Shortening the Securities Transaction Settlement Cycle

Federal RegisterFeb 24, 2022

Ask Donna

What actually matters in this document.

Text

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 232, 240, and 275

[Release Nos. 34-94196, IA-5957; File No. S7-05-22]

RIN 3235-AN02

Shortening the Securities Transaction Settlement Cycle

AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rule.

SUMMARY:

The Securities and Exchange Commission (“Commission”) proposes rules to shorten the standard settlement cycle for most broker-dealer transactions from two business days after the trade date (“T+2”) to one business day after the trade date (“T+1”). To facilitate a T+1 standard settlement cycle, the Commission also proposes new requirements for the processing of institutional trades by broker-dealers, investment advisers, and certain clearing agencies. These requirements are designed to protect investors, reduce risk, and increase operational efficiency. The Commission proposes to require compliance with a T+1 standard settlement cycle, if adopted, by March 31, 2024. The Commission also solicits comment on how best to further advance beyond T+1.

DATES:

Comments should be received on or before April 11, 2022.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's internet comment form (

https://www.sec.gov/rules/submitcomments.htm

); or

• Send an email to

rule-comments@sec.gov.

Please include File Number S7-05-22 on the subject line.

Paper Comments

• Send paper comments to Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number S7-05-22. This file number should be included on the subject line if email is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's website (

http://www.sec.gov/rules/proposed.shtml

). Comments are also available for website viewing and printing in the Commission's Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. Operating conditions may limit access to the Commission's public reference room. All comments received will be posted without change. Persons submitting comments are cautioned that the Commission does not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly.

Studies, memoranda, or other substantive items may be added by the Commission or staff to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on the Commission's website. To ensure direct electronic receipt of such notifications, sign up through the “Stay Connected” option at

www.sec.gov

to receive notifications by email.

FOR FURTHER INFORMATION CONTACT:

Matthew Lee, Assistant Director, Susan Petersen, Special Counsel, Andrew Shanbrom, Special Counsel, Jesse Capelle, Special Counsel, Tanin Kazemi, Attorney-Adviser, or Mary Ann Callahan, Senior Policy Advisor, Office of Clearance and Settlement at (202) 551-5710, Division of Trading and Markets; Amy Miller, Senior Counsel, at (202) 551-4447, Emily Rowland, Senior Counsel, at (202) 551-6787, and Holly H. Miller, Senior Policy Advisor, at (202) 551-6706, Division of Investment Management; U.S. Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION:

The Commission proposes rules to shorten the standard settlement cycle to T+1 and improve the processing of institutional trades by broker-dealers, investment advisers, and certain clearing agencies. First, the Commission proposes to amend 17 CFR 240.15c6-1 (“Rule 15c6-1”) to shorten the standard settlement cycle for most broker-dealer transactions from T+2 to T+1 and to repeal the T+4 standard settlement cycle for firm commitment offerings priced after 4:30 p.m.,

as discussed in Part III.A. Second, the Commission proposes 17 CFR 240.15c6-2 (“Rule 15c6-2”) to prohibit broker-dealers from entering into contracts with their institutional customers unless those contracts require that the parties complete allocations, confirmations, and affirmations by the end of the trade date, a practice the securities industry has commonly referred to as “same-day affirmation,” as discussed in Part III.B. Third, the Commission proposes to amend 17 CFR 275.204-2 (“Rule 204-2”) to require investment advisers that are parties to contracts under Rule 15c6-2 to make and keep records of their allocations, confirmations, and affirmations described in Rule 15c6-2, as discussed in Part III.C. Fourth, the Commission proposes 17 CFR 240.17Ad-27 (“Rule 17Ad-27”) to require a clearing agency that is a central matching service provider (“CMSP”) to establish policies and procedures to facilitate straight-through processing, as discussed in Part III.D. To assess and manage the potential impact of a T+1 settlement cycle, the Commission is also soliciting comment on the following Commission rules and regulations: Regulation SHO; the financial responsibility rules for broker-dealers; requirements in 17 CFR 240.10b-10 (“Rule 10b-10”); and requirements related to prospectus delivery. The Commission proposes to require compliance with each of the proposed rules and rule amendments by March 31, 2024. The Commission solicits comment on this proposed compliance date in Part III.F.

See infra

Part III.A, notes 83-85, and accompanying text (discussing the types of securities to which Rule 15c6-1 applies, which includes equities, corporate bonds, unit investment trusts (“UITs”), mutual funds, exchange-traded funds (“ETFs”), American Depositary Receipts (“ADRs”), security-based swaps, and options).

In addition, accelerating beyond a T+1 settlement cycle to a same-day standard settlement cycle (

i.e.,

settlement no later than the end of trade date, or “T+0”) is an objective that the Commission is actively assessing; however, the Commission is not proposing rules to require a T+0 standard settlement cycle at this time. In Part IV, the Commission discusses and requests comment regarding potential pathways to T+0, as well as certain challenges to implementing T+0 that have been identified by market participants. The comments received will be used to inform any future action to further shorten the settlement cycle beyond T+1.

Table of Contents

I. Introduction

II. Background

A. Relevant History

B. Current State of Post-Trade Processing

1. Clearing Agencies—CCPs, CSDs, and CMSPs

2. Broker-Dealers

3. Retail and Institutional Investors

C. Recent Initiatives and Market Events

III. Proposals for T+1

A. Shortening the Length of the Standard Settlement Cycle

1. Proposed Amendment to Rule 15c6-1(a)

2. Basis for Shortening the Standard Settlement Cycle to T+1

3. Proposed Deletion of Rule 15c6-1(c) and Conforming Technical Amendments to Rule 15c6-1

4. Basis for Eliminating T+4 Standard for Certain Firm Commitment Offerings

5. Request for Comment

B. New Requirement for “Same-Day Affirmation”

1. Proposed Rule 15c6-2 Under the Exchange Act

2. Basis for Requiring Affirmation No Later Than the End of Trade Date

3. Request for Comment

C. Proposed Amendment to Recordkeeping Rule for Investment Advisers

1. Request for Comment

D. New Requirement for CMSPs To Facilitate Straight-Through Processing

1. Policies and Procedures To Facilitate Straight-Through Processing

2. Annual Report on Straight-Through Processing

3. Request for Comment

E. Impact on Certain Commission Rules and Guidance and SRO Rules

1. Regulation SHO Under the Exchange Act

2. Financial Responsibility Rules Under the Exchange Act

3. Rule 10b-10 Under the Exchange Act

4. Prospectus Delivery and “Access Versus Delivery”

5. Changes to SRO Rules and Operations

F. Proposed Compliance Date

IV. Pathways to T+0

A. Possible Approaches to Achieving T+0

1. Wide-Scale Implementation

2. Staggered Implementation Beginning With Key Infrastructure

3. Tiered Implementation Beginning With Pilot Programs

B. Issues To Consider for Implementing T+0

1. Maintaining Multilateral Netting at the End of Trade Date

2. Achieving Same-Day Settlement Processing

3. Enhancing Money Settlement

4. Mutual Fund and ETF Processing

5. Institutional Trade Processing

6. Securities Lending

7. Access to Funds and/or Prefunding of Transactions

8. Potential Mismatches of Settlement Cycles

9. Dematerialization

V. Economic Analysis

A. Background

B. Economic Baseline and Affected Parties

1. Central Counterparties

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

3. Investment Companies and Investment Advisers

4. 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+1 Settlement Cycle

D. Reasonable Alternatives

1. Amend 15c6-1(c) to T+2

2. Propose 17Ad-27 To Require Certain Outcomes

E. Request for Comment

VI. Paperwork Reduction Act

A. Proposed Amendment to Rule 204-2

B. Proposed Rule 17Ad-27

C. Request for Comment

VII. Small Business Regulatory Enforcement Fairness Act

VIII. Regulatory Flexibility Act

A. Proposed Rules and Amendments for Rules 15c6-1, 15c6-2, and 204-2

1. Reasons for, and Objectives of, the Proposed Actions

2. Legal Basis

3. Small Entities Subject to the Proposed Rule and Proposed Rule Amendments

4. Projected Reporting, Recordkeeping, and Other Compliance Requirements

5. Duplicative, Overlapping, or Conflicting Federal Rules

6. Significant Alternatives

7. Request for Comment

B. Proposed Rule 17Ad-27

Statutory Authority and Text of the Proposed Rules and Rule Amendments

I. Introduction

In the 1920s, capital markets maintained a one-day settlement cycle for transactions in securities.

Over the course of the twentieth century, the length of the settlement cycle grew to five days—a response to the ever-growing number of investors, the rising volume of transactions, and the increasing complexity of the processing infrastructure necessary to facilitate the settlement of those transactions.

Since the late 1980s, the Commission, seeking to protect investors and reduce risk, has been working with the securities industry to minimize the time it takes for securities transactions to settle. The first initiative to shorten the standard settlement cycle emerged following studies by government and industry groups after the October 1987 market break, including the Report of the Bachmann Task Force on Clearance and Settlement Reform in U.S. Securities Markets.

The Bachmann Report presented multiple recommendations to improve the securities market by improving the safety and soundness of the National C&S System.

The Bachmann Report, submitted to the Commission in May 1992, recommended that by 1994 the Commission shorten the standard settlement cycle from five days to three days.

See

Kenneth S. Levine, Was Trade Settlement Always on T+3? A History of Clearing and Settlement Changes, Friends of Financial History No. 56, at 20, 22 (Summer 1996),

https://archive.org/details/friendsoffinanci00muse_12/page/20/mode/2up?view=theater.

See

Levine,

supra

note 2, at 23-25.

See

Report of the Bachmann Task Force on Clearance and Settlement Reform in U.S. Securities Markets, Submitted to The Chairman of the U.S. Securities and Exchange Commission (May 1992) (“Bachmann Report”),

https://www.govinfo.gov/content/pkg/FR-1992-06-22/pdf/FR-1992-06-22.pdf.

The task force was headed by John W. Bachmann, the Managing Principal of Edward D. Jones & Co. of St. Louis, Missouri. The recommendations in the Bachmann Report were intended to help inform the Commission's approach to considering reforms of the national system for clearance and settlement (“National C&S System”).

See id.

To support its recommendation, the Bachmann Report used the concept “time equals risk” to illustrate that “less time between a transaction and its completion reduces risk.”

In addition, the report stated that a “shorter settlement cycle will also uncover potential problems sooner, before they mushroom or begin to cascade throughout the industry.”

In recommending that the Commission shorten the standard settlement cycle, the Bachmann Report also stated, “[t]he system and legal initiatives necessary to accomplish the T+3 settlement for corporate and municipal securities should serve as a stepping stone to further reductions in settlement periods over time as technology and systems permit.”

See id.

at 4. Specifically, the concept posits that the length of time between the execution and settlement of a securities transaction correlates to the financial risk exposure inherent in the transaction, and that shortening this length of time can reduce the overall risk exposure.

Id.

at 6.

In 1993, the Commission adopted Rule 15c6-1 to shorten this process by requiring the settlement of most securities transactions within three business days (“T+3”),

and in 2017, the Commission amended the rule to require settlement within two business days (“T+2”).

The Commission believes that further shortening of the settlement cycle would promote investor protection, reduce risk, and increase operational efficiency. This view has been informed by two recent episodes of increased market volatility—in March 2020 following the outbreak of the COVID-19 pandemic, and in January 2021 following heightened interest in certain “meme” stocks.

Exchange Act Release No. 33023 (Oct. 6, 1993), 58 FR 52891 (Oct. 13, 1993) (“T+3 Adopting Release”). In adopting Rule 15c6-1, the Commission set a compliance date of June 1, 1995.

Exchange Act Release No. 80295 (Mar. 22, 2017), 82 FR 15564, 15601 (Mar. 29, 2017) (“T+2 Adopting Release”).

These two episodes have highlighted potential vulnerabilities in the U.S. securities market that shortening the standard settlement cycle could help mitigate.

Accordingly, the Commission is proposing a transition to a T+1 standard settlement cycle. The Commission also believes that achieving settlement by the end of trade date (“T+0”) could benefit investors as well.

While the Commission is not proposing a T+0 standard settlement cycle at this time, the Commission would like to better understand the challenges that market participants may need to address and resolve to achieve T+0. Accordingly, the Commission solicits comments on potential paths to and challenges associated with achieving a T+0 standard settlement cycle in Part IV.

See, e.g.,

Staff Report on Equity and Options Market Structure Conditions in Early 2021 (Oct. 14, 2021),

https://www.sec.gov/files/staff-report-equity-options-market-struction-conditions-early-2021.pdf.

This report represents the views of Commission staff. It is not a rule, regulation, or statement of the Commission. The Commission has neither approved nor disapproved its content. This report, like all staff reports, has no legal force or effect: It does not alter or amend applicable law, and it creates no new or additional obligations for any person.

