Senior Counsel for Regulatory and Legal Affairs, Financial Services Roundtable (Dec. 5, 2016) (“FSR”); Martin A. Burns, Chief Industry Operations Officer, Investment Company Institute (Dec. 5, 2016) (“ICI”); Amy B.R. Lancellotta, Managing Director, Independent Directors Council (Dec. 5, 2016) (“IDC”); Stuart J. Kaswell, Executive Vice President & Managing Director, General Counsel, Managed Funds Association (Dec. 5, 2016) (“MFA”); Thomas F. Price, Managing Director, Operations and Technology & BCP, Securities Industry and Financial Markets Association (Dec. 5, 2016) (“SIFMA”); Manisha Kimmel, Chief Regulatory Officer, Wealth Management, Thomson Reuters (Dec. 5, 2016) (“Thomson Reuters”); Robert J. McCarthy, Director of Regulatory Policy, Wells Fargo Advisors (Dec. 5, 2016) (“WFA”); Ryan M. Newill (Dec. 8, 2016) (“Newill”); Jezamine Wee (Dec. 8, 2016) (“Wee”); Gene Finn, Ph.D. (Dec. 21, 2016) (“Finn I”); Gee Finn, Ph.D. (Dec. 21, 2016) (“Finn II”); Suzanne Shatto (Jan. 24, 2017) (“Shatto”). Copies of the comment letters are available at
https://www.sec.gov/comments/s7-22-16/s72216.htm
.

The Commission is adopting as proposed the amendment to Rule 15c6-1(a) to shorten the standard settlement cycle. Specifically, paragraph (a) of Exchange Act Rule 15c6-1, as amended, will prohibit broker-dealers from effecting or entering into a contract for the purchase or sale of a security (other than certain exempted securities
51

that provides for payment of funds and delivery of securities later than the second business day after the date of the contract, unless otherwise expressly agreed to by the parties at the time of the transaction. Subject to the exceptions enumerated in the rule, the prohibition in paragraph (a) of Rule 15c6-1 applies to all securities.
52

51
Rule 15c6-1(a) does not apply to a contract for an exempted security, government security, municipal security, commercial paper, bankers' acceptances, or commercial bills. 17 CFR 240.15c6-1(a). The rule also provides additional exemptions for: (i) Transactions in limited partnership interests that are not listed on an exchange or for which quotations are not disseminated through an automated quotation system of a registered securities association; (ii) contracts for the purchase and sale of securities that the Commission may from time to time, taking into account then existing market practices, exempt by order; and (iii) contracts for the sale of cash securities that priced after 4:30 p.m. (Eastern Standard Time) that are sold by an issuer to an underwriter pursuant to a firm commitment offering registered under the Securities Act of 1933 (“Securities Act”) or the sale to an initial purchaser by a broker-dealer participating in such offering. 17 CFR 240.15c6-1(b) and (c).

Additionally, as discussed further in the T+3 Adopting Release, the Commission determined not to include transactions in municipal securities within the scope of Rule 15c6-1, with the expectation that the MSRB would take the lead in implementing three-day settlement of municipal securities by the implementation date of the new rule. The Commission requested a report from the MSRB within six months of the Commission's adoption of Rule 15c6-1 outlining the schedule in which the MSRB intended to implement T+3 in the municipal securities market. T+3 Adopting Release,
supra
note 15, 58 FR at 52899. MSRB rules that established T+3 as the standard settlement cycle for transactions in municipal securities became operative on June 7, 1995 (the same date as Exchange Act Rule 15c6-1).
See
Order Approving MSRB Proposed Rule Change Establishing Three Business Day Settlement Time Frame, Exchange Act Release No. 35427 (Feb. 28, 1995), 60 FR 12798 (Mar. 8, 1995).

52

See
note 23
supra
for a discussion of the securities subject to Rule 15c6-1.

1. Reduction in Risk to CCPs in the Clearance and Settlement Process

In the T+2 Proposing Release, the Commission noted its preliminary belief that shortening the standard settlement cycle would (assuming current levels of trading activity remain constant), for a CCP, result in fewer unsettled trades at any given point in time and a reduced time period of exposure to such trades, which would, in turn, reduce the CCP's credit, market, and liquidity risk exposure to its members.
53

Commenters generally agreed with this position.
54

53
T+2 Proposing Release,
supra
note 1, 81 FR at 69257 and 69241 n.3.

54
Bloomberg at 1; CFA at 3; DTCC Letter at 2; Fidelity at 1; FIF at 2; FSI at 2; ICI at 4-5; IDC at 1; MFA at 1-2; SIFMA at 1.

Several commenters noted that the reduced period of exposure for CCPs would result in a reduction of credit, market, and/or liquidity risk. For example, one commenter noted that shortening the settlement cycle would reduce the period during which CCPs are exposed to credit risk due to non-payment or non-delivery of a security (
i.e.,
the CCP's exposure to risk if a member defaults on a payment), which could result in the CCP using its financial resources to meet the CCP's end-of-day settlement obligations.

55

Similarly, one commenter stated that a shorter settlement cycle would diminish counterparty and mark-to-market risks because the number of days between entering a transaction, until the time it is settled, is reduced by one day. This reduction would decrease the possibility of a counterparty failure prior to settlement, as well as the possibility of changes in the market value of the security purchased.
56

Another commenter stated, from the perspective of a CCP, that the T+2 transition would correspondingly decrease the number of unsettled trades in the clearance and settlement system at any given time, which would mean that fewer unsettled trades would be subject to counterparty risk and market risk. The commenter further added that the market risk of unsettled trades would be reduced because there would be less time between trade execution and settlement for potential price movements in the securities underlying those trades.
57

55
FIF at 2.

56
ICI at 5. Generally, market risk refers to the risk that the value of securities bought and sold will change between trade execution and settlement such that the completion of the trade would result in a financial loss. T+2 Proposing Release,
supra
note 1, 81 FR at 69241 n.3.

57
DTCC Letter at 2.

The Commission believes that, in the case of a CCP, fewer unsettled trades and a reduced time period of exposure to such trades will reduce the CCP's credit, market, and liquidity risk exposure to its members.
58

As discussed earlier, a CCP, through novation and the provision of its trade guaranty, acts as the counterparty to its members and faces resultant credit risk in that a clearing member, both on behalf of purchasers of securities who may fail to deliver the payment and on behalf of sellers of securities who may fail to deliver the securities. In each case, the CCP is required to meet its obligation to its members, which in respect of the buyer is to deliver securities, and in respect of the seller is to deliver cash.

58

See also
note 5
supra.

The CCP also faces market risk if, during the settlement cycle, a member defaults and the CCP may be forced to liquidate open positions of the defaulting member and any financial resources of the member it may hold (
i.e.,
collateral) to cover losses and expenses in adverse market circumstances. For example, if the market value of the unsettled securities has increased after the trade date, in the case of a seller default, the CCP may be forced to obtain the replacement securities in the market at a higher price, and in the case of a buyer default, the CCP may be forced to obtain cash to purchase the securities at a higher price, which could involve liquidation of its members' collateral.

Finally, the CCP can face liquidity risks during the settlement cycle if a member defaults, resulting in the CCP deploying financial resources to meet the CCP's end-of-day settlement obligations.
59

In each instance, the amount and period of risk to which the CCP is exposed is a function of the length of the settlement cycle, and the Commission therefore believes that shortening the settlement cycle should reduce the CCP's overall exposure to those risks.