In this release, the Commission uses “T+0” to refer to a settlement cycle that is complete by the end of the day on which the trade was executed (“trade date”). This is sometimes referred to as “same-day” settlement and is distinct from real-time settlement, which contemplates settlement in real time or near real time (

i.e.,

immediately following trade execution) on a gross basis.

See infra

Part IV (further discussing the concept of “T+0” as used in this release, as well as the related concepts of real-time settlement and rolling settlement, where trades are netted and settled intraday on a recurring basis).

Part IV discusses potential paths to and challenges associated with implementing a T+0 settlement cycle. For example, activities that are linked to the length of the settlement cycle include securities lending activities.

See infra

Part IV.B.6.

On December 1, 2021, the Depository Trust and Clearing Corporation (“DTCC”),

the Investment Company Institute (“ICI”),

the Securities Industry and Financial Markets Association (“SIFMA”),

and Deloitte & Touche LLP (“Deloitte”)

published a report that presented industry recommendations to implement a T+1 standard settlement cycle in the U.S.

The Commission has considered the potential requirements, benefits, and costs associated with further shortening the standard settlement cycle in the U.S., and proposes to require that the standard settlement cycle transition to T+1, if adopted, by March 31, 2024.

As the securities industry considers how it would implement T+1, the Commission believes that market participants also generally should consider investments in new technology or operations now that can be effective over the long term at maximizing the benefits of risk reduction and improved efficiency in post-trade processing that accompany shortening the settlement cycle, mindful of efforts to shorten the settlement cycle beyond T+1.

DTCC is the holding company for three registered clearing agencies: The Depository Trust Company (“DTC”), the National Securities Clearing Corporation (“NSCC”), and the Fixed Income Clearing Corporation (“FICC”). It is also the holding company for DTCC ITP Matching (US) LLC (“DTCC ITP Matching”), which operates a CMSP pursuant to an exemption from registration as a clearing agency.

ICI is an association representing regulated funds globally, including mutual funds, ETFs, closed-end funds, and unit investment trusts in the United States, and similar funds offered to investors in jurisdictions worldwide.

SIFMA is a trade association for broker-dealers, investment banks, and asset managers operating in the U.S. and global capital markets.

See infra

note 18.

Deloitte, DTCC, ICI, & SIFMA, Accelerating the U.S. Securities Settlement Cycle to T+1 (Dec. 1, 2021) (“T+1 Report”),

https://www.sifma.org/wp-content/uploads/2021/12/Accelerating-the-U.S.-Securities-Settlement-Cycle-to-T1-December-1-2021.pdf. See infra

Part II.C (summarizing the recommendations in the T+1 Report).

See infra

Part III.F (discussing the proposed compliance date). The T+1 Report contemplates implementation of T+1 in the first half of 2024, and the Commission believes that sufficient time is available to achieve T+1 by March 31, 2024, as discussed further in Part III.F.

In Part II, the Commission provides (i) a history of the key Commission and industry efforts to shorten the standard settlement cycle, including past concerns related to T+1 and T+0 settlement cycles, (ii) an overview of the current state of post-trade processing in the market for U.S. equity securities, and (iii) a summary of other recent market events related to this rule proposal. In Part III, the Commission describes the rule proposals that are necessary to achieve T+1. In Part IV, the Commission discusses the potential pathways and challenges associated with implementing a standard T+0 settlement cycle and requests comment on any and all aspects of achieving T+0.

II. Background

In developing the rule proposals included in this release, the Commission considered the history related to shortening the standard settlement cycle, the current state of post-trade processing in the U.S. equities market, and recent initiatives and market events that have focused attention in the securities industry and the public on the appropriate length of the standard settlement cycle. Each of these is discussed further below.

A. Relevant History

The first industry-level engagement on T+1 began in the late 1990s and developed a business case for using straight-through processing to achieve T+1,

estimating that an industry investment of $8 billion in improved settlement technologies and processes could reduce settlement exposures by 67% and return $2.7 billion in annual savings. Implementation of the building blocks described in the Securities Industry Association (“SIA”) Business Case Report was postponed when improving operational resilience following the terrorist attacks of September 11, 2001 took priority,

although many of them were subsequently achieved.

The term “straight-through processing” generally refers to processes that allow for the automation of the entire trade process from trade execution through settlement without manual intervention.

See infra

Part III.D.1 (further discussing the concept of straight-through processing).

See

SIA, T+1 Business Case Final Report (July 2000) (“SIA Business Case Report”),

https://www.sifma.org/wp-content/uploads/2017/05/t1-business-case-final-report.pdf.

In 2012, DTCC commissioned a new study that found moving to a T+2 settlement cycle would be significantly less costly and take less time to implement than either an immediate or gradual transition to T+1, while still delivering significant benefits with respect to reducing risks and costs.

The BCG Study ruled out as infeasible at the time a settlement cycle with settlement on trade date (

i.e.,

T+0) “given the exceptional changes required to achieve it and weak support across the industry.”

It concluded that a T+0 settlement cycle would face major challenges with processes such as trade reconciliation and exception management, securities lending, and transactions with foreign counterparties (especially where time zones are least aligned). It also concluded that payment systems used for final settlement would need to be significantly altered to enable transactions late in the day. The BCG Study noted that market participants were aware that a T+2 settlement cycle could be accomplished through mere compression of timeframes and corresponding rule changes but that implementing T+2 without certain building blocks would limit the amount of savings that would be realized across the industry.

See

The Boston Consulting Group (“BCG”), Cost Benefit Analysis of Shortening the Settlement Cycle (Oct. 2012) (“BCG Study”),

https://www.dtcc.com/~/media/Files/Downloads/WhitePapers/CBA_BCG_Shortening_the_Settlement_Cycle_October2012.pdf.

Id.

at 9.

The BCG Study further concluded that moving to a T+1 settlement cycle would require new infrastructure to enable near real-time trade processing and would also require transforming the securities lending and foreign buyer processes.

Id.

In 2014, DTCC, ICI, SIFMA, and other market participants formed an Industry Steering Group (“ISG”) to facilitate a transition to T+2.

The ISG and PricewaterhouseCoopers LLP published a white paper describing certain “industry-level requirements” and “sub-requirements” that the ISG believed would be required for a successful migration to a T+2 settlement cycle.

In conjunction with the ISG, Deloitte published in December 2015 a “T+2 Playbook” setting forth the requested implementation timeline with milestones and dependencies, as well as detailing “remedial activities” that impacted market participants should consider to prepare for migration to T+2.

The ISG White Paper also included an implementation timeline that targeted the transition for the end of the third quarter of 2017.

See

Press Release, DTCC, Industry Steering Committee and Working Group Formed to Drive Implementation of T+2 in the U.S. (Oct. 16, 2014),

http://www.dtcc.com/news/2014/october/16/ust2.aspx.

PricewaterhouseCoopers LLP & ISG, Shortening the Settlement Cycle: The Move to T+2 (June 2015) (“ISG White Paper”),

http://www.ust2.com/pdfs/ssc.pdf.

This release uses “ISG” rather than “ISC” (“Industry Steering Committee,” the term used in the ISG White Paper) when referring to the T+2 effort so that this release clearly distinguishes between the ISC's current work on T+1, as reflected in the T+1 Report,

supra

note 18, from past work on T+2.

Deloitte & ISG, T+2 Industry Implementation Playbook (Dec. 18, 2015) (“T+2 Playbook”),

http://www.ust2.com/pdfs/T2-Playbook-12-21-15.pdf.

In 2015, the Commission's Investor Advisory Committee recommended that the Commission pursue T+1 (rather than T+2), noting that retail investors would significantly benefit from a T+1 standard settlement cycle.

In the event that the Commission determined to pursue a T+2 standard settlement cycle, the IAC recommended that the Commission work with industry participants to create a clear plan for moving to T+1 shortly thereafter.

Investor Advisory Committee (“IAC”), U.S. Securities and Exchange Commission, Recommendation of the Investor Advisory Committee: Shortening the Settlement Cycle in U.S. Financial Markets (Feb. 12, 2015),

https://www.sec.gov/spotlight/investor-advisory-committee-2012/settlement-cycle-recommendation-final.pdf.

Id.

The Commission amended Rule 15c6-1 in 2017 to shorten the standard settlement cycle from T+3 to T+2 and set a compliance date for September 2017.

The Commission recognized that the clearance and settlement process for securities transactions encompassed by the rule involved a number of market participants and entities whose functions and capabilities would be impacted significantly by a change in the standard settlement cycle, and the Commission considered these in its analysis supporting the move to T+2. Among these entities were the NSCC and the DTC, which respectively operate the central counterparty (“CCP”) and central securities depository (“CSD”) for transactions in U.S. equity securities,

three CMSPs,

and the diverse population of market participants that depend on the clearance and settlement services provided by NSCC, DTC, and the CMSPs. These market participants include but are not limited to, retail and institutional investors, registered investment advisers, broker-dealers, exchanges, alternative trading systems, service providers, and custodian banks.

T+2 Adopting Release,

supra

note 10;

see also

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

NSCC and DTC are subsidiaries of DTCC and each a clearing agency registered with the Commission.

See supra

note 14.

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); 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) (“BSTP and SS&C Order”). In the T+2 Adopting Release, the Commission also referred to these entities as “matching and electronic trade confirmation service providers.” T+2 Adopting Release,

supra

note 10, at 15566.

In the T+2 Adopting Release, the Commission explained that a T+1 standard settlement cycle could produce greater reductions in market, credit, and liquidity risk for market participants than a move to T+2, but that shortening beyond T+2 would require significantly larger investments in new systems and processes.

In an effort to analyze, among other things, the impacts of further shortening beyond T+2, the Commission directed Commission staff to study the issue.

As a result of the staff's study and analysis of the settlement cycle, the Commission believes that, among other things, improvements to institutional trade processing are critical to promoting the operational efficiency necessary to facilitate a standard settlement cycle shorter than T+2, as discussed further in Part III.B below.

T+2 Adopting Release,

supra

note 10, at 15582.

Id.

at 15582-83.

B. Current State of Post-Trade Processing

In the T+2 Proposing Release, the Commission provided a detailed overview of post-trade processing for transactions in equity securities, including the roles of the CCP, the CSD, and CMSPs.

The Commission also provided a summary of the affected market participants—investors, broker-dealers, prime broker-dealers (“prime brokers”), and custodian banks—and described at a high level the different paths to settlement available depending on whether a transaction involves a retail or institutional investor.

While this overview remains an accurate summary of the post-trade process, the Commission recognizes that shortening the standard settlement cycle beyond T+2 will require particular focus on improving institutional trade processing.

T+2 Proposing Release,

supra

note 30, at 69243-46.

As in the T+2 Proposing Release, the distinction between “retail investor” and “institutional investor” is made only for the purpose of illustrating the manner in which these types of entities generally clear and settle their securities transactions.

To provide context for understanding the Commission's rule proposals and the related economic analysis that follows in this release, the Commission provides below an overview of the current state of post-trade processing, including a brief summary of trade flows relevant to the processing of institutional trades. As a general matter, investors often rely on securities intermediaries to facilitate the clearance and settlement of their securities transactions. These intermediaries include broker-dealers, which maintain a securities account on the investor's behalf to facilitate purchases and sales of securities, and clearing agencies, which provide a range of services designed to facilitate the clearance and settlement of a securities transaction. As relevant to this release, a clearing agency may act as a CCP, a CSD, or a CMSP. The role of each of these entities is explained further below.

1. Clearing Agencies—CCPs, CSDs, and CMSPs

As explained more fully in the T+2 Proposing Release,

a CCP interposes itself between the counterparties to a trade following trade execution, becoming the buyer to each seller and seller to each buyer to ensure the performance of open contracts. One critical function of a CCP is to eliminate bilateral credit risk between individual buyers and sellers. NSCC is a registered

clearing agency that provides CCP services for transactions in U.S. equity securities to its members.

NSCC facilitates the management of risk among its members using a number of tools, which include: (1) Novating and guaranteeing trades to assume the credit risk of the original counterparties; (2) 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;

and (3) netting to reduce NSCC's overall exposure to its counterparties.

T+2 Proposing Release,

supra

note 30, at 69243.

As discussed further in the T+2 Proposing Release, NSCC also provides CCP services for other types of securities, including corporate bonds, municipal securities, and UITs.

Id.

Commission rules require a covered clearing agency that provides CCP services to have policies and procedures reasonably designed to maintain financial resources that cover a wide range of foreseeable stress scenarios that include, but are not limited to, the default of the participant family that would potentially cause the largest aggregate credit exposure for the covered clearing agency in extreme but plausible market conditions.

See

17 CFR 240.17Ad-22(e)(4)(iii).

These functions are discussed in more detail in the T+2 Proposing Release.

See

T+2 Proposing Release,

supra

note 30, at 69243. Since publication of the T+2 Proposing Release, NSCC has amended its rules to provide a trade guarantee as soon as NSCC has validated the trade upon submission for clearing.