59
The costs associated with deploying such resources are ultimately borne by the CCP members, both in the ordinary course of the CCP's daily risk management process and in the event of an extraordinary event where members may be subject to additional liquidity assessments. As discussed earlier, these costs may be passed on through the CCP members to broker-dealers and investors.

2. Reduction in Risk to CCP Members

In the T+2 Proposing Release, the Commission stated its preliminary belief that shortening the standard settlement cycle to T+2 would result in liquidity risk reductions for broker-dealers that are CCP members.
60

As discussed earlier and in the T+2 Proposing Release,
61

a CCP may take a number of measures to manage the risks its members present, including the collection of member financial resource contributions and netting down the total outstanding exposure of a particular member. However, the extent to which a CCP must apply these risk mitigation tools is dictated by, among other things, the amount of unsettled trades that remain outstanding as well as the time during which the CCP remains exposed to these risks. Thus, the Commission believes that reducing the amount of unsettled trades and the period of time during which the CCP is exposed to such trades will result in a reduction in financial resource obligations for CCP members.
62

60

See
T+2 Proposing Release,
supra
note 1, 81 FR at 69257.

61

See
T+2 Proposing Release,
supra
note 1, 81 FR at 69243-44; Part III.A.1
supra.

62

See
T+2 Proposing Release,
supra
note 1, 81 FR at 69250-51.

Many commenters agreed.
63

For example, one commenter stated that shortening the settlement cycle would result in fewer unsettled trades at any point in time, which would reduce capital and clearing fund requirements for the CCP and its broker-dealer clearing members, which, in turn, would result in positive liquidity to broker-dealers that are direct members of clearing agencies.
64

Similarly, one commenter noted that by shortening the settlement cycle, market participants' exposure to customers' open positions would be reduced, which would allow financial institutions to better manage liquidity needs and margin requirements at CCPs.
65

63
ICI at 4-5; SIFMA at 15; DTCC at 2; WFA at 2; FIF at 2; Fidelity at 1; FSI at 3; IDC at 1; Newill at 1.

64
ICI at 4-5.

65
WFA at 2.

Another commenter stated that reduced collateral requirements would also help reduce liquidity risks, thereby improving capital utilization by market participants.
66

An additional commenter agreed with the Commission's preliminary belief, as articulated in the T+2 Proposing Release, that a shorter settlement cycle is likely to reduce liquidity risk for broker-dealers, with less collateral required to mitigate the risk of unsettled trades.
67

Another commenter stated that the reduction in counterparty risk would directly translate into a reduction of collateral requirements from CCPs, thus improving capital efficiency by CCP members.
68

Several other commenters stated generally that the transition to T+2 would reduce liquidity demands on market participants, decrease clearing capital requirements for broker-dealers, enhance liquidity, and/or improve the use of capital.
69

66
SIFMA at 15.

67
FIF at 2.

68
The commenter, the holding company for, among other entities, NSCC and DTC, noted a recent analysis that it conducted which indicated that the move to T+2 would reduce NSCC clearing fund deposits by an average of almost 25%, which translates into approximately $1.36 billion of freed capital for NSCC's members, although this analysis does not reflect the implementation of NSCC's accelerated trade guaranty, as discussed in note 27
supra
and accompanying text. DTCC Letter at 2 and n.2; SIFMA at 10 n.43.

69
Fidelity at 1; FSI at 3; IDC at 1; Newill at 1.

After considering the comments, the Commission continues to believe that the transition to a T+2 standard settlement cycle will have a positive impact on the liquidity risks and costs faced by CCP members. The Commission expects that the reduction in the amount of unsettled trades and the period of time during which the CCP is exposed to risk will reduce the amount of financial resources that CCP members may have to provide to support the CCP's risk management process, both on an ordinary-course basis as well as in less predictable or procyclical instances where adverse general market conditions or a CCP member default results in a sudden liquidity demand by the CCP for additional financial resources from market participants.
70

This reduction in

the potential need for financial resources should, in turn, reduce the liquidity costs and capital demands clearing broker-dealers face in the current environment and allow for improved capital utilization.

70
The term “procyclical” is generally understood to refer to changes in risk-management practices

that are positively correlated with market, business, or credit cycle fluctuations that may cause or exacerbate financial stability.

The Commission believes that shortening the standard settlement cycle to T+2 will result in reductions in liquidity risk for broker-dealers that are CCP members and additionally provide certain attendant benefits, including but not limited to, lower costs on a business and transactional basis, and improved use of financial resources.

3. Benefits to Other Market Participants From a Shortened Settlement Cycle

In the T+2 Proposing Release, the Commission stated its preliminary belief that shortening the standard settlement cycle would also lead to benefits to other market participants, including introducing broker-dealers, institutional investors, and retail investors.
71

These benefits would include quicker access to funds and securities following trade execution, which should further reduce liquidity risks and financing costs faced by market participants who may use those proceeds to transact in other markets, including the derivatives markets and non-U.S. markets that already operate on a T+2 settlement cycle.
72

They would also include reduced margin charges and other fees that clearing broker-dealers may pass down to other market participants, thereby reducing transaction costs generally and freeing up capital for deployment elsewhere in the markets by those entities.
73

Commenters generally supported this belief.
74

71
To the extent they engage in proprietary trading, clearing broker-dealers should also realize many of the same benefits described in this section, including quicker access to funds and securities following trade execution and a reduction in liquidity risk.

72
The length of the settlement cycle governs the time when the proceeds of a securities transaction may be made available to the member/participant. A mismatch in timing between the settlement cycle for the securities transaction and the settlement cycle for another market transaction, such as in the derivatives market or a non-U.S. market with a different settlement cycle, can in turn lead to liquidity risk for the member in meeting all of its settlement obligations across markets.
See
T+2 Proposing Release,
supra
note 1, 81 FR at 69251 and n.77.

73
T+2 Proposing Release,
supra
note 1, 81 FR at 69257-58.

74
FSI at 2; SIFMA at 15-16; ICI at 4-5; IDC at 1-2; WFA at 2-3; Wee at 1; Fidelity at 1; Newill.

a. Introducing Broker-Dealers

With respect to introducing broker-dealers, one commenter stated that introducing firms would benefit from shortening the settlement cycle to T+2, including through the reduction in liquidity risk and lowered costs related to margin and other charges and fees imposed by clearing brokers in association with managing credit risk. The commenter also stated that the underlying customer of an introducing firm would stand to realize significant benefits from the migration, including the more rapid returns of the proceeds of a sale of a security given the shortened settlement cycle.
75

75
SIFMA at 12.

The Commission agrees that introducing broker-dealers would benefit from a T+2 settlement cycle. Such entities would be able to access their own funds and securities from a transaction more quickly than under the current settlement cycle, which would reduce liquidity risk and free up capital. They would also face lower costs related to margin charges and other fees that clearing brokers may pass down as part of the costs related to the clearing brokers' risk management program. As noted above, several commenters noted that clearing broker-dealers would likely benefit from reduced clearing requirements.
76

The Commission agrees that such reduced requirements could, in turn, result in reduced charges and fees for introducing broker-dealers.