As discussed further in Part V.B.1, CCP netting reduces risk in the settlement process by reducing the overall number of obligations that must be settled. NSCC's netting and accounting system is called the Continuous Net Settlement System (“CNS”). NSCC accepts trades into CNS for clearing from the nation's exchanges and other trading venues, and it uses CNS to net each NSCC member's trades in each security traded that day to a single position for each security, either long (

i.e.,

the right to receive securities) or short (

i.e.,

an obligation to deliver securities). Throughout the day, NSCC records cash debit and credit data generated by its members' activities, and at the end of the processing day, NSCC nets the debits and credits to produce one aggregate cash debit or credit for each member.

The operation of CNS is explained more fully in the T+2 Proposing Release.

See id.

at 69244.

While NSCC provides final settlement instructions to its members each day, the payment for and transfer of securities ownership occurs at DTC, which serves as the CSD and settlement system for U.S. equity securities. At the conclusion of each trading day, an NSCC member's short and long positions are compared against its corresponding DTC account to determine whether securities are available for settlement. If securities are available, they will be transferred to cover the NSCC member's short positions. Specifically, on settlement date NSCC submits instructions to DTC to deliver (

i.e.,

transfer) securities positions for each security netted through CNS to 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.

The interaction between NSCC and DTC to achieve settlement is explained more fully in the T+2 Proposing Release.

See id.

at 69245.

As noted above, DTC is a CSD, which is an entity that holds securities for its participants either in certificated or uncertificated (

i.e.,

immobilized or dematerialized) form so that ownership can be easily transferred through a book entry (rather than the transfer of physical certificates) and provides central safekeeping and other asset services. Additionally, a CSD may operate a securities settlement system, which is a set of arrangements that enables transfers of securities, either for payment or free of payment, and facilitates the payment process associated with such transfers. DTC serves as the CSD and settlement system for most U.S. equity securities, providing custody and book-entry services.

In accordance with its rules, DTC accepts deposits of securities from its participants, credits those securities to the depositing participants' accounts, and effects book-entry transfer of those securities. DTC substantially reduces the number of physical securities certificates transferred in the U.S. markets, which significantly improves operational efficiencies and reduces risk and costs associated with the processing of physical securities certificates.

DTC's role as CSD is discussed more fully in the T+2 Proposing Release.

See id.

at 69245-46. As of 2017, DTC retained custody of more than 1.3 million active securities issues valued at $54.2 trillion, including securities issued in the U.S. and 131 other countries and territories.

See

DTCC, Businesses and Subsidiaries: The Depository Trust Company (DTC),

https://www.dtcc.com/about/businesses-and-subsidiaries/dtc.

The corporate bond market accounted for another $30 billion and the municipal bond market saw over $10 billion on average traded every day in 2016.

See

SIFMA, T+2 Fact Sheet,

https://www.sifma.org/wp-content/uploads/2017/09/Sep-8-T2-Update-Fact-Sheet.pdf.

In addition to a securities account at DTC, each DTC participant has a settlement account at a clearing bank to record any net funds obligation for end-of-day settlement. 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 fund 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 Service (“NSS”) of the Federal Reserve System.

The relevance of NSS to achieving money settlement in a T+0 environment is discussed in Part IV.B.3.

CMSPs electronically facilitate communication among a broker-dealer, an institutional investor or its investment adviser, and the institutional investor's custodian to reach agreement on the details of a securities trade.

These entities emerged as a result of efforts by market participants to develop a more efficient and automated matching process that continues to be viewed as a necessary step in achieving straight-through processing for the settlement of institutional trades.

The role of the CMSP in facilitating settlement is discussed more fully in the T+2 Proposing Release.

See

T+2 Proposing Release,

supra

note 30, at 69246.

CMSPs provide the communication facilities to enable a broker-dealer and an institutional investor to send messages back and forth that results in the agreement of the trade details, generally referred to as an “affirmation” or “affirmed confirmation,” which is then sent to DTC to effect settlement of the trade.

In general, the formatting and content of messages used to communicate confirmations and affirmations varies and may include use of, for example, SWIFT, FIX, ISITC, or other formats. The delivery method of such messages also may vary across market participants. The CMSP, by acting as a centralized hub, helps promote standardization and facilitate communication.

Specifically, the CMSP will send the affirmed confirmations to DTC where the DTC participants, who will deliver the securities, will authorize the trades for automated settlement.

In addition, a CMSP may offer a “matching” process by which it compares and reconciles the broker-dealer's trade details with the institutional investor's trade details to determine whether the two descriptions of the trade agree, at which point it can generate an affirmation to effect settlement of the trade. As part of such process, the CMSP may offer services that can assist with the automated identification of trades that do not match, allowing market participants to identify errors and remediate any trade information that does not match.

2. Broker-Dealers

Broker-dealers are securities intermediaries that, among other things, may hold accounts on behalf of investors to facilitate the purchase and sale of securities transactions. Broker-dealers that are direct members of clearing agencies are typically referred to as “clearing brokers.” Clearing brokers must comply with the rules of the clearing agency, including but not limited to rules for operational and financial requirements.

Broker-dealers that submit transactions to a clearing agency through a clearing broker are typically referred to as “introducing brokers.” In general, broker-dealers executing trades on a registered securities exchange are required to clear those transactions through a registered clearing agency. Broker-dealers executing trades outside the auspices of a trading venue (

e.g.,

on an internalized basis) may clear through a clearing agency or may choose to settle those trades through mechanisms internal to that broker-dealer.

The requirements for membership or participation established by the clearing agencies are discussed more fully in the T+2 Proposing Release.

See

T+2 Proposing Release,

supra

note 30, at 69247.

3. Retail and Institutional Investors

As discussed in the T+2 Proposing Release, institutional investors are entities such as, but not limited to, pension funds, mutual 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 CMSPs, bank custodians, or prime brokers, and the need to manage certain regulatory or business obligations.

By contrast, the settlement of retail investor trades generally occurs directly with the investor's broker-dealer,

without relying on a separate custodian bank or prime broker.

Institutional investors also include employee-benefit plans, foundations, endowments, insurance companies and registered investment companies (“RICs”) (of which mutual funds are one type), among other investor types.

See

T+2 Proposing Release,

supra

note 30, at 69247 (discussing the same).

As previously discussed, if the broker-dealer is an introducing broker-dealer, the broker-dealer may use a clearing broker-dealer to facilitate clearance and settlement.

See id.

(discussing the same).

Institutional investors may choose to trade through an executing broker-dealer that clears and settles its securities transactions using NSCC and DTC. However, depending on the size and complexity of the trade and the number of trading partners involved in the transaction, institutional investors may also choose to avail themselves of processes specifically designed to address the unique aspects of their trades. Specifically, as described below, many institutional trades settle on an allocated trade-for-trade basis through a custodian bank. Many hedge funds settle their trades using prime brokers.

Below are diagrams that illustrate at a high level the typical path to settlement for retail trades and institutional trades.

(a) Retail Trades

In general, individual retail investors rely on their broker-dealers to execute trades on their behalf as customers of their broker-dealers. As previously discussed, a broker-dealer may choose to internalize a customer's order using its own inventory of securities. However, the broker-dealer may also take other steps, away from its customer, to deliver securities to its customer's account. Depending on how the broker-dealer executes such trades away from its customer, these other trades may clear through a clearing agency or may settle bilaterally.

Retail investors may engage in “self-directed” trading. Figure 1 illustrates, at a high level, the activities that take place for a self-directed retail trade. In this scenario, when a retail investor places an order to trade with its counterparty, the counterparty—typically, the broker-dealer through which the retail investor holds its securities account—will execute the trade. The counterparty will issue a trade confirmation identifying certain trade details, such as the transaction type, the account information, the security and quantity of shares traded, the trade and settlement dates, and the net amount of money to be received or paid at settlement.

The confirmation may also include other financial details, such as commissions, taxes, and fees. A retail investor generally would review the information provided in the confirmation and contact its broker-dealer to correct any errors. In the absence of errors, the broker-dealer can proceed with settlement processing.

See infra

Part III.B.1 (further discussing trade confirmations and distinguishing the requirements with respect to a confirmation under existing Rule 10b-10 and a confirmation under proposed Rule 15c6-2).

BILLING CODE 8011-01-P

EP24FE22.000

In some instances, self-directed retail trades and trades directed by an investment adviser are executed together as part of a block trade initiated by an investment adviser, which could also engage the use of a CMSP to communicate the allocations of the block trade to participating accounts.

Further discussion of institutional trades and the use of block trades by institutional investors follows below.

See supra

Part II.B.1 (discussing the services provided by a CMSP);

infra

Part II.B.3.c) (discussing block trades).

(b) Institutional Trades

Institutional investors often engage a broker-dealer or another counterparty for trade execution, and separately, a bank custodian to provide custodial safekeeping and asset servicing for their investments.

Because the counterparty and the custodian are different entities in this scenario, additional steps are necessary to complete the post-trade process, as identified by the black shapes in Figure 2. Specifically, the institutional investor or its investment adviser will need to instruct the bank custodian on the details of each transaction and authorize the bank custodian to settle the trade. The black shapes in Figure 2 also illustrate how the investor's counterparty generally will provide the institutional investor or investment adviser with execution details prior to issuing a trade confirmation.

Some institutional investors use broker-dealers to custody their securities, and in such cases their transactions will trade and settle as described in Figure 1. In this release, we have grouped such circumstances under the retail investor scenario because of the similar transaction flow.

An electronic copy of the execution details is sometimes referred to as a “notice of execution.”

EP24FE22.001

Institutional investors, along with their broker-dealers and bank custodians, may rely on the services of a CMSP to transmit confirmations and affirmations or match the trade details to prepare a trade for settlement. Alternatively, they may use other standardized messaging protocols, such as FIX and SWIFT,

to communicate trade information. Some market participants, however, still rely on manual processes to communicate trade information, such as through the use of fax machines or email, and may use Excel data files rather than standardized data protocols.

Whichever the mechanism, achieving an affirmed confirmation by the end of trade date is considered a securities industry best practice.

According to data from DTCC, however, only 68% of trades are affirmed on trade date.

Figure 2 illustrates a scenario where the institutional investor does not rely on a CMSP to complete the confirmation/affirmation process.

See

T+1 Report,

supra

note 18, at 5.

Protocols are the rules that govern the exchange or transmission of data and may refer to the specific content and formatting of trade information (

i.e.,

ISO15022, FIX, SWIFT or an Excel template), the method for delivery trade information (

i.e.,

file transfer protocol (FTP), SSH file transfer protocol (SFTP), SWIFT, DTC ITP, email, etc.), or both. They may also refer to the frequency of transmission, deadlines for data delivery, and whether data is sent for individual trades or a group (or “batch”) of trades. Some delivery mechanisms may offer a hub-and-spoke model for delivery, in which the sender delivers data to a central hub and the hub passes the data on to identified recipients. Other delivery mechanisms are bi-lateral, in which the sender and receiver have a direct communication with one another without transmission through a hub.

See

T+1 Report,

supra

note 18, at 8-9.

Sean McEntee, Executive Director, ITP Product Management, DTCC, Remarks at the DTCC ITP Forum—Americas (June 17, 2021) (“DTCC ITP Forum Remarks”) (recording available at

https://www.dtcc.com/events/archives

For some institutional investors, such as hedge funds, a prime broker may act as both the counterparty to the trade and the custodian of the securities. In this scenario, the institutional investor or its investment adviser provides trade details to the prime broker, and the prime broker will affirm the transaction to facilitate settlement. As a broker-dealer, the prime broker may also use NSCC to clear the transaction. Generally, the Commission understands that the prime broker will “disaffirm” a transaction if the institutional investor does not make margin payments required of the investor by the prime broker.

Investment advisers commonly trade in “blocks” to manage the accounts of their institutional clients. In such a scenario, investment advisers aggregate the orders of multiple clients into a block for trade execution. After trade execution of the block order by the broker-dealer, the investment adviser

will allocate securities within the block to the accounts of its clients participating in the block, as reflected in Figure 3. These allocation instructions are communicated to the broker-dealer so that the broker-dealer can generate a confirmation of the trade details for each account for the investment adviser to affirm.

EP24FE22.002

BILLING CODE 8011-01-C

C. Recent Initiatives and Market Events

Efforts to facilitate a settlement cycle shorter than T+2 began soon after the transition to a T+2 standard settlement cycle had been completed. For example, DTCC announced two initiatives in January 2018 to achieve additional operational and capital efficiencies, dubbed “Accelerating Time to Settlement” and “Settlement Optimization.”

Among other things, the DTCC-owned clearing agencies have been exploring steps to modify their settlement process to be more efficient, such as by introducing new algorithms to position more transactions for settlement during the “night cycle” process (which currently begins in the evening of T+1) to reduce the need for activity on the day of settlement. Portions of these two initiatives have been submitted to the Commission and approved as proposed rule changes.

DTCC, Modernizing the U.S. Equity Markets Post-Trade Infrastructure (Jan. 2018) (“DTCC Modernizing Paper”),

https://www.dtcc.com/~/media/Files/downloads/Thought-leadership/modernizing-the-u-s-equity-markets-post-trade-infrastructure.pdf.

These initiatives are relevant to the discussion of T+0 building blocks related to netting and batch processing, as discussed in Part IV.B.1 and Part IV.B.2.

See, e.g.,

Exchange Act Release No. 87022 (Sept. 19, 2019), 84 FR 50541 (Sept. 25, 2019) (order amending NSCC's settlement guide to implement a new algorithm for night cycle transactions); Exchange Act Release No. 87756 (Dec. 16, 2019), 84 FR 70256 (Dec. 20, 2019) (order extending the implementation timeframe for the new algorithm for transactions processed in the night cycle); Exchange Act Release No. 87023 (Sept. 19, 2019), 84 FR 50532 (Sept. 25, 2019) (order amending the CNS Accounting Operation of NSCC's Rules & Procedures with respect to receipt of securities from NSCC's CNS System).

More recently, periods of increased market volatility—first in March 2020 following the outbreak of the COVID-19 pandemic, and again in January 2021 following heightened interest in certain “meme” stocks—highlighted the significance of the settlement cycle to the calculation of financial exposures and exposed potential risks to the stability of the U.S. securities market.

Specifically, these two events have expanded a public debate over the length of the settlement cycle, and whether a shorter settlement cycle could have reduced the impact of the market volatility on investors by, among other things, reducing the length of time over which a broker-dealer member of NSCC is required to provide margin deposits with respect to a given transaction, thereby also potentially reducing the size of the deposits required per portfolio to manage the increased volatility.

According to DTCC, on March 12, 2020, NSCC processed over 363 million market-side transactions in equity securities, topping by 15% its prior peak set in October 2008 during the financial crisis. On an average day, NSCC processes approximately 106 million market-side transactions. DTCC, Advancing Together: Leading the Industry to Accelerated Settlement, at 4 (Feb. 2021) (“DTCC White Paper”),

https://www.dtcc.com/-/media/Files/PDFs/White%20Paper/DTCC-Accelerated-Settle-WP-2021.pdf.

In February 2021, DTCC published the DTCC White Paper stating that accelerating settlement beyond T+2 may bring significant benefits to market participants but requires careful consideration and a balanced approach so that settlement can be achieved as close to the trade as possible without creating capital inefficiencies or introducing new, unintended consequences—such as inadvertently reducing or eliminating the benefits and cost savings provided by multilateral netting.

DTCC suggested that shortening the settlement cycle to T+1 could occur in the second half of 2023, and it estimated that a T+1 settlement cycle could reduce the volatility component of NSCC margin requirements by up to 41%.

DTCC also contended that achieving T+1 could be largely supported by using existing systems and available tools and procedures.

With respect to a T+0 settlement cycle, DTCC distinguished between netted T+0 settlement and real-time gross settlement,

noting that in a netted settlement environment, trades would be netted either during the day or prior to settlement at the end of the day; with real-time gross settlement, trades would be settled instantaneously without netting. Currently, the DTCC clearing agencies can facilitate settlement on either T+1 or T+0 pursuant to their rules and procedures for accelerated settlement.

The DTCC White Paper explained that DTCC's participants believe “the hurdles to T+0 settlement,” especially real-time gross settlement, are “too great at this time.”

Furthermore, DTCC noted that real-time gross settlement could require trades to be funded on a trade-for-trade basis, eliminating the liquidity and risk-reduction benefits of existing CCP netting processes.

Additionally, DTCC indicated that over the past year it has been working collaboratively with a cross-section of market participants to build support for further shortening of the settlement cycle, and has outlined a plan to increase these efforts to forge a consensus on setting a firm date and approach to achieving a transition to T+1.

Id.

at 2. The DTCC White Paper notes that centralized multilateral netting reduces the value of payments that need to be exchanged each day by an average of 98%, and netting is particularly important during times of heightened volatility and volume.

Id.

at 5, 8.

Id.

at 5.

See supra

note 12 and accompanying text (making the same distinction);

infra

Part IV (discussing three potential models for T+0 settlement, and soliciting comment on these models).

See, e.g.,

DTCC, Same-Day Settlement (SDS),

https://www.dtcc.com/sds.

DTCC White Paper,

supra

note 61, at 7.

Id.

See

Press Release, DTCC, DTCC Proposes Approach to Shortening U.S. Settlement Cycle to T+1 Within 2 Years (Feb. 24, 2021),

https://www.dtcc.com/news/2021/february/24/dtcc-proposes-approach-to-shortening-us-settlement-cycle-to-t1-within-two-years.

Following publication of the DTCC White Paper, the securities industry formed an Industry Steering Committee (“ISC”) and an Industry Working Group (“IWG”)

with the intent of developing industry consensus for an accelerated settlement cycle transition, including to understand the impacts, evaluate the potential risks, and develop an implementation approach. To support this effort, the ISC engaged Deloitte to facilitate the IWG's analysis of the benefits and barriers to moving to T+1, and coordinate with the industry on recommending solutions for the transition.

In April 2021, DTCC, ICI, and SIFMA issued a joint press release to announce their collaboration “on efforts to accelerate the U.S. securities settlement cycle from T+2 to T+1.”

IWG participation consisted of over 800 subject matter advisors representing over 160 firms from buy- and sell-side firms, custodians, vendors, and clearinghouses. T+1 Report,

supra

note 18, at 4.

Id.

See

Press Release, DTCC, SIFMA, ICI and DTCC Leading Effort to Shorten U.S. Securities Settlement Cycle to T+1, Collaborating with the Industry on Next Steps (Apr. 28, 2021),

https://www.dtcc.com/news/2021/april/28/sifma-ici-and-dtcc-leading-effort-to-shorten-us-securities-settlement-cycle-to-t1.

As stated above, on December 1, 2021, DTCC, SIFMA and ICI, together with Deloitte, published the T+1 Report, which outlined the ISC's recommendations for achieving a T+1 standard settlement cycle, and proposed transitioning to T+1 settlement by the second quarter of 2024.

These recommendations focused on the following topics: Allocation and confirmation of institutional trades, trade documentation, global settlement and FX markets, corporate actions, prime brokerage services, securities lending, settlement errors and fails, creation and redemption of exchange traded funds (“ETFs”), equity and debt offerings, and regulatory requirements.

See

T+1 Report,

supra

note 18.

Id.

In addition to presenting the ISC's recommendations regarding the requirements for moving to T+1, the T+1 Report stated that the IWG also considered the impacts and benefits of moving to T+0 settlement.

The ISC and IWG concluded, by consensus, that T+0 is not achievable in the short term given the current state of the settlement ecosystem.

The T+1 Report stated that a move towards a shortening of the settlement cycle to T+0 would require an overall modernization of current-day clearance and settlement infrastructure, changes to business models, revisions to industry-wide regulatory frameworks, and the potential implementation of real-time currency movements to facilitate such a change.

Additionally, the IWG indicated that “adoption of such technologies would disproportionately fall on small and medium-sized firms that rely on manual processing or legacy systems and may lack the resources to modernize their infrastructure rapidly.”

The T+1 Report also described several “key areas” that the IWG concluded would be significantly impacted by a move to T+0 settlement. These areas included: Re-engineering of securities processing; securities netting; funding requirements for securities transactions; securities lending practices; prime brokerage practices; global settlement; and primary offerings, derivatives markets and corporate actions.

The Commission is assessing these challenges, and in Part IV, includes further discussion of them in requesting comment on considerations related to T+0 settlement.

Id.

at 10.

Id.

at 11.

III. Proposals for T+1

The Commission is proposing the following rules to implement a T+1 standard settlement cycle. First, the Commission proposes to amend Rule 15c6-1 to establish a standard settlement cycle of T+1 for most broker-dealer transactions.

In so doing, the Commission also proposes to repeal Rule 15c6-1(c), which currently establishes a T+4 standard settlement cycle for certain firm commitment offerings.

Second, the Commission proposes three additional rules applicable, respectively, to broker-

dealers, investment advisers, and CMSPs to improve the efficiency of managing the processing of institutional trades under the shortened timeframes that would be available in a T+1 environment. Specifically, the Commission proposes new Rule 15c6-2 to prohibit broker-dealers who have agreed with a customer to engage in an allocation, confirmation or affirmation process from effecting or entering into a contract for the purchase or sale of a security on behalf of that customer unless the broker-dealer has also entered into a written agreement that requires the allocation, confirmation, affirmation to be completed as soon as technologically practicable and no later than the end of the day on trade date in order to complete settlement in the timeframes required under Rule 15c6-1(a). The Commission also proposes to amend the recordkeeping obligations of investment advisers to ensure that they are properly documenting their related allocations and affirmations, as well as retaining the confirmations they receive from their broker-dealers. Finally, the Commission proposes a requirement for CMSPs to establish, implement, maintain, and enforce written policies and procedures designed to facilitate straight-through processing. Each proposal is discussed further below.

See infra

Part III.A.1.

See infra

Part III.A.3.

In addition, the Commission also discusses the anticipated impact of T+1 on other Commission rules and existing Commission guidance on Regulation SHO, the financial responsibility rules for broker-dealers under the Exchange Act, Rule 10b-10, prospectus delivery, and rules and operations of self-regulatory organizations (“SROs”). Finally, the Commission proposes to require compliance with each of the above rule proposals, if adopted, by March 31, 2024. The Commission is soliciting comment on all aspects of the proposals, and in each section below also solicits comment on specific aspects of the proposed rules and rule amendments, the anticipated impact on the other Commission rules noted above, and the proposed compliance date.

A. Shortening the Length of the Standard Settlement Cycle

Existing Rule 15c6-1(a) under the Exchange Act provides that, unless otherwise expressly agreed by the parties at the time of the transaction, a broker-dealer is prohibited from 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 second business day after the date of the contract.

Rule 15c6-1(a) covers contracts for the purchase or sale of all types of securities except for the excluded securities enumerated in paragraph (a)(1) of the rule. The definition of the term “security” in Section 3(a)(10) of the Exchange Act covers, among others, equities, corporate bonds, UITs, mutual funds, ETFs, ADRs, security-based swaps, and options.

Application of Rule 15c6-1(a) extends to the purchase and sale of securities issued by investment companies (including mutual funds),

private-label mortgage-backed securities, and limited partnership interests that are listed on an exchange.

17 CFR 240.15c6-1(a).

15 U.S.C. 78c(a)(10). 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 in July 2011 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.

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, 39938-39 (July 7, 2011). This temporary exemptive relief expired on February 5, 2020.

See

Order Granting a Limited Exemption from the Exchange Act Definition of “Penny Stock” for Security-Based Swap Transactions between Eligible Contract Participants; Granting a Limited Exemption from the Exchange Act Definition of “Municipal Securities” for Security-Based Swaps; and Extending Certain Temporary Exemptions under the Exchange Act in Connection with the Revision of the Definition of “Security” to Encompass Security-Based Swaps, Exchange Act Release No. 84991 (Jan. 25, 2019), 84 FR 863 (Jan. 31, 2019) (extending the expiration date for the relevant portion of the temporary exemptive relief to February 5, 2020); Order Extending Temporary Exemptions from Exchange Act Section 8 and Exchange Act Rules 8c-1, 10b-16, 15a-1, 15c2-1 and 15c2-5 in Connection with the Revision of the Definition of “Security” to Encompass Security-Based Swaps, Exchange Act Release No. 87943 (Jan. 10, 2020), 85 FR 2763 (Jan. 16, 2020) (allowing the relevant portion of the temporary exemptive relief to expire on February 5, 2020).

The Commission applied Rule 15c6-1 to broker-dealer contracts for the purchase and sale of securities issued by investment companies, including mutual funds, because the Commission recognized that these securities represented a significant and growing percentage of broker-dealer transactions.

See

T+3 Adopting Release,

supra

note 9, at 52900.

With regard to limited partnership interests, the Commission excluded non-listed limited partnerships due to complexities related to processing the trades in these securities and the lack of an active secondary market. In contrast, the Commission included listed limited partnerships primarily to ensure exclusion of these securities would not unnecessarily contribute to the bifurcation of the settlement cycle for listed securities generally.

See id.

at 52899.

Rule 15c6-1(a) allows the parties to the trade to agree that settlement will take place later than two business days after the trade date, provided that such an agreement is express and reached at the time of the transaction.

This provision is sometimes referred to as the “override provision.” When the Commission first adopted Rule 15c6-1(a), it stated that use of the override provision “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.”

The override provision in 15c6-1(a) continues to be intended to apply only to these unusual transactions.

17 CFR 240.15c6-1(a).

T+3 Adopting Release,

supra

note 9, at 52902. 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. T+2 Proposing Release,

supra

note 30, at 69257 n.153.

To date, the Commission has not identified instances indicating a risk of overuse of this provision.

Rule 15c6-1(b) provides an exclusion for contracts involving the purchase or sale of 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.