76
Newill at 1; DTCC Letter at 2; Fidelity at 1; ICI at 4-5.

b. Institutional Investors

Several commenters noted that a shortened settlement cycle would reduce funding gaps and potential additional financing costs for institutional investors resulting from mismatched settlement cycles that apply to mutual funds whose own securities settle on a different cycle than those in their portfolio.
77

Specifically, these commenters stated that, in the context of mutual funds, a shortened settlement cycle would reduce the funding gap between settlement of a mutual fund's portfolio securities (which settle on T+3) and the settlement of shares issued to investors through the mutual fund itself (which settle on T+1), improving cash management for funds to meet redemptions.
78

77
ICI at 4: IDC at 1-2.

78
ICI at 4; IDC at 1-2. These commenters also noted more generally that the proposal would reduce funding gaps among all types of securities, as settlement cycles would be better aligned, including those for various types of portfolio securities such as derivatives and government bonds. For example, the settlement cycle timeframe for open-end mutual funds that settle through NSCC is generally T+1. However, the standard settlement cycle timeframe for many underlying portfolio securities held by mutual funds is T+3. Settlement timeframes for securities with non-standard settlements held by these funds may be longer than T+3. This mismatch in timing presents potential liquidity risks for such funds as market participants with respect to the receipt of portfolio proceeds and in satisfying their investor redemption obligations.
See
T+2 Proposing Release,
supra
note 1, 81 FR at 69251 n.77; Investment Company Liquidity Risk Management Programs Release No. 32315 (Oct. 13, 2016), 81 FR 82142, 82143 n.9 (Nov. 18, 2016).

These comments support the Commission's belief, as initially expressed in the T+2 Proposing Release,
79

that by better aligning the settlement cycles between the underlying portfolio securities and the securities issued to investors through the mutual fund, the risk to the fund, and ultimately investors, is reduced. Under a shortened standard settlement cycle, the mutual fund will receive the proceeds of the transaction more quickly, which, in turn, will free up liquidity generally and, in particular, if there are significant new outflows or cash is needed to address other market stresses.

79

See
T+2 Proposing Release,
supra
note 1, 81 FR at 69257 n.156.

c. Retail Investors

Several commenters stated that a shortened standard settlement cycle would lead to benefits for retail investors, particularly through quicker access to funds and securities following trade execution. Specifically, these commenters noted that settlement of trades on a T+2 standard settlement cycle would improve investors' access to capital and reduce the need to borrow funds.
80

80
WFA at 2-3; Wee at 1; Fidelity at 1.

Several commenters noted that retail investors would benefit from a shorter standard settlement cycle because of reduced risk in the settlement process. One commenter stated that different settlement cycles have the potential to contribute towards failed trades for an investor who, for example, attempts to buy a mutual fund upon selling an exchange-traded fund. This can be especially true when an investor attempts to rebalance a portfolio of securities consisting of various securities with differing settlement cycles.
81

An additional commenter stated that retail investors, among others, would benefit from a shorter standard settlement cycle through reduced risk in the settlement process, based on the related reduction in counterparty risk and liquidity demands on market participants, decreased clearing capital requirements for broker-dealers, and harmonization of the global settlement process as many foreign securities markets already operate on a

T+2 settlement cycle.
82

The Commission agrees that, like other market participants, retail investors will benefit from reduced risks arising in a shortened standard settlement cycle as a result of the reduced risks for CCPs and CCP members discussed above in Parts III.A.1 and III.A.2. The Commission further believes that reducing the number of days in the standard settlement cycle will reduce the exposure of retail investors, and institutional investors, to the risks of failure to make payment or deliver securities, thereby reducing overall risks to all investors.

81
WFA at 2-3.

82
Fidelity at 1.

In addition, one commenter cited lower transaction costs for investors as a benefit of shortening the settlement cycle to T+2, although this commenter did not provide specific data or information to support this conclusion.
83

As noted above, the Commission generally believes that a transition to a T+2 standard settlement cycle will result in reduced costs for broker-dealers, including those whose customers are retail investors. Such broker-dealers may or may not choose to pass on the benefit of reduced costs to their retail investor customers, and therefore it is not clear that retail investors would, in all instances, experience a benefit of reduced fees or other costs charged by their broker-dealers. However, as discussed further below, the Commission generally believes that retail investors may bear few (if any) direct costs in a transition to a T+2 standard settlement cycle because their respective broker-dealers handle the back-office settlement functions of each transaction.
84

The Commission further agrees with the comments described above that moving to a T+2 standard settlement cycle should, in and of itself, result in a number of the benefits that the comments identify, including with respect to the rebalancing of an investor's portfolio or the modification of asset allocation, by reducing settlement timeframes and related risks. For example, the Commission believes that a T+2 settlement cycle will allow retail investors to gain quicker access to funds and securities following trade execution.

83
Newill.

84
For a further discussion, see Part VI.B.2
infra.
As discussed further therein, it is possible that retail investors may face indirect costs from the transition, such as those passed through from broker-dealers or banks.

One commenter who focused on the concerns of retail investors stated that the Commission's proposal to transition to a T+2 settlement cycle would be “woefully insufficient” to address their needs in the current environment.
85

In discussing the impact of the T+3 standard settlement cycle on retail investors, the commenter noted that the time from order execution until the securities are exchanged for cash is a lengthy waiting process (up to five days if the process extends over a weekend) that can be frustrating and potentially damaging for investors who are faced with immediate and unexpected financial obligations. The commenter noted that investors may respond to this lengthy settlement process by keeping larger buffers of cash on hand, which can be costly and inefficient, or alternatively, they may borrow money short-term, often at high interest rates, to bridge the gap, which can be costly, or they may just have to wait until the transaction has settled, which can have other opportunity costs.
86

This same commenter noted that other scenarios related to the current settlement timeframe can cost investors money and impede basic transactions. For example, if an investor tries to sell shares of an ETF and then tries to buy shares of a traditional open-end mutual fund on the same day, the broker may not allow the trade due to the two-day difference in settlement between the ETF shares and the mutual fund shares. If the investor tries to make the trade, the account will be short cash for several days, which means at best, the investor would be charged interest or the buy order would not go through. The delay in settlement may cause routine rebalancing of an investor's portfolio or the modification of asset allocation to turn into a lengthy and complicated multi-step processes. In short, this commenter stated that the Commission's proposal to shorten the T+3 settlement cycle by only one day would be inadequate to address the range of retail investor challenges identified by the commenter.
87

85

See
CFA at 1. In particular, this commenter supported shortening the settlement cycle to a T+1 standard based on STP. The Commission addresses this portion of the commenter's letter regarding a standard settlement cycle shorter than T+2 further in Parts VI.D.1 and Part VI.D.2
infra.

86
CFA at 2-3.

87
Id at 1, 3-5.

The Commission agrees that, all else being equal, moving to a T+1 standard settlement cycle would likely result in retail investors receiving transaction proceeds sooner than under a T+2 standard settlement cycle, and that a shorter standard settlement cycle could mitigate, or in some cases eliminate, the potential issues for retail investors identified by the commenter.
88

However, the Commission believes that shortening the standard settlement cycle to T+2 will address many of these concerns. Additionally, the Commission believes that the important risk-reducing benefits of a shortened standard settlement cycle for market participants, including retail investors, can be quickly achieved at this time with a T+2 settlement cycle because the necessary preparation (including appropriate technological and operational changes) has occurred to support moving to a T+2 standard settlement cycle. Consequently, movement at this time to a T+2 standard may be accomplished in a timely and cost-effective, manner that minimizes undue disruptions in the securities markets. As noted earlier, the near-term benefits of a T+2 standard settlement cycle include quicker access to funds and a reduction in borrowing and other transaction costs, as well as reduced risk in the settlement process and a greater ability to manage asset allocation (including the allocation challenges the commenter describes above in the context of mutual fund and exchange-traded fund security purchases). Therefore, the Commission believes, as discussed further in Part VI.D.1 below, that a transition to a T+2 standard settlement cycle will realize these important benefits in the near term in a manner that is relatively more cost effective and consistent with the current state of market participant preparedness than a transition to T+1. The Commission also notes that this belief is supported by those commenters who observed that a move to a T+2 standard settlement cycle, and the realization of risk-reducing benefits for retail and other investors, is relatively more feasible and cost effective in the near term than a T+1 transition.
89

Therefore, the Commission notes that a move to a T+2 standard settlement cycle is an appropriate step at this time. Further, the movement to T+2 at this time does not foreclose future efforts to shorten the settlement cycle beyond T+2.
90

88

See, e.g.,

id.
at 2-3 (identifying as issues for retail investors under the current settlement cycle the lengthy waiting period that can arise between trade execution and settlement, exposing retail investors to the potential need to address the risk of immediate and unexpected financial obligations, as well as the mismatch in settlement cycles between the shares of an ETF and the shares of a traditional open-end mutual fund).

89

See
Part VI.D.1
infra
for a discussion of such comments.

90

See
Part V
infra.

Several other commenters raised concerns regarding how a change in the current T+3 environment could result in challenges and costs for retail investors.
91

Two commenters discussed

the impact that a shortened settlement cycle would have on individuals who use paper checks to facilitate payment and transfer of funds for the settlement of securities transactions. One of these commenters observed that moving to a settlement cycle shorter than T+3 would impose hardships on such individuals, noting that the current T+3 settlement cycle already places pressure on individuals who may use paper checks instead of other modes of payment, such as electronic payment transfer systems. The commenter further observed that a T+2 settlement cycle therefore would increase such pressures as well as the likelihood of increased reliance on electronic payment transfers; the commenter also expressed concern about the potential for new risks and costs that may come from such reliance upon electronic payment transfers, including risks and costs related to the security of personal information. In light of these potential new risks and costs, the commenter expressed a belief that a T+2 standard settlement cycle could give rise to barriers to stock ownership by retail investors.
92

91
Gellert; CSLC at 1-2; BDA at 1. In addition, one commenter stated that the Commission failed to

meaningfully address how the amendment would affect smaller individual investors and instead focused on institutional market participants, primarily broker-dealers, and clearing firms. CSLC at 2. The commenter asserted that the Commission had failed to identify or analyze significant impediments with the current T+3 standard settlement cycle, and concluded by stating that it opposed the proposal until the proposal adequately takes these considerations into account. CSLC at 3. In response, the Commission notes that the T+2 Proposing Release specifically detailed both the current process by which retail investors clear and settle their securities transactions in a T+3 environment and the impact of that process on retail investors.
See, e.g.,
T+2 Proposing Release,
supra
note 1, 81 FR at 69427-69428. In addition, the Commission solicited specific comment in the T+2 Proposing Release regarding the potential impact a move to T+2 could have on retail investors, including potential costs and benefits for retail investors.
See id.
at 69262. Further, as described herein, a number of commenters, including this commenter, submitted specific responses to the inquiries in the T+2 Proposing Release focused on retail investors. Among those commenters, a number raised specific issues related to retail investors that the Commission has addressed herein, including ways that a move to T+2 could potentially heighten or lower impediments to a national system for the prompt and accurate clearance and settlement of securities transactions.

92
Gellert.

The other commenter who raised issues with respect to the use of paper checks expressed concern that the proposed amendment to Rule 15c6-1(a) would shorten the timeframe within which a broker-dealer would be required to cancel or liquidate an unpaid cash account transaction under the Federal Reserve Board's Regulation T, from the current five business days after the transaction date, to four business days after the transaction date.
93

The commenter urged regulators to ensure that the shortened settlement cycle does not negatively impact retail clients that still rely on sending checks, which may not be sent, received, processed, and cleared within four days after the transaction date.
94

93
BDA at 1-2 (noting that under Regulation T, the term “payment period” means the number of business days in the standard securities settlement cycle in the United States, as defined in paragraph (a) of Rule 15c6-1, plus two business days). Regulation T provides that, with respect to cash account transactions, a creditor shall obtain full cash payment for customer purchases within one payment period of the date any “nonexempted security” was purchased, and that a creditor shall promptly cancel or liquidate a transaction or any part of a transaction for which the customer has not made full cash payment with the required time. 12 CFR 220.8(b)(i) and (ii)(4).

94
BDA at 2.

In response to these commenters, the Commission acknowledges that shortening the standard settlement cycle to T+2 may create additional costs for retail investors who choose to fund securities transactions by mailing a paper check to their broker-dealer. For example, retail investors who wish to continue using paper checks may need to deliver their checks to their broker-dealers more quickly and in a more costly manner (
i.e.,
hand or overnight delivery as opposed to delivery via the postal service). The Commission also acknowledges that, in light of such challenges, certain retail investors may need to adopt or increase their use of electronic payment methods, and that the use of electronic payment methods may introduce new costs and risks for such investors, including with respect to the protection of personal information. The Commission further acknowledges that such costs and risks could potentially impact the willingness of certain retail investors to participate in the securities markets, including via stock ownership. However, using electronic payment options may also lower existing costs to retail investors.

While recognizing the concerns raised by these commenters, however, the Commission believes that the risk-reducing benefits discussed above that will be realized by market participants, including retail investors, as a result of a shortened standard settlement cycle justify the potential costs and risks identified by the commenters. As noted above, the Commission believes that retail investors will gain quicker access to funds and securities following trade execution, which in turn will allow retail investors to re-deploy their assets more quickly and efficiently for other purposes, including additional investment and risk management. On balance, the Commission believes that this benefit is more likely to decrease rather than increase barriers to participation by retail investors in the securities markets, including through stock ownership.

Separately, while discussing the potential negative impact of a shortened settlement cycle on retail investors, one commenter asserted that shortening the standard settlement cycle to T+2 could give rise to destabilizing effects on the financial markets. In making this observation, the commenter expressed a view that shortened settlement periods result in weaker liquidity requirements for broker-dealers and market makers, as well as an increased likelihood of computerized high-volume trading that could destabilize the market.
95

In response, the Commission notes that, as discussed in Parts III.A.1, 2, and 3.a and b above, a transition to a T+2 standard settlement cycle will reduce, as opposed to heighten, liquidity risk exposure for market participants because, for a CCP, there would be fewer unsettled trades at any given point in time and a reduced time period of exposure to such trades, resulting in a CCP's reduced potential need for financial resources, which should, in turn reduce the liquidity costs for clearing broker-dealers and those market participants that rely upon the services of clearing broker-dealers.