Pursuant to Rule 15c6-1(b), the Commission has granted an exemption from Rule 15c6-1 for securities that do not have facilities for transfer or delivery in the U.S.

However, if the parties execute a transaction on a registered securities exchange, the transaction will be subject to both the rules of the exchange and Rule 15c6-1.

Under the exemption, an ADR is considered a separate security from the underlying security.

Thus, if there are no transfer facilities in the U.S. for a foreign security but there are transfer facilities for an ADR based on such

foreign security, only the foreign security will be exempt from Rule 15c6-1.

The Commission has also granted a separate exemption for contracts for the purchase or sale of any security issued by an insurance company (as defined in Section 2(a)(17) of the Investment Company Act

) that is funded by or participates in a “separate account” (as defined in Section 2(a)(37) of the Investment Company Act

), including a variable annuity contract or a variable life insurance contract, or any other insurance contract registered as a security under the Securities Act of 1933 (“Securities Act”).

17 CFR 240.15c6-1(b). In recognition of the fact that the Commission may not have identified all situations or types of trades where T+2 settlement would be problematic, Rule 15c6-1(b) provides that the Commission may exempt by order additional types of trades from T+2 settlement, either unconditionally or on specified terms and conditions, if the Commission determines that such an exemption is consistent with the public interest and the protection of investors.

Id.

See

Exchange Act Release No. 35750 (May 22, 1995), 60 FR 27994, 27995 (May 26, 1995) (granting an exemption from Rule 15c6-1 for certain transactions in foreign securities). The exemption also provides that if less than 10% of the annual trading volume in a security that has U.S. transfer or deliver facilities occurs in the U.S., the transaction in such security will be exempt from the requirements in the rule.

Id.

at n.7.

Id.

15 U.S.C. 80a-2(a)(17).

15 U.S.C. 80a-2(a)(37).

See

Exchange Act Release No. 35815 (June 6, 1995), 60 FR 30906, 30907 (June 12, 1995) (granting an exemption from Rule 15c6-1 for transactions involving certain insurance contracts). The Commission determined not to rescind or modify the exemptive order when it shortened the settlement cycle from T+3 to T+2.

See

T+2 Adopting Release,

supra

note 10, at 15581.

Rule 15c6-1(c) establishes a T+4 settlement cycle for firm commitment underwritings for securities that are priced after 4:30 p.m. Eastern Time (“ET”).

Specifically, the rule states that the standard settlement cycle set forth in Rule15c6-1(a) does not apply to contracts for the sale of securities that are priced after 4:30 p.m. ET on the date that such securities are priced and that are sold by an issuer to an underwriter pursuant to a firm commitment offering registered under the Securities Act or sold to an initial purchaser by a broker-dealer participating in such offering. Under the rule, the broker or dealer must effect or enter into a contract for the purchase or sale of those securities that provides for payment of funds and delivery of securities no later than the fourth 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(c).

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.

17 CFR 240.15c6-1(d).

1. Proposed Amendment to Rule 15c6-1(a)

The Commission proposes to amend Rule 15c6-1(a) to prohibit a broker-dealer from effecting or entering into a contract for the purchase or sale of a security (other than an exempted security, a government security, a municipal security, commercial paper, bankers' acceptances, or commercial bills) that provides for payment of funds and delivery of securities later than the first business day after the date of the contract unless otherwise expressly agreed to by the parties at the time of the transaction.

The Commission's proposal to amend Rule 15c6-1(a) would change only the standard settlement date for securities transactions covered by the existing rule, and would not impact the existing exclusions enumerated in the rule. In addition, the Commission's proposal would retain the so-called “override provision,” and the Commission continues to intend for the “override provision” to apply only to unusual cases to ensure that the settlement cycle set by Rule 15c6-1(a) is in fact the standard settlement cycle.

100

17 CFR 240.15c6-1(a).

100

See supra

note 88.

2. Basis for Shortening the Standard Settlement Cycle to T+1

First, the Commission preliminarily believes that market participants have made substantial progress toward identifying the technological and operational changes that would be necessary to establish a T+1 standard settlement cycle, and significant industry support for such a move has emerged. By contrast, at the time the Commission proposed to shorten the standard settlement cycle to T+2, market participants generally supported moving to T+2 and many believed that moving to T+1 would be substantially more costly and take longer to achieve than moving to T+2.

101

At that time, neither the Commission nor the industry supported moving to a T+1 standard settlement cycle.

102

Since then, Commission staff has continued to study the potential impact of further shortening the settlement cycle, and the ISC has recommended that the securities industry implement a T+1 standard settlement cycle.

103

101

See

T+2 Adopting Release,

supra

note 10, at 15598-99.

102

See id.

at 15572.

103

See supra

notes 73-74 and accompanying text (discussing the recommendations in the T+1 Report).

The Commission acknowledges that a transition from a T+2 to T+1 standard settlement cycle, and implementation of the necessary operational, technical, and business changes, will likely result in varying burdens, costs and benefits for a wide range of market participants.

104

The Commission has remained mindful and observant of industry initiatives and progress targeted at facilitating an environment where a shortened standard settlement cycle could be achieved in a manner that reduces risk for market participants while also minimizing the likelihood of disruptive burdens and costs. Having taken current industry initiatives and their relative progress into consideration, the Commission preliminarily believes there has been collective progress by market participants sufficient to facilitate a transition to a T+1.

104

See infra

Part V (analyzing the economic effects of shortening the standard settlement cycle to T+1).

Furthermore, when the Commission adopted a T+2 standard settlement cycle, it identified a number of incremental improvements to the functioning of the U.S. securities market likely to result relative to a T+3 standard settlement cycle.

105

The Commission preliminarily believes that a T+1 settlement cycle would produce similar incremental improvements to the functioning of the U.S. securities market relative to a T+2 settlement cycle. These benefits, discussed further in Part V.C.1, are summarized briefly here.

105

See

T+2 Adopting Release,

supra

note 10, at 15569-75.

First, as a general matter, time to settlement determines a significant portion of a market participant's risk exposure on a given securities transaction. As a result, all else being equal, shortening the time to settlement reduces exposure to credit,

106

market,

107

and liquidity risk.

108

In addition, assuming that trading volume remains constant, shortening the time to settlement also decreases the total number of unsettled trades that exists at any point in time, as well as the total

market value of all unsettled trades.

109

This reduction in the number and total value of unsettled trades should correspond to a reduction in a market participant's overall exposure to risk arising from unsettled transactions.

106

Credit risk refers to the potential for the market participant's counterparty to a given transaction to default on the transaction and therefore the market participant will not receive either the cash or securities necessary to settle the transaction.

107

Market risk refers to the potential for the value of the security that underlies the transaction to change between trade execution and settlement.

108

Liquidity risk refers to the risk that the market participant will be unable to timely settle a transaction because it does not have access to sufficient cash or securities. The market participant may not have access to sufficient cash or securities for a given transaction if, for example, it has recently been exposed to the default of a counterparty on a separate transaction and did not receive the anticipated proceeds of that transaction.

109

In other words, a T+2 settlement cycle results in two days of unsettled transactions at any given time, whereas a T+1 settlement cycle would result in one day of unsettled transactions at any given time.

Second, the above dynamics produce noticeable effects for transactions that are centrally cleared because they reduce the CCP's exposure to credit, market, and liquidity risk arising from its obligations to its participants, promoting the stability of the CCP and thereby reducing the potential for systemic risk to transmit through the financial system. For example, when the CCP faces a participant default, the CCP will liquidate open positions of the defaulting participant and use the defaulting participant's financial resources held by the CCP to cover the CCP's losses and expenses. The CCP may face losses if the market value of the defaulting participant's open positions has moved significantly in the time between trade execution and default.

110

While the CCP works to close out the defaulting participant's open positions, it also needs to continue to meet its end-of-day settlement obligations to non-defaulting participants, and so the CCP is exposed to liquidity risk when a member defaults because it may need to use its own resources to complete end-of-day settlement.

111

In each instance, the amount of risk to which the CCP is exposed is determined in part by the length of the settlement cycle, and shortening the settlement cycle would reduce the CCP's overall exposure to these risks.

110

For example, if the open position is net long, to close the position the CCP would obtain replacement securities in the market, possibly at a higher price than the original transaction. Conversely, if the open position is net short, to close the position the CCP would sell the defaulting participant's securities in the market, possibly at a lower price than the original transaction.

111

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. These costs may be passed on through the CCP members to broker-dealers and investors.

Third, reducing these risks to the CCP would reduce the overall size of the financial resources that the CCP requires of its participants,

112

thereby reducing the risks and costs faced by the CCP participants (

i.e.,

broker-dealers) and, by extension, their customers (

i.e.,

investors).

113

CCP participants may choose to pass these reductions down to their customers.

112

See

T+2 Proposing Release,

supra

note 30, at 69251 n.77 (discussing mutual fund settlement timeframes and related liquidity risk, which may be exacerbated during times of stress). The Commission preliminarily believes that shortening settlement timeframes for portfolio securities to T+1 will generally assist in reducing liquidity and other risks for funds that must satisfy investor redemption requests that settle pursuant to shorter settlement timeframes (

e.g.,

T+1).

113

See id.

at 69251.

Fourth, the Commission anticipates that the above effects would reduce the potential for systemic risk.

114

When the Commission proposed to shorten the standard settlement cycle from T+3 to T+2 it explained that its “views are even more apt today given the increasing interconnectivity and interdependencies among markets and market participants.”

115

In particular, in periods of market stress, liquidity demands imposed by the CCP on its participants, such as in the form of intraday margin calls, can have procyclical effects that reduce overall market liquidity.

116

Reducing the CCP's liquidity exposure by shortening the settlement cycle can help limit this potential for procyclicality,

117

enhancing the ability of the CCP to serve as a source of stability and efficiency in the national clearance and settlement system.

118

114

As the Commission noted when it adopted Rule 15c6-1, 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.

See

T+3 Adopting Release,

supra

note 9, at 52894.

115

T+2 Proposing Release,

supra

note 30, at 69258 n.160 (citing Exchange Act Release No. 68080 (Oct. 22, 2012), 77 FR 66220, 66254 (Nov. 2, 2012) (“Clearing Agency Standards Adopting Release”) and DTCC, Understanding Interconnectedness Risks—To Build a More Resilient Financial System (Oct. 2015),

http://www.dtcc.com/news/2015/october/12/understanding-interconnectedness-risks-article

116

For a discussion regarding procyclicality,

see

T+2 Proposing Release,

supra

note 30, at 69250-52.

117

See

T+3 Adopting Release,

supra

note 9, at 52894.

118

See

Standards for Covered Clearing Agencies, Exchange Act Release No. 71699 (Mar. 12, 2014), 79 FR 16865 (Mar. 26, 2014),

corrected at

79 FR 29507, 29598 (May 22, 2014) (“CCA Standards Proposing Release”). 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.

Finally, shortening the standard settlement cycle to T+1 would enable investors to access the proceeds of their securities transactions sooner than they are able to in the current T+2 environment. In particular, in a T+1 environment, sellers would have access to cash proceeds one day sooner and buyers would see purchased securities in their accounts one day earlier relative to a T+2 standard settlement cycle.

In addition, as noted above, the Commission has evaluated the potential for shortening the settlement cycle to impose costs on market participants, which are likely to vary across market participants depending on a number of facts. These costs and considerations are discussed in Part V.C.2. The costs include those costs associated with investments in improved operations and new technologies to manage the compression of time resulting from a shorter settlement cycle. Shortening the settlement cycle may have other effects as well. For example, shortening the standard settlement cycle to T+1 for equity securities would disconnect settlement with foreign exchange (“FX”) transactions, which settle on a T+2 basis. Mismatched settlement timeframes between equities and FX transactions may increase the cost needed to fund and hedge related securities transactions.

119

In addition, the Commission recognizes that a disorderly transition to a shorter settlement cycle could lead to an increase in settlement fails. However, as discussed in Part V.B.4, in analyzing the shortening of the settlement cycle from T+3 to T+2, the Commission found no marked change in the volume of such failures. The Commission preliminarily believes that an orderly transition to a T+1 standard settlement cycle can limit the negative effects of settlement fails. The Commission also believes that facilitating an increase in same-day affirmations helps mitigate the effects of settlement fails, as affirmations on trade date can limit the potential for processing errors on settlement day that cause fails.

120

More generally, the Commission preliminarily believes that the anticipated benefits of a shortened settlement cycle justify the anticipated costs.

119

See infra

Part V.C.2 (noting that market participants will have a choice between bearing an additional day of currency risk or incurring the cost related to hedging away this risk in the forward or futures market).

120

See infra

Part III.B (proposing new Rule 15c6-2 to increase same-day affirmations); Part V.C.1 (noting that the proposed rule can facilitate an orderly transition to T+1).

3. Proposed Deletion of Rule 15c6-1(c) and Conforming Technical Amendments to Rule 15c6-1

As explained above, Rule 15c6-1(c) establishes a T+4 settlement cycle for firm commitment offerings for securities that are priced after 4:30 p.m. ET, unless otherwise expressly agreed to by the parties at the time of the transaction.

The Commission proposes to delete this provision. Deleting Rule 15c6-1(c) would, in conjunction with the proposed amendment to Rule 15c6-1(a), set a T+1 standard settlement cycle for firm commitment offerings priced after 4:30 p.m. ET. However, the so-called “override” provisions in paragraphs (a) and (d) of Rule 15c6-1 would continue to allow contracts currently covered by paragraph (c) to provide for settlement on a timeframe other than T+1 if the parties expressly agree to a different settlement timeframe at the time of the transaction.

In proposing to delete paragraph (c) of Rule 15c6-1, the Commission also proposes conforming amendments to paragraphs (a), (b), and (d) of the rule. Specifically, the Commission is proposing to delete all references to paragraph (c) of Rule 15c6-1 that currently appear in paragraphs (a), (b) and (d) of the rule.

4. Basis for Eliminating T+4 Standard for Certain Firm Commitment Offerings

The Commission believes that expanded application of the “access equals delivery” standard for prospectus delivery supports removing paragraph (c) from Rule 15c6-1 because delays in the process that made delivery of the prospectus difficult to achieve under the standard settlement cycle have been mitigated by the “access equals delivery” standard. In addition, if paragraph (c) is removed as proposed, paragraph (d) would continue to provide underwriters and the parties to a transaction the ability to agree, in advance of a particular transaction, to a settlement cycle other than the standard set forth in Rule 15c6-1(a) when needed to manage obligations associated with the firm commitment offering.

The Commission adopted paragraphs (c) and (d) of Rule 15c6-1 in 1995, two years after Rule 15c6-1 was originally adopted.

121

At the time, the rule included a limited exemption from the requirements under paragraph (a) of the rule for the sale for cash pursuant to a firm commitment offering registered under the Securities Act.

122

The exemption for firm commitment offerings was added in response to public comments stating that new issue securities could not settle on T+3 because prospectuses could not be printed prior to the trade date (the date on which the securities are priced).

123

121

See

Prospectus Delivery; Securities Transaction Settlement Cycle, Exchange Act Release No. 34-35705 (May 11, 1995), 60 FR 26604 (May 17, 1995) (“1995 Amendments Adopting Release”).

122

The exemption was limited to sales to an underwriter by an issuer and initial sales by the underwriting syndicate and selling group. Any secondary resales of such securities were to settle on a T+3 settlement cycle. T+3 Adopting Release,

supra

note 9, at 52898.

123

Id.

When the Commission proposed to amend Rule 15c6-1 in 1995, it stated that, since the adoption of the rule, members of the brokerage community had suggested the Commission eliminate the exemption and ease the problems associated with prospectus delivery by other means. The primary reasons expressed for requiring T+3 settlement of such offerings were: (i) The secondary market for a new issue may be subject to greater price fluctuations or instability, which in turn may expose underwriters, dealers and investors to disproportionate credit and market risk; and (ii) the bifurcated settlement cycle created for initial sales and resales of new issues would be disruptive to broker-dealer operations and to the clearance and settlement system.

124

In particular, it was explained that if a purchaser of a new issue sells on the first or second day after pricing, the purchaser's broker will not be able to settle with the buyer's broker on a T+3 schedule because the securities would not yet be available for settlement purposes.

125

As a result, all such trades by the purchasers would “fail” and result in expense, inefficiencies, and greater settlement risk for all participants. A bifurcated settlement cycle also may require the maintenance of separate computer systems and additional internal procedures.

124

See

Exchange Act Release No. 34-35396 (Feb. 21, 1995), 60 FR 10724 (Feb. 27, 1995) (“1995 Amendments Proposing Release”).

125

Id.

The vast majority of commenters submitting feedback in response to the 1995 Amendments Proposing Release supported T+4 as the standard settlement cycle for firm commitment offerings price after 4:30 p.m.

126

Several of these commenters reasoned that it is difficult to print prospectuses within a T+3 timeframe when securities are priced late in the day. These commenters also stated that the potential systemic and market risks associated with the proposed T+4 provision should be limited because most secondary market trading in the subject securities would not begin trading until the opening of the market on the next business day, and therefore the primary issuance of securities would be available to settle secondary trading in the security.

127

126

1995 Amendments Adopting Release,

supra

note 121, at 26608.

127

Id.

The T+1 Report stated that paragraph (c) is rarely used in the current T+2 settlement environment, but the IWG expects a T+1 standard settlement cycle would increase reliance on paragraph (c).

128

The T+1 Report further stated that the IWG recommends retaining paragraph (c) but amending it to establish a standard settlement cycle of T+2 for firm commitment offerings.

129

The T+1 Report cited issues with respect to complex documentation and other operational elements of equity offerings that may delay settlement to T+2 in a T+1 environment.

128

T+1 Report,

supra

note 18, at 33-35.

129

Id.

at 33.

With respect to debt offerings, the T+1 Report stated that many such offerings frequently rely on the exception provided in Rule 15c6-1(d).

130

In describing the reasons debt offerings “have historically needed, and will continue to need, this exemption if the standard settlement cycle is moved to T+1,” the T+1 Report stated that such offerings are “document-intensive and typically have more documentation than equity offerings.”

131

According to the T+1 Report, this documentation includes indentures, guarantees, and collateral documentation, all of which are individually negotiated and unique to the transaction.

132

Thus, the T+1 Report states, a substantial portion of debt offerings settle later than T+3.

133

130

Id.

131

Id.

132

Id.

133

Id.

While the Commission appreciates that documentation relating to firm commitment offerings for equities must be completed prior to settlement of such transactions, the T+1 Report did not explain why or how timely completion of such documentation would not be possible if the exception in paragraph (c) of Rule 15c6-1 were eliminated. In contrast, the T+1 Report states, as discussed above, that firm commitment offerings generally settle in alignment with the standard settlement cycle. As the Commission is not currently aware of any data or facts indicating that the documentation associated with firm commitment offerings cannot be completed by T+1, the Commission preliminarily believes that the need to complete transaction documentation prior to settlement does not justify proposing a separate standard settlement cycle of T+2 for equity offerings. Rather, to the extent that documentation may in some cases require more time to complete than is available under a T+1 standard settlement cycle, the parties to the

transaction can agree to a longer settlement period pursuant to paragraph (d) when they enter the transaction. In this way, deleting paragraph (c) does not prevent the parties from using paragraph (d) to agree to a longer settlement period; it only removes the presumption that such firm commitment offerings should be subject to a different settlement cycle than the standard settlement cycle set forth in paragraph (a).

In addition, as discussed further in Part III.E.4, 17 CFR 230.172 (“Rule 172”) has implemented an “access equals delivery” model that permits, with certain exceptions, final prospectus delivery obligations to be satisfied by the filing of a final prospectus with the Commission, rather than delivery of the prospectus to purchasers. As a result of these changes, broker-dealers generally would not require time to print and deliver prospectuses—a point originally cited by many commenters in support of adopting paragraph (c)—and the Commission preliminarily believes that broker-dealers are able to satisfy their obligations with respect to these firm commitment offerings on a timeline much shorter than the current T+4 standard settlement cycle for these firm commitment offerings.

In addition, establishing T+1 as the standard settlement cycle for these firm commitment offerings, and thereby aligning the settlement cycle with the standard settlement cycle for securities generally, would reduce exposures of underwriters, dealers, and investors to credit and market risk, and better ensure that the primary issuance of securities is available to settle secondary market trading in such securities.

134

The Commission believes that harmonizing the settlement cycle for such firm commitment offerings with secondary market trading, to the greatest extent possible, limits the potential for operational risk.

134

As noted above, prior to the Commission's 1995 amendments to Rule 15c6-1 members of the broker-dealer community expressed the view that (i) the secondary market for a new issue may be subject to greater price fluctuations or instability, which in turn may expose underwriters, dealers and investors to disproportionate credit and market risk; and (ii) a bifurcated settlement cycle created for initial sales and resales of new issues would be disruptive to broker-dealer operations and to the clearance and settlement system.

See supra

notes 124, 125, and accompanying text. While these arguments were made by market participants when the standard settlement cycle in the U.S. was still T+3, the Commission preliminarily believes that they remain relevant to the Commission's proposed amendment to Rule 15c6-1(a) and proposed deletion of Rule 15c6-1(c). In particular, if the Commission were to adopt the proposed amendment to Rule 15c6-1(a) without deleting Rule 15c6-1(c), a broker-dealer settling on behalf of a customer who sells shares of a new issue on the first day after pricing might, in some cases, not be able to settle with the purchaser's broker-dealer because the securities may not yet be available for settlement. Specifically, if the new issue settled on T+2 and the secondary market transactions executed on the first day of trading settled on T+1, the primary issuance would presumably not be available for timely settlement of the secondary market transactions. Conversely, if the Commission adopts both the proposed amendment to Rule 15c6-1(a) and the proposed deletion of Rule 15c6-1(c), the settlement cycle would not be bi-furcated and the basis for the above-described concerns raised previously by the broker-dealer community related to bi-furcation of the settlement cycle would not be applicable.

Therefore, in the Commission's view, deleting paragraph (c) while retaining paragraph (d) provides sufficient flexibility for market participants to manage the potential need for longer than T+1 settlement on certain firm commitment offerings priced after 4:30 p.m. that may include “complex” documentation because paragraph (d) would continue to permit the underwriters and the parties to a transaction to agree, in advance of entering the transaction, whether T+1 settlement or some other settlement timeframe is appropriate for the transaction. In addition, the Commission believes that having the underwriters and the parties to the transaction agree in advance of entering the transaction whether to deviate from the standard settlement cycle established in paragraph (a) would promote transparency among the parties, in advance of entering the transaction, as to the length of the time that it takes to complete documentation with respect to the transaction. The Commission requests comment on these views. To the extent that commenters agree with the T+1 Report, the Commission requests that such commenters provide data or other detailed information explaining why a T+1 settlement cycle is an inappropriate standard for all firm commitment offerings priced after 4:30 p.m., such as an explanation or description for what specific documentation cannot be completed consistent with a T+1 settlement cycle.

5. Request for Comment

The Commission is requesting comment on all aspects of the proposed amendments to Rule 15c6-1 to shorten the current T+2 and T+4 standard settlement cycles to T+1. The Commission also solicits comment on the particular questions set forth below, and encourages commenters to submit any relevant data or analysis in connection with their answers.

1. Should the Commission amend Rule 15c6-1 to shorten the standard settlement cycle to T+1 as proposed? Why or why not?

2. Are efforts to shorten the standard settlement cycle to T+1 a logical step on the path to T+0 settlement, or would shortening to T+1 require investments or processes that would be outdated or unnecessary in a T+0 environment?

135

Please explain why or why not.

135

See supra

note 12 and accompanying text (explaining that T+0 in this release is intended to refer to netted settlement by the end of trade date);

see also

T+2 Proposing Release,

supra

note 30, at 69252, 69254 (describing in detail the SIA Business Case Report and the BCG Study). The building blocks are described generally as the core initiatives that need to be implemented prior to shortening the settlement cycle.

See

SIA Business Case Report,

supra

note 21, at 18.

147

See, e.g.,

Press Release, SIA, SIA Board Endorses Program to Modernize Clearing, Settlement Process for Securities (July 18, 2002) (statement from the SIA Board of Directors endorsing straight-through processing); letter from Jeffrey C. Bernstein, Chairman, SIA STP Steering Committee, Securities Industry Association (June 16, 2004) (“SIA Letter”). The comment letter is available at

https://www.sec.gov/rules/concept/s71304.shtml

148

T+2 Proposing Release,

supra

note 30, at 69252.

In its 2004 concept release seeking comment on methods to improve the safety and operational efficiency of the National C&S System to achieve straight-through processing,

149

the Commission explored whether to adopt its own rule or whether the SROs should amend their existing rules to require the completion of the confirmation and affirmation process on trade date.

150

Many market participants supported a Commission rule to mandate it, but believed that such requirements should be implemented in phases to allow for the development of certain processing improvements.

151

Recommendations for such improvements included: (i) Achieving 100% of trades as matched or affirmed as soon as possible after execution on trade date; (ii) achieving asynchronous (non-sequential) and electronic communication between all trade parties, including notices of execution, allocations, match status, confirmation status, and settlement instructions; (iii) adoption of an industry standard electronic format for message communication; and (iv) adoption of standards that allow manual processing on an exception-only basis.

152

149

Exchange Act Release No. 49405 (Mar. 11, 2004), 69 FR 12922 (Mar. 18, 2004) (“Concept Release”).

150

Id.

151

See

SIA Letter,

supra

note 147 (commenting on the Concept Release); letter from Margaret R. Blake, Counsel to the Association, Dan W. Schneider, Counsel to the Association, The Association of Global Custodians (June 28, 2004) (commenting on the Concept Release). Copies of the comment letters are available at

https://www.sec.gov/rules/concept/s71304.shtml

152

See supra

note 151.