95
Gellert.

Further, with respect to the impact a shorter settlement cycle may have on the presence of computerized high-volume trading in the financial markets, the Commission notes that the commenter has not provided information or other evidence demonstrating how an increase in the pace of trade settlement will result in an increase in the presence of computerized high-volume trading that could destabilize the financial markets. The Commission believes that amending the length of the settlement cycle will affect the manner in which post-trade processes occur, but does not expect the proposed amendment to alter the incidence of computerized trading or how such activity influences market stability. The Commission further believes that, as discussed above, a shortened standard settlement cycle is appropriate given the reduction in credit, market, and liquidity risks associated with a shorter settlement cycle. Therefore, the Commission is not persuaded that a shortened standard settlement cycle will give rise to the liquidity risk and market stability concerns raised by the commenter.

4. Cross-Border Harmonization

In the T+2 Proposing Release, the Commission noted that the proposed amendment to Rule 15c6-1(a) would harmonize the settlement cycle in the U.S. with non-U.S. markets that had already moved to a T+2 settlement cycle or were planning to do so.
96

In addition, the Commission discussed the potential benefits of harmonizing settlement cycles across markets, which included reducing the degree to and time during which, market participants are exposed to credit, market, and liquidity risk arising from unsettled transactions.
97

96
T+2 Proposing Release,
supra
note 1, 81 FR at 69258.

97
T+2 Proposing Release,
supra
note 1, 81 FR at 69258, 69259, 69269.

A number of commenters cited increased global harmonization of settlement cycles as a prospective benefit of moving to a T+2 settlement cycle in the U.S.
98

One commenter stated that the benefits of harmonized settlement cycles would include increased efficiency in coordinating trading among investors across international markets and decreased operational risk because investment managers would not need to balance inconsistent settlement cycles across broad asset classes common to both U.S. and international markets.
99

98
DTCC Letter at 2 and 3; Fidelity at 1; FIF at 3; FSI at 3; ICI at 5-6; IDC at 1; MFA at 2; Newill at 1; SIFMA at 16; STA at 1-2; Thomson Reuters at 3 (noting further that T+2 would be consistent with the FX markets); WFA at 3; Wee at 1-2.

99
SIFMA at 16. The commenter also noted that a transition to a T+2 settlement cycle in the United States would result in over 77% of top ten markets worldwide, as calculated by market capitalization, operating in a T+2 settlement environment.
Id.

Another commenter stated that the industry would benefit from the reduction of hedge risks stemming from mismatched settlement cycles (
e.g.,
the one day lag between settlement in Europe and settlement in the U.S.). The same commenter noted that harmonization between markets should also further reduce risk to market participants, as participants would no longer be required to choose between bearing an additional day of market risk in the European trading markets by delaying by one day the purchase of securities on European markets, or funding such a transaction with short-term borrowing, as the settlement cycle in both U.S. and European markets will be aligned.
100

100
FIF at 3.

Another commenter noted that consistency in the settlement cycle across the U.S. and non-U.S. markets could help funds better manage liquidity and cash flow, which could reduce and simplify financing needs.
101

A fourth commenter stated that a further harmonized global securities settlement cycle would reduce operational risk for institutional investors by closing the gap in the settlement cycle between the U.S. and other foreign markets in which they invest, standardizing cross-border settlement processes, and fostering adoption of industry best practices.
102

101
IDC at 1.

102
ICI at 5.

These commenters generally supported the Commission's belief that aligning the settlement cycle in the U.S. with the settlement cycle in several major non-U.S. markets that have already moved to T+2 or are planning to do so will benefit market participants. The Commission agrees that harmonization of settlement cycles may reduce the need for some market participants engaging in cross-border transactions to hedge risks stemming from mismatched settlement cycles. In addition, the Commission agrees that harmonization of the U.S. settlement cycle with the T+2 settlement cycle in certain non-U.S. markets will reduce financing/borrowing costs for market participants who engage in cross-border transactions in both those markets and U.S. markets.
103

103
However, the Commission notes that the shortened standard settlement cycle cannot address the fact that certain non-U.S. markets may continue to face harmonization issues based on the different time zones in which the transactions occur.

5. Reduction in Systemic Risk

In the T+2 Proposing Release, the Commission noted its preliminary belief that the reductions in credit, market, and liquidity risks should reduce systemic risk, and that, as it stated in adopting Rule 15c6-1 in 1993, reducing the total volume and value of outstanding obligations in the settlement pipeline at any point in time will better insulate the financial sector from the potential systemic consequences of serious market disruptions. The Commission also noted that reducing the period of time during which a CCP is exposed to credit, market, and liquidity risk should enhance the CCP's overall ability to serve as a source of stability and efficiency in the national clearance and settlement system, thereby reducing the likelihood that disruptions in the clearance and settlement process will trigger consequential disruptions that extend beyond the cleared markets.
104

104
T+2 Proposing Release,
supra
note 1, 81 FR at 69257.
See also
Parts III.A.1 and III.A.2,
supra.

Several commenters generally agreed with this belief, noting that shortening the standard settlement cycle to T+2 would result in reduced systemic risk or enhanced financial stability.
105

For example, one commenter strongly agreed with the Commission's description of the systemic risk benefits from moving to T+2, noting that, in light of the financial resource and liquidity demands facing CCPs and other market participants during times of market volatility and stress, a shorter settlement cycle should help meaningfully reduce those demands. The commenter also agreed with the Commission that reducing the total volume and value of obligations in the settlement pipeline at any given time would help minimize the systemic consequences of serious market disruptions. The commenter further noted that minimizing risk in the context of CCPs can limit the circumstances in which a disruption in the clearance and settlement system will extend to other aspects of the market.
106

Another commenter identified one benefit of the shortened settlement cycle as a more stable financial system, based on reduced counterparty risk and the amount of capital required to be maintained by clearing firms to mitigate such risk, as well as less operational and systemic risk through reduced exposure between the parties to a trade, between the counterparties to the clearinghouse, and for the clearinghouse itself.
107

105
Bloomberg at 1; DTCC Letter at 2; FIF at 2; FSR; FSI at 2; Kim at 1; MFA at 1-2; Newill at1; SIFMA at 15; WFA at 2. An additional commenter noted generally that shortening the settlement cycle would help protect market participants from credit, market, and liquidity risks, reduce the threat of systemic risk, and hasten the processing of investors' transactions, but continued to advocate for changes beyond T+2. CFA at 3.
See also
T+2 Proposing Release,
supra
note 1, 81 FR at 69258.

106
SIFMA at 15.

107
FSI at 2.

The Commission agrees with commenters that the reduction in credit, market, and liquidity risks resulting from a shortened settlement cycle should reduce systemic risk. Because of the potential procyclical impact on financial resource and other liquidity demands by CCPs and other market participants during times of market volatility and stress, efforts to reduce these liquidity demands through a shorter settlement cycle are expected to reduce systemic risk.
108

108
T+2 Proposing Release,
supra
note 1, 81 FR at 69258.

The Commission noted in the T+2 Proposing Release that the reduction in exposure to credit, market, liquidity, and systemic risk arising from fewer unsettled transactions at any one time due to a shorter settlement cycle should improve the stability of the U.S.

markets.
109

One commenter agreed with the Commission and stated that CCPs would be better positioned to serve as a source of stability and efficiency within the clearance and settlement system when there is a shorter period of time during which they are exposed to credit, market, and liquidity risks, because the shorter period of time limits the volume of trades subject to the guarantee at any one time.
110

Another commenter stated that the decrease in counterparty and mark-to-market risk, which are typically magnified during times of highly volatile markets, would add to the overall stability of the financial system.
111

109
T+2 Proposing Release,
supra
note 1, 81 FR at 69257.

110
SIFMA at 15.

111
ICI at 18.

The Commission agrees with these commenters that reducing the period of time during which a CCP is exposed to credit, market, and liquidity risk should enhance the overall ability of the CCP to serve as a source of stability and efficiency in the national clearance and settlement system, thereby reducing the likelihood that disruptions in the clearance and settlement process will trigger consequential disruptions that extend beyond the cleared markets.
112

112

See
T+2 Proposing Release,
supra
note 1, 81 FR at 69258;
see also
CCA Standards Adopting Release,
supra
note 14, 81 FR at 70849. Clearing members are often members of larger financial networks, and the ability of a covered clearing agency to meet payment obligations to its members can directly affect its members' ability to meet payment obligations outside of the cleared market. Thus, management of liquidity risk may mitigate the risk of contagion between asset markets.