Since 2004, the industry has made significant progress in developing new centralized systems and processes designed to automate and streamline the institutional trade processing environment, both from an operational and technological perspective.

153

Market participants also rely on a variety of “local” matching tools that allow them to compare trade information received from another party against their own trade information. Further, industry coordination has facilitated improved communication between the parties to a trade using standardized messaging protocols, such as FIX, and the SWIFT network. When the Commission proposed to shorten the settlement cycle to T+2, the Commission observed that the market has improved these confirmation, affirmation, and matching processes through the use of CMSPs.

154

153

For example, DTCC ITP Matching has introduced centralized matching with its CTM platform that continues to automate the trade confirmation process and includes connectivity via FIX and the SWIFT network to custodian banks for the purposes of settlement notification.

See

DTCC, Why Is DTCC Migrating US Trade Flows to CTM and Terminating OASYS?,

https://dtcclearning.com/content/1439-cat-institutional-trade-processing/cat-ctm/us-trade-flows/us-trades-on-ctm-faqs/us-trades-on-ctm-general-faqs/7353-why-is-dtcc-migrating-us-trade-flows-to-ctm-and-terminating-oasys.html

154

T+2 Proposing Release,

supra

note 30, at 69258.

A 2010 white paper issued by Omgeo (now DTCC ITP) also described same-day affirmation as “a prerequisite” of shortening the settlement cycle because of its impact on the rate of settlement fails and on operational risk.

155

According to data published in 2011 regarding affirmation rates achieved through the use of one CMSP, on average, 45% of trades were affirmed on trade date, 90% were affirmed by the end of T+1, and 92% were affirmed by noon on T+2.

156

Existing processes for matching institutional trades rely on a number of manual elements, and currently only about 68% of trades achieve affirmation by 12:00 midnight at the end of trade date.

157

While these rates have improved over time, the improvements have been incremental and, in the Commission's view, insufficient. Failing to affirm by the end of trade date increases the likelihood that errors or exceptions will not be resolved in time for settlement. The sooner the parties have affirmed the trade information for their transaction, the lower the likelihood of a settlement fail because the parties will have more time to identify and resolve any potential errors. The T+1 Report highlights the need for achieving affirmation on trade date and encourages that on trade date allocations be completed by 7:00 p.m. ET and affirmations by 9:00 p.m. ET to facilitate shortening of the standard settlement cycle to T+1.

158

As discussed below, the Commission proposes Rule 15c6-2 to require completion of institutional trade allocations, confirmations, and affirmations by the end of trade date.

155

Omgeo, Mitigating Operational Risk and Increasing Settlement Efficiency through Same Day Affirmation (SDA), at 2, 7 (Oct. 2010) (“Omgeo Study”).

156

DTCC, Proposal to Launch a New Cost-Benefit Analysis on Shortening the Settlement Cycle, at 7 (Dec. 2011),

https://www.dtcc.com/en/news/2011/december/01/proposal-to-launch-a-new-cost-benefit-analysis-on-shortening-the-settlement-cycle.aspx

157

DTCC ITP Forum Remarks,

supra

note 58.

158

See

T+1 Report,

supra

note 18, at 13.

1. Proposed Rule 15c6-2 Under the Exchange Act

The Commission proposes Rule 15c6-2 to require that, where parties have agreed to engage in an allocation, confirmation, or affirmation process, a broker or dealer would be prohibited from effecting or entering into a contract for the purchase or sale of a security (other than an exempted security, a government security, a municipal security, commercial paper, bankers' acceptances, or commercial bills) on behalf of a customer unless such broker or dealer has entered into a written agreement with the customer that requires the allocation, confirmation, affirmation, or any combination thereof, be completed as soon as technologically practicable and no later than the end of the day on trade date in such form as may be necessary to achieve settlement in compliance with Rule 15c6-1(a). As explained in further detail below, the Commission believes that implementing a T+1 standard settlement cycle, as well as any potential further shortening beyond T+1, would require a significant improvement in the current rates of same-day affirmations to ensure timely settlement in a T+1 environment. In this way, the Commission also believes that proposed Rule 15c6-2 should facilitate timely settlement as a general matter, regardless of shortening the settlement cycle, because it will accelerate the completion of affirmations on trade date. Because broker-dealers and their institutional customers will review and reconcile trade data earlier in the settlement process, the Commission believes that same-day affirmation can improve the accuracy and efficiency of institutional trade processing. In particular, conducting these activities earlier in the process, and as soon as technologically practicable, will allow more time to resolve errors, an important consideration as shorter settlement cycles compress the available time to resolve errors.

Proposed Rule 15c6-2 applies requirements to a broker-dealer's contractual arrangements with its institutional customers because the Commission preliminarily believes that broker-dealers are best positioned to ensure (through their contractual arrangements) that their customers, including those acting on behalf of their customers, will perform the required allocation, confirmation, and affirmation functions on the appropriate timeframe and as soon as technologically practicable. Because broker-dealers are the party to a transaction most likely to have access to a clearing agency, the broker-dealer is also the party best positioned to ensure the timely settlement of institutional trades, and as such, should be able to ensure via its customer agreements that institutional customers or their agents also comport their operations to facilitate same-day affirmation.

159

In addition, requiring broker-dealers to enter into written agreements that require the allocation, confirmation, and affirmation processes be completed as soon as technologically practicable and no later than the end of trade date may help increase the use of standardized terms and trade details across market participants, which may enable the parties to reduce their reliance on manual processes in favor of more automated methods.

159

In an effort to also encourage investment advisers to ensure that their own operations and procedures for institutional trade processing can accommodate T+1 or shorter settlement timeframes, in Part III.C the Commission proposes an amendment to an existing recordkeeping rule for registered investment advisers.

As proposed, Rule 15c6-2 does not define the terms “allocation,” “confirmation,” or “affirmation.” As discussed in Part II.B.3.c), trade allocation refers to the process by which an institutional investor (often an investment adviser) allocates a large trade among various client accounts or determines how to apportion securities trades ordered contemporaneously on behalf of multiple funds or non-fund clients.

160

The terms “confirmation” and “affirmation” refer to the transmission of messages among broker-dealers, institutional investors, and custodian banks to confirm the terms of a trade executed for an institutional investor, a process necessary to ensure the accuracy of the trade being settled. Broker-dealers transmit trade confirmations to their customers to verify trade information, and customers provide an affirmation in response to affirm the confirmation so that the transaction can be prepared for settlement. The Commission believes that these terms are widely used and generally understood by market participants who engage in institutional trade processing.

160

For example, DTCC ITP's OASYS platform is a trade allocation and acceptance service that communicates trade and allocation details between investment managers and broker-dealers. DTCC ITP is in the process of decommissioning OASYS and replacing it with CTM, an enriched automated system that offers central matching workflow (including allocation) settlement notification and ALERT services. ALERT provides a database for the maintenance and communication of account and SSI information so that investment managers, broker-dealers, custodian banks and prime brokers can share account information electronically.

See

DTCC, ALERT,

https://www.dtcc.com/institutional-trade-processing/itp/alert

Proposed Rule 15c6-2 uses the term “confirmation” to refer to the operational message that includes trade details provided by the broker-dealer to the customer to verify trade information so that a trade can be prepared for settlement on the timeline established in Rule 15c6-1(a).

161

In contrast,

confirmations required by Exchange Act Rule 10b-10 concern a series of disclosures that broker-dealers are required to provide in writing to customers at or before completion of a transaction.

162

While some matching or electronic trade confirmation services may use the operational confirmation process described in proposed Rule 15c6-2 to produce a confirmation for purposes of compliance with Rule 10b-10, others may not. Accordingly, the term “confirmation” as used in proposed Rule 15c6-2 should be understood to refer to the institutional trade processing message or verification and not the disclosure required under Rule 10b-10. Below the Commission solicits comment as to whether these terms are sufficiently understood to facilitate compliance with the proposed rule.

161

Confirmations will include the following trade information: transaction type, security (including an identifier and description), account ID and title, trade date, settlement date, quantity, price, commission (if any), taxes and fees (if any), accrued interest (if appropriate) and the net amount of money to be paid or received at settlement. A

confirmation will also include the broker name and whether the broker-dealer was acting as principal or agent on the trade.

162

17 CFR 240.10b-10. For more information on confirmations required under Rule 10b-10,

see

Part III.E.3.

Proposed Rule 15c6-2 would also require broker-dealers to enter into a written agreement with a “customer” that has agreed to engage in the allocation, confirmation, or affirmation process. For purposes of the rule, the term “customer” includes any person or agent of such person who opens a brokerage account at a broker-dealer to effect an institutional trade or purchases or sells a security for which the broker-dealer receives or will receive compensation. In the institutional trade processing environment, the Commission understands that at times, a broker-dealer may accept instructions or trades from entities acting on behalf of the institutional investor. The term, as used in proposed Rule 15c6-2, is intended to cover both the institutional investor and any and all agents acting on its behalf. As stated below, the Commission is seeking further comment on whether the obligations imposed by proposed Rule 15c6-2 should explicitly state that contracts of such agents acting on behalf of the broker-dealer's customer are subject to the proposed rule or whether the proposed rule text as written is sufficiently clear.

Finally, the written agreement executed pursuant to proposed Rule 15c6-1 requires that the allocation, confirmation, and affirmation processes, or any combination thereof, related to these trades be completed as soon as technologically practicable and no later than the end of the day on trade date in such form as may be necessary to achieve settlement in compliance with Rule 15c6-1(a).

163

The Commission is proposing “end of the day on trade date” rather than requiring a specific time earlier than end of day to allow firms to maximize their internal processes to meet the appropriate cutoff times and other deadlines, as soon as technologically practicable. The Commission expects that different sectors of the market, different types of asset classes or market participants, and different operational processes (

e.g.,

cross-border transactions) may have varying processing deadlines, some of which may need to be earlier than end of the day to facilitate trade processing. For example, as noted above, the T+1 Report contemplates moving the “ITP Affirmation Cutoff” from 11:30 a.m. on the day after trade date to 9:00 p.m. on trade date to facilitate a T+1 settlement cycle.

164

Accordingly, the parties would be able under the rule to require earlier timeframes when appropriate. Moreover, the SROs could consider whether and how to use earlier than end of day deadlines, such as those recommended by the T+1 Report.

163

For purposes of this rule, “end of the day” has the same meaning as it is generally understood: no later than 11:59:59 p.m., Eastern Standard Time or Eastern Daylight Saving Time, whichever is currently in effect on trade date.

164

See

T+1 Report,

supra

note 18, at 39.

2. Basis for Requiring Affirmation No Later Than the End of Trade Date

As discussed in Part II.B, aspects of post-trade processing for institutional transactions remain inefficient and costly for several reasons. Although same-day affirmation is considered a best practice for institutional trade processing, adoption is not universal across market participants or even across all trades entered by a given participant.

165

Market participants continue to use hundreds of “local” matching platforms,

166

and rely on inconsistent SSI data independently maintained by broker-dealers, investment managers, custodians, sub-custodians, and agents on separate databases.

167

As discussed in Part II.B, processing institutional trades requires managing the back and forth involved with transmitting and reconciling trade information among the parties, functionally matching and re-matching with the counterparties to the trade, as well as custodians and agents, to facilitate settlement. It also requires market participants to engage in allocation processes, such as allocation-level cancellations and corrections, some of which are still processed manually.

168

This collection of redundant, often manual steps and the use of uncoordinated (

i.e.,

not standardized) databases can lead to delays, exceptions processing, settlement fails, wasted resources, and economic losses. While the proposed rule does not require any changes to manual processes or existing uses of databases and exceptions processing, the Commission preliminarily believes that market participants may pursue improvements to these existing processes to manage their obligations under Rule 15c6-2, if adopted.

165

While the concept of completing these functions on trade date has often been referred to a “same-day” affirmation, the Commission is proposing instead to use the term “trade date” in the rule to be clear that the allocation, confirmation, and affirmation process should be completed on the trade date.

166

Local matching platforms include, for example, the trade reconciliation and inventory management tools that market participants use to reconcile trade information.

See

DTCC, Embracing Post-Trade Automation: Seven Ways the Sell-Side Will Benefit from No-Touch Future (Nov. 2020) (“DTCC Embracing Post-Trade Automation”),

https://www.dtcc.com/itp-hub/dist/downloads/broker_supplement_11.11.20z.pdf

. Examples of such service providers include Bloomberg, Corfinancial, Lightspeed, and SS&C Technologies.

167

For more information about the use and impact of “local” matching platforms,

see supra

note 166. A 2020 DTCC survey of global broker-dealers found that certain institutional post-trade processing costs could be reduced by 20-25% through leveraging post-trade automation, which would in turn eliminate redundancies and manual processing and mitigate operational risks.