6. Leveraging and Advancement of Existing Technology, Operations, and Market Infrastructure

In the T+2 Proposing Release, the Commission stated its preliminary belief that significant advancements in technology and the changes in market infrastructures and operations that have occurred since 1993, which are widely assimilated into market practices, provide a basis to accommodate shortening the standard settlement cycle to T+2.
113

The Commission further noted in the T+2 Proposing Release that it has observed that market participants have begun to accelerate collective progress to prepare for a transition to a T+2 settlement cycle.
114

Several commenters expressed general support for this view.
115

113

See
T+2 Proposing Release,
supra
note 1, 81 FR at 69258.

114

Id.

115
Kim at 1; SIFMA at 14; DTCC Letter at 4.

One commenter stated that, with current computer and software technology, a move to T+2 is feasible and sensible.
116

An additional commenter supported the Commission's preliminary belief, noting that market participants already have invested in evaluating and preparing for a potential move to a T+2 standard settlement cycle, thus making the industry well-positioned to capitalize on those efforts and complete the transition to a shorter settlement cycle.
117

The commenter further noted that the industry has made incremental improvements in batch processing systems as the technology to do so has become available, and has moved to real-time processing where logical (
e.g.,
NSCC Trade Reporting).
118

116
Kim at 1.

117
SIFMA at 14.

118
SIFMA at 14.

The Commission agrees with the comments that the current state of technology and market infrastructure and operations support amending Rule 15c6-1(a) to establish a T+2 settlement cycle. As noted by commenters, market participants are actively working to transition to a T+2 settlement cycle and have made investments in technology and operations to do so. The Commission believes that these advancements in technology and changes in market infrastructures and operations, which have occurred since 1993 generally and in conjunction with recent efforts to transition to a T+2 standard settlement cycle, support shortening the settlement cycle.

Several commenters also expressed support for shortening the standard settlement cycle to T+2 by noting that a shorter settlement cycle will promote operational efficiencies.
119

In the T+2 Proposing Release the Commission noted that a shortened settlement cycle may necessitate incremental increases in utilization by certain market participants of Matching/ETC Providers, with a focus on improving and accelerating affirmation/confirmation processes, as well as relative enhancements to efficiencies in the services and operations of the Matching/ETC Providers themselves.
120

The Commission further stated that it preliminarily expects that these changes may be necessary in a T+2 environment because certain steps related to the allocation, confirmation, and affirmation of institutional trades will need to occur earlier in the settlement cycle compared to in a T+3 environment.
121

119
DTCC Letter at 2; IDC at 1; SIFMA at 15.

120
T+2 Proposing Release,
supra
note 1, 81 FR at 69258.

121

Id.

Consistent with this view, one commenter noted that a T+2 standard settlement cycle would motivate market participants to tighten their operational processes. This commenter stated that it expects institutional investors to improve the quality of settlement instructions and static settlement data maintenance, and increase automation and STP rates with their broker-dealers and custodian banks.
122

This commenter added that this would result in higher numbers of on-time affirmed, confirmed, and settled trades.
123

Similarly, another commenter stated a T+2 standard settlement cycle would lead to enhancements and compression of batch processing systems.
124

122
ICI at 5.

123

Id.

124
SIFMA at 14.

Another commenter noted that it believes that a shorter settlement cycle would lead to greater use of automation in the settlement process.
125

This commenter stated that automation in the settlement process will enable STP and contribute to increases in same-day affirmation rates and increases in settlement rates, with an attendant decrease in exceptions that lead to fails, and that automation will also eliminate inefficient procedures for clearance and settlement and lower overall costs to investors.
126

In addition, this commenter noted that it believes that automation would not only enable a T+2 standard settlement cycle but will also facilitate moving to an even shorter settlement cycle.
127

125
Bloomberg at 2-3.

126

Id.
at 2. The commenter also noted that its trade matching service will offer solutions to move manual clients to an automated work flow, which will minimize exceptions and reduce costly inefficiencies.

127

Id.
at 2-3.

The Commission agrees with the comments that moving to a T+2 settlement cycle will lead market participants to develop and utilize more efficient operational processes. The Commission noted in the T+2 Proposing Release that technological and operational changes necessary to support a T+2 standard settlement cycle would in many cases require only incremental modifications to existing market infrastructures and systems and processes. Some comments anticipated that the changes necessary to support a T+2 standard settlement cycle may improve operational efficiency.
128

128

See
Bloomberg at 2-3; SIFMA at 14; ICI at 5.

B. Paragraphs (b), (c), and (d) of Rule 15c6-1

In the T+2 Proposing Release, the Commission requested comment as to whether the Commission should consider any amendments to paragraphs

(b), (c), and (d) of Rule 15c6-1.
129

No commenters requested changes to those paragraphs, and the Commission is not amending those portions of the Rule.

129

See
T+2 Proposing Release,
supra
note 1, 81 FR at 69263-64.

One commenter requested clarification regarding the application of Rule 15c6-1(d) and the Commission's statement in the T+2 Proposing Release regarding what is sometimes referred to as the “override provision” of Rule 15c6-1(a) that permits broker-dealers to agree expressly at the time of the transaction to settlement beyond the standard settlement cycle.
130

Rule 15c6-1(d) provides that, for purposes of paragraphs (a) and (c) of the rule, parties to a contract shall be deemed to have expressly agreed to an alternate date for payment of funds and delivery of securities at the time of the transaction for a contract for the sale for cash of securities pursuant to a firm commitment offering if the managing underwriter and the issuer have agreed to such date for all securities sold pursuant to such offering and the parties to the contract have not expressly agreed to another date for payment of funds and delivery of securities at the time of the transaction.
131

In raising its concerns, the commenter expressed the belief that current market practices indicate that extended settlement periods beyond the standard settlement cycle are applied for the settlement of certain primary firm commitment offerings, particularly those in the convertible debt, preferred equity, options on securities and fixed income markets.
132

The commenter further observed that, in such markets, issuers, underwriters and the initial purchasers of those securities have increasingly relied on an extended settlement cycle pursuant to Rule 15c6-1(d) for many primary distributions.

130
SIFMA at 19-20 (discussing footnote 153 of the T+2 Proposing Release). Specifically, Rule 15c6-1(a) allows a broker-dealer to agree that settlement will take place in a period longer. than the T+3 standard settlement cycle if expressly agreed to by the parties at the time of the transaction.

131
17 CFR 240.15c6-1(d).
See also
Prospectus Delivery; Securities Transaction Settlement, Exchange Act Release No. 35705 (May 11, 1995), 60 FR 26604, 26612 (May 17, 1995) (“Rule 15c6-1(d) Adopting Release”).

132
SIFMA at 19.

In light of this belief regarding current market practices for many primary distributions, the commenter expressed concern over a statement made by the Commission in a footnote of the T+2 Proposing Release regarding the override provision in Rule 15c6-1(a). Specifically, in the T+2 Proposing Release, the Commission noted that at the time Rule 15c6-1(a) was adopted, the Commission stated its belief that the usage of the override provision of Rule 15c6-1(a) was intended to apply only to unusual transactions, such as seller's option trades that typically settle as many as sixty days after execution as specified by the parties to the trade at execution. In the T+2 Proposing Release, the Commission stated its preliminary belief that the use of this provision should continue to be applied in limited cases to ensure that the settlement cycle set by Rule 15c6-1(a) remains a standard settlement cycle.
133

In response to this statement, the commenter raised the concern that such a belief did not match actual market practices and may result in unintended negative consequences.
134

Accordingly, the commenter requested that, in adopting a T+2 standard settlement cycle, the Commission clarify that parties to a primary offering may continue the practice of agreeing to extended settlements in accordance with Rule 15c6-1 in appropriate cases, including those identified by the commenter. In addition, the commenter requested that the Commission clarify that the use of such extended settlements in primary offerings of these securities need not be limited to unusual circumstances or confined to situations where settlement on a T+2 basis is not feasible.
135

133
T+2 Proposing Release,
supra
note 1, 81 FR at 69257 n.153 (quoting T+3 Adopting Release,
supra
note 15, 58 FR at 52902).

134
SIFMA at 20.

135

Id.

The commenter's concern applies to two distinct, but related, parts of Rule 15c6-1. One part is the general override provision for extended settlement set forth in Rule 15c6-1(a) and the other part is the extended settlement provision specific to firm commitment primary offerings in Rule 15c6-1(d). In response to the commenter, the Commission notes that its statement, as expressed in the footnote in the T+2 Proposing Release, is only with respect to the override provision in Rule 15c6-1(a) and does not relate to the application of Rule 15c6-1(d) in the specific context of firm commitment offerings.
136

136

See
Rule 15c6-1(d) Adopting Release,
supra
note 131, 60 FR at 26612.

C. Impact on Other Commission Rules and Guidance; Relevant No-Action and Exemptive Relief

The Commission stated in the T+2 Proposing Release that it reviewed its existing regulatory framework to consider the potential impact a T+2 standard settlement cycle may have on other Commission rules. Some Commission rules require market participants to perform certain regulatory obligations on settlement date or within a specified number of business days after the settlement date, or are otherwise keyed off of settlement date. Accordingly, shortening the standard settlement cycle to T+2 could have ancillary consequences for how market participants comply with these existing regulatory obligations. In response to the T+2 Proposing Release, several commenters identified specific rules, as well as related guidance and no-action and exemptive relief, on which a T+2 standard settlement cycle may have an impact.

1. Regulation SHO

In the T+2 Proposing Release, the Commission identified several provisions of Regulation SHO under the Exchange Act that may be impacted by the adoption of a T+2 settlement cycle. While not referencing specific settlement timeframes (
i.e.,
T+3), certain provisions of Regulation SHO key off of “trade date” and “settlement date” to determine the timeframes for compliance relating to sales of equity securities and fails to deliver on settlement date. In particular, Rule 204 of Regulation SHO (“Rule 204”) provides that a participant
137

of a registered clearing agency must deliver securities to a registered clearing agency for clearance and settlement on a long or short sale in any equity security by settlement date, or if a participant has a fail to deliver position, the participant shall, by no later than the beginning of regular trading hours on the applicable close-out date, immediately close out the fail to deliver position by borrowing or purchasing securities of like kind and quantity.
138

If a fail to deliver position results from a short sale, the participant must close out the fail to deliver position by no later than the beginning of regular trading hours on the settlement day following the settlement date.
139

137
For purposes of Regulation SHO, the term “participant” has the same meaning as in Section 3(a)(24) of the Exchange Act, 15 U.S.C. 78c(a)(24).
See
Amendments to Regulation SHO, Exchange Act Release No. 60388 (July 27, 2009), 74 FR 38266, 38268 n.34 (July 31, 2009) (“Rule 204 Adopting Release”).

138
17 CFR 242.204(a). Under the current T+3 standard settlement cycle, the close-out for short sales is required by the beginning of regular trading hours on T+4. If a fail to deliver results from a long sale or a sale from bona fide market making activity, the participant must close-out the fail to deliver position by no later than the beginning of regular trading hours on the third consecutive settlement day following the settlement date
(i.e.,
T+6). 17 CFR 242.204(a)(1) and (a)(3) respectively.

139

Id.

Shortening the standard settlement cycle to T+2 will also impact the application of Rule 200(g)(1) of Regulation SHO as it pertains to loaned but recalled securities.
140

Pursuant to Rule 200(g), a broker-dealer may only mark a sale as “long” if the seller is “deemed to own” the security being sold under paragraphs (a) through (f) of Rule 200,
141

and either (i) the security is in the broker-dealer's physical possession or control; or (ii) it is reasonably expected that the security will be in the broker-dealer's possession or control by settlement of the transaction.
142

In order to clarify the operation of Rule 200(g)(1) in the context of loaned but recalled securities, the Commission has stated that:

140

See
17 CFR 242.200(g).

141

See
17 CFR 242.200(a)-(f).

142

See
17 CFR 242.200(g)(1).

. . . if a person that has loaned a security to another person sells the security and a bona fide recall of the security is initiated within two business days after trade date, the person that has loaned the security will be `deemed to own' the security for purposes of Rule 200(g)(1), and such sale will not be treated as a short sale for purposes of Rule 204T. In addition, a broker-dealer may mark such orders as `long' sales provided such marking is also in compliance with Rule 200(c) of Regulation SHO.
143

143

See
Rule 204 Adopting Release,
supra
note 137, 74 FR at 38270 at n.55 (citations omitted).

Thus, broker-dealers that initiate bona fide recalls
144

on T+2 of loaned securities that sellers are “deemed to own” under paragraphs (a) through (f) of Rule 200 may currently mark such orders as “long.”
145

The Commission limited this application of Rule 200(g)(1) regarding the marking of sales of loaned securities “long” to those in which bona fide recalls are initiated on or before the business day preceding settlement date under the current T+3 settlement cycle because the Commission believed that, pursuant to industry standards for loaned but recalled securities, such recalls would likely be delivered within three business days after initiation of a recall.
146

As a result, in a T+3 environment, recalled securities would be available by T+5 to close out the fail to deliver on a “long” sale, or before the close-out for fails on sales marked “long” is otherwise required by Rule 204 (
i.e.,
no later than the beginning of regular trading hours on T+6).

144
Because a recall must be initiated by no later than the business day preceding the settlement date to be delivered prior to the required Rule 204 close-out, any cancellation or modification of a recall of a security would not constitute a bona fide recall.

145
In the release adopting the “naked” short selling antifraud rule, Rule 10b-21, 17 CFR 240.10b-21, the Commission stated that “a seller would not be making a representation at the time it submits an order to sell a security that it can or intends to deliver securities on the date delivery is due if the seller submits an order to sell securities that are held in a margin account but the broker-dealer has loaned out the shares pursuant to the margin agreement. Under such circumstances, it would be reasonable for the seller to expect that the securities will be in the broker-dealer's physical possession or control by settlement date.”
See
“Naked” Short Selling Antifraud Rule, Exchange Act Release No. 58774 (Oct. 14, 2008), 73 FR 61666, 61672 (Oct. 17, 2008). Thus, a seller of securities would not be deemed to be deceiving a broker-dealer under Rule 10b-21 if the seller submits a sell order to an executing broker-dealer and informs the executing broker-dealer that the seller's shares are in the physical possession or control of a prime broker, but neither the seller nor the executing broker-dealer knows or has reason to know that the prime broker has loaned out the securities pursuant to a margin agreement. The Commission notes that this interpretation, which concerns whether a seller has made a misrepresentation regarding the deliverability of its securities in time for settlement, does not apply to rules other than Rule 10b-21.

146

See
Master Securities Loan Agreement (“MSLA”), Paragraph 6.1(a), discussing the termination of a loan of securities (“Unless otherwise agreed, either party may terminate a Loan on a termination date established by notice given to the other party prior to the Close of Business on a Business Day. The termination date established by a termination notice shall be a date no earlier than the standard settlement date that would apply to a purchase or sale of the Loaned Securities (in the case of notice given by Lender) or the noncash Collateral securing the Loan (in the case of a notice given by Borrower) entered into at the time of such notice, which date shall, unless Borrower and Lender agree to the contrary, be (i) in the case of Government Securities, the next Business Day following such notice and (ii) in the case of all other Securities, the third Business Day following such notice”). A sample MSLA can be found at
http://www.sec.gov/Archives/edgar/data/59440/000095014405003873/g94498exv10w1.htm.

The Commission sought comment generally on which, if any, Commission rules (including Regulation SHO) would need to be amended, and whether there is a need to provide interpretive guidance concerning any Commission rules, to accommodate a T+2 standard settlement cycle. In addition, the Commission sought comment on operational issues that might arise by the application of Rule 200(g) of Regulation SHO relating to loaned but recalled securities being recalled on T+1 instead of T+2. The Commission received five comment letters relevant to the discussion of Regulation SHO in the T+2 Proposing Release.
147

147
FSR at 4; Fidelity at 3-4; SIFMA at 17-18; Thomson Reuters at 2; Guinn. One of these commenters expressed concerns about short selling generally and the negative effect of short selling on the market, but did not express a view on Regulation SHO.
See
Guinn.

Several commenters agreed with the Commission's preliminary views that shortening the settlement cycle to T+2 would impact other rules, and in particular, compliance with Regulation SHO.
148

Three commenters acknowledged that the close-out periods required by Rule 204 will accelerate because the Rule 204 close-out periods are measured from settlement date,
149

with one of the three raising the specific concern that the shorter timeframe may impact customers who do not make timely deliveries.
150

Despite this compression in the compliance timeframes under Rule 204, two of these commenters agreed with the Commission that because the text of Rule 204 does not explicitly reference T+3 as the standard “settlement date,” the rule is therefore unaffected by the amendment to Rule 15c6-1.
151

Three commenters also agreed that modification of existing interpretation or guidance concerning Regulation SHO was appropriate.
152

Two of these commenters specifically encouraged the Commission to revise the staff's Frequently Asked Questions on Regulation SHO on the Commission's Web site to clarify the implications of a move to T+2 settlement cycle and, in particular, that the close-out periods will shorten by a single day when measured from the trade date.
153

148
SIFMA at 17; Fidelity at 3-4; FSR at 4; Thomson Reuters at 2.

149
SIFMA at 17; Fidelity at 3; FSR at 4.

150
FSR at 4.

151
SIFMA at 17; Fidelity at 3.

152
SIFMA at 18; Fidelity at 3; Thomson Reuters at 2.

153
SIFMA at 18; Fidelity at 3.
See also
Division of Market Regulation: Responses to Frequently Asked Questions Concerning Regulation SHO, available at
https://www.sec.gov/divisions/marketreg/mrfaqregsho1204.htm
.

Several commenters noted the potential consequences to the securities lending markets, particularly with respect to recalling loans to settle transactions.
154

One of these commenters also raised concern that there would likely be an operational impact to stock loan departments in terms of policies and procedures and a need to train staff to adjust to a shortened recall cycle.
155

Two of these commenters believed that security lenders, security borrowers, and service providers are currently addressing the impact of a shortened settlement cycle on their business models and trading strategies, and in particular, that the move to T+2 will shorten the loan recall period by one day.
156

However, one of these two commenters stated that industry participants recognize and support the need for the move to T+2 settlement, despite the implication that this move will necessarily shorten the recall period by one day, and are prepared to make the necessary operational adjustments to accommodate this shortened period.

These changes, this commenter believed, were anticipated as part of the move to T+2 and its clients have been preparing accordingly.
157

Both of these commenters recommended the Commission modify its interpretation or guidance regarding the recall period so that it reflects the consequences of the move to T+2.
158

154
SIFMA at 18; Fidelity at 3; Thomson Reuters at 2.

155
Thomson Reuters at 2.

156
SIFMA at 18; Fidelity at 4.

157
SIFMA at 18.

158
SIFMA at 18; Fidelity at 4.

The Commission acknowledges that the amendment to Rule 15c6-1, as adopted, will operate to reduce the timeframes to effect a close-out under Rule 204. For example, the existing close-out requirement for fail to deliver positions resulting from short sales would be reduced from T+4 to T+3 based on the existing definition of settlement date in Rule 204.
159

Similarly, with regard to fails to deliver resulting from long sales or sales from bona fide market making activity, the existing close-out requirement would be reduced from T+6 to T+5. After considering comments, in particular that industry participants stated that they have either already anticipated the shortening of the Regulation SHO close-out period or are prepared to make the necessary operational adjustments, the Commission is not making any changes to the rule text of Regulation SHO.
160

159

See
17 CFR 242.204(g)(1).

160

See
17 CFR 200
et seq.

The Commission believes, however, that, to the extent that customers have not made timely deliveries and have caused a fail to deliver by a broker-dealer, any indirect impacts on such customers are warranted.
161

In addition, the Commission believes that a compliance date of September 5, 2017 will provide retail investors with time to become informed—either directly or through their broker-dealers—of the change to a T+2 standard settlement cycle and determine what changes to their own processes and behaviors may be necessary to participate in the market under a shorter settlement cycle.

161
In the Rule 204 Adopting Release, the Commission recognized that requiring broker-dealers to close-out fails to deliver promptly after they occur may result in costs to certain participants, but believed that “such costs are limited and are justified by the fact that the rule will continue our efforts to achieve our goals of reducing fails to deliver by maintaining the reductions in fails to deliver achieved by the adoption of temporary Rule 204T, as well as other actions taken by the Commission, and addressing potentially abusive `naked' short selling and, thereby help restore, maintain, and enhance investor confidence in the markets.” Rule 204 Adopting Release,
supra
note 137, 74 FR at 38286.

With regard to commenters' request to modify guidance regarding the recall of loaned securities to reflect the consequences of the move to T+2, the adoption of

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2017-06037. Public record. Not legal advice.