See

DTCC, DTCC Identifies Seven Areas of Broker Cost Savings as a Result of Greater Post-Trade Automation (Nov. 18, 2020),

https://www.dtcc.com/news/2020/november/18/dtcc-identifies-seven-areas-of-broker-cost-savings-as-a-result-of-greater-post-trade-automation; see also

DTCC Embracing Post-Trade Automation,

supra

note 166.

168

See

DTCC, Re-Imagining Post-Trade: No-Touch Processing Within Reach, at 4 (Sept. 2019),

https://www.dtcc.com/-/media/Files/Downloads/Institutional-Trade-Processing/ITP-Story/DTCC-Re-Imagining-Post-Trade.pdf

Although proposed Rule 15c6-2 does not require settlement of the transaction on trade date, the Commission preliminarily believes the proposed rule helps ensure that institutional trades will timely settle on T+1 because, by promoting the completion of these processes as soon as technologically practicable and no later than the end of trade date, it reduces the likelihood of exceptions or other errors with respect to trade information that can prevent a transaction from settling. In the Commission's view, because the rule requires that allocation, confirmation, and affirmation be completed as soon as technologically practicable and no later than the end of trade date, it can also facilitate shortening the settlement cycle, both with respect to T+1 and potentially for shortening beyond T+1 in the future. By elevating an industry best practice to a Commission

requirement, the Commission believes that proposed Rule 15c6-2 can significantly improve the current 68% rate of affirmations on trade date by standardizing the obligations of broker-dealers and their institutional customers with respect to the timing of achieving affirmations. This, in turn, could facilitate increases in operational efficiency necessary to support an orderly transition to shorter settlement cycles. The Commission also anticipates that SROs will consider whether to propose rule changes to incorporate the requirements in new Rule 15c6-2 if adopted,

169

and proposed Rule 15c6-2 would likely encourage further development of automated and standardized practices among market participants to facilitate settlement of institutional trades.

169

For example, Financial Industry Regulatory Authority (“FINRA”) Rule 11860 does not require that a broker-dealer send a confirmation of trade details until the day after trade date, which can delay the affirmation process until T+1 (in a T+2 environment) and reduce the time available to manage trade exceptions. FINRA, as well as DTC and DTCC ITP Matching may propose new rules, procedures or services to further enhance the ability of market participants to settle in shorter timeframes.

3. Request for Comment

The Commission solicits comment on the particular questions set forth below, and encourages commenters to submit any relevant data or analysis in connection with their answers.

28. Would proposed Rule 15c6-2 accomplish the stated objectives? Would the proposed rule encourage further standardization and automation in the processing of institutional trades? What effect will the proposed rule have on improving efficiencies and reducing errors and fails? Please provide a basis or explanation for your position.

29. Proposed Rule 15c6-2 uses such terms as “allocation,” “confirmation,” and “affirmation.” As discussed above, the Commission believes that these are well understood concepts. Should these terms be defined for purposes of the proposed rule? If so, please explain which terms need further definition and why? Please include the recommended elements of such definitions.

30. Similarly, does the term “end of the day on trade date” need to be defined? If so, please provide information as to why and include recommended elements of such a definition.

31. Proposed Rule 15c6-2 uses the term “customer.” Given that often agents of the customer are providing allocation, confirmation or affirmation instructions or communications to the broker-dealer on behalf of the broker-dealer's customer, does the rule as written address this scenario? Does the use of the term “customer” sufficiently incorporate any and all agents of the customer? Is the Commission's understanding of these terms consistent with the industry's use of these terms? Why or why not? Should the term “customer” be defined for purposes of Rule 15c6-2? If so, please include the recommended elements of such a definition.

32. What effect would proposed Rule 15c6-2 have on the relationship between a broker-dealer and its customer?

33. Do the perceived benefits of proposed Rule 15c6-2 or the benefits of trade date confirmation and affirmation accrue to all participants—brokers-dealers (including prime brokers), institutional customers, custodians, or matching utilities? If not, why? Do they accrue differently based on size of the entity? Please explain.

34. Does proposed Rule 15c6-2 introduce any new risks? If so, please describe such risks and whether they can be quantified. Can these risks be mitigated? If so, how?

35. If proposed Rule 15c6-2 is adopted by the Commission, what should be the necessary time frame for implementing such a rule? What factors should the Commission consider in determining the implementation date?

36. Would proposed Rule 15c6-2 affect cross-border trading or cross-border trade processing? If so, how would it do so?

37. As proposed, Rule 15c6-2 excludes exempted securities, government securities, municipal securities, commercial paper, bankers' acceptances, and commercial bills. For those asset classes that do not already settle on T+1, should the proposed rule apply to any or all of these excluded securities? Please discuss the reasons why any or all of these securities should or should not be excluded from Rule 15c6-2.

38. What if anything should the Commission do to further facilitate the use of standardized industry protocols and standardization of reference data by broker-dealers and institutional customers, including investment advisers and custodians? What if anything should the Commission do to further facilitate efficiency in processing institutional trades and reducing errors and fails?

39. Would the adoption of further Commission rules be necessary to require or further facilitate the objective of ensuring that institutional trades are operationally capable of settling on a T+1 or shorter timeframe?

40. The T+1 Report indicates that market participants may cancel and rebill an affirmed trade because of a monetary change to the trade and states that these instances occur frequently in a T+2 settlement cycle.

170

Why are trades affirmed when monetary amounts may not agree? Should it be permissible to cancel an affirmed trade? Why or why not?

170

See

T+1 Report,

supra

note 18, at 26.

41. Are investment advisers matching their records about a trade against the received confirmation prior to affirming? If not, why not? If so, what criteria are used to determine that a `match' has occurred? Which fields must match? Should financial values, such as unit price, total commission, accrued interest for fixed-income trades and net amount to be paid or received be matched? What steps does or should the adviser take to ensure the affirming party, if not the adviser, is matching adviser-provided trade information against the broker or dealer confirmation before affirming trades?

42. When matching trade information on a given transaction between the investment adviser and the broker-dealer, the parties to the transaction may view differences, such as differences in amounts, as minor and therefore within a satisfactory “tolerance” range to match, whereas in other cases a party may be unwilling to match if any discrepancy in trade information exists. These differences in trade information may be perceived to be small in absolute terms or relative to the size of the trade. Parties also may set “tolerance” thresholds in their systems to ignore some differences, such as trade information where an element differs by “one penny” or less than 0.01% of the value being compared. To what extent do advisers apply such tolerances when matching trades? What fields are subject to such tolerance thresholds and what size tolerances are generally used? For example, if the net money for settlement as calculated by the adviser differs from the net money for settlement as calculated by the broker or dealer as part of the confirmation by a dollar, is that trade a “match”? And if so, which value is used for settlement, the amount on the confirmation or the adviser's records? Does the other party then adjust its records to the amount used for settlement? Are investors ever harmed by this approach? Is there general consensus on tolerances? Are there industry groups that define guidelines or best practices on the use of tolerances and, if so, do they all agree?

43. Should advisers be expected to affirm trades or should this always be a

function of the broker-dealer or bank custodian holding the account where securities will be delivered? How should the adviser proceed if the deadline to notify a broker-dealer or bank custodian is approaching yet a confirmation has not been received? If advisers delay notification of the custodian until after affirming the trade in such a scenario, will this create delays in recalling loaned securities or securities that may have been pledged as collateral?

44. In some cases, bank custodians may receive a copy of a confirmation (a “duplicate confirmation”) as an early alert of potential trade activity. Are these duplicate confirmations relied upon to affirm the trade information? Do custodians ever settle trades based solely on information received in a duplicate confirmation? Should this practice be permitted? Please explain why or why not. Do custodians use these duplicate confirmations as an early alert to call a security back from being on loan or to identify a security that may be pledged as collateral?

45. Elements of FINRA Rule 11860 could be used to help facilitate compliance with proposed Rule 15c6-2, if adopted. Is proposed Rule 15c6-2 consistent with the approach to RVP/DVP settlement set forth in FINRA Rule 11860 and, more generally, the Uniform Practice Code (“UPC”) set forth in the FINRA Rule 11000 series?

171

If not, please explain.

171

The UPC is a series of FINRA rules, interpretations and explanations designed to make uniform, where practicable, custom, practice, usage, and trading technique in the investment banking and securities business, particularly with regard to operational and settlement issues. These can include such matters as trade terms, deliveries, payments, dividends, rights, interest, reclamations, exchange of confirmations, stamp taxes, claims, assignments, powers of substitution, computation of interest and basis prices, due-bills, transfer fees, “when, as and if issued” trading, “when, as and if distributed” trading, marking to the market, and close-out procedures. The UPC was created so that the transaction of day-to-day business by members may be simplified and facilitated; that business disputes and misunderstandings, which arise from uncertainty and lack of uniformity in such matters, may be eliminated; and that the mechanisms of a free and open market may be improved and impediments thereto removed.

See, e.g.,

Exchange Act Release No. 91789 (May 7, 2021), 86 FR 26084, 26088 (May 12, 2021).

46. Should proposed Rule 15c6-2 have separate requirements and deadlines for each step in the allocation, affirmation, and confirmation processes? And if so, should deadlines be relative to a prior dependent activity? For example, should allocations be communicated within an hour of, or no later than three hours after, receipt of the notice of execution and affirmations be communicated within an hour of, or no later than three hours after, receipt of the confirmation? Or is it acceptable to require end of day for all activity? What changes would be recommended for a T+0 environment?

C. Proposed Amendment to Recordkeeping Rule for Investment Advisers

Under proposed Rule 15c6-2, a broker-dealer would be prohibited from entering into a contract on behalf of a customer for the purchase or sale of certain securities

172

unless it has entered into a written agreement with the customer that requires the allocation, confirmation, affirmation, or any combination thereof to be completed no later than the end of the day on trade date in such form as may be necessary to achieve settlement in compliance with proposed Rule 15c6-1(a).

173

Investment advisers, as customers of a broker or dealer, may become a party to such an agreement. Proposed Rule 15c6-2 does not specify which party would be obligated to provide the necessary allocation, confirmation, and affirmation, although the Commission understands that, generally, the customer (here, the investment adviser) customarily provides the broker or dealer with instructions directing how to allocate the securities to be purchased or sold, and the broker or dealer confirms the trade details, which the adviser, in turn, affirms.

172

As discussed in Part III.B.1, proposed Rule 15c6-2 would not apply to an exempted security, government security, municipal security, commercial paper, bankers' acceptances, or commercial bills.

173

See supra

Part III.B (discussing the proposed new requirement for “same-day affirmation”).

Based on staff experience, the Commission believes that advisers generally have recordkeeping processes that include keeping originals and/or electronic copies of such allocations, confirmations, and affirmations. However, in some instances this may not be the case. Some activities, such as affirmation, may be performed on the adviser's behalf by a third party, such as middle-office outsourcing provider, a custodian or a prime broker, and advisers may not maintain these records.

174

In addition, based on staff experience, the Commission also believes that some advisers do not maintain these records or maintain them only in paper. Accordingly, the Commission is proposing an amendment to the investment adviser recordkeeping rule designed to ensure that registered investment advisers that are parties to contracts under proposed Rule 15c6-2 retain records of confirmations received, and keep records of the allocations and affirmations sent to a broker or dealer.

175

Specifically, the Commission proposes to amend Rule 204-2 under the Investment Advisers Act of 1940 (the “Advisers Act”) by adding a requirement in paragraph (a)(7)(iii) that advisers maintain records of each confirmation received, and any allocation and each affirmation sent, with a date and time stamp for each allocation (if applicable) and affirmation that indicates when the allocation or affirmation was sent to the broker or dealer if the adviser is a party to a contract under proposed Rule 15c6-2. As with other records required under Rule 204-2(a)(7), advisers would be required to keep originals of confirmations, and copies of allocations and affirmations, described in the proposed rule, but may maintain records electronically if they satisfy certain conditions.

176

174

See

DTCC ITP Forum Remarks,

supra

note 58 (stating that up to 70% of institutional trades are affirmed by custodians).

175

See

proposed Rule 204-2(a)(7)(iii),

infra

Part 0.

176

See

Rule 204-2(a)(7) (requiring making and keeping originals of all written communications received and copies of all written communications sent by an investment adviser relating to the records listed thereunder).

But see

Rule 204-2(g) (permitting advisers to maintain records electronically if they establish and maintain required procedures).

While the Commission believes that retaining records of all of these documents is important, we understand that the timing of communicating allocations to the broker or dealer is a critical pre-requisite to ensure that confirmations can be issued in a timely manner, and affirmation is the final step necessary for an adviser to acknowledge agreement on the terms of the trade or alert the broker or dealer of a discrepancy. The proposed amendment to Rule 204-2 therefore would require advisers to time and date stamp records of any allocation and each affirmation. The proposed time and date stamp for these communications would occur when they were “sent to the broker or dealer.” To meet this proposed requirement, an adviser generally should time and date stamp records of each allocation (if applicable) and affirmation to the nearest minute.

Based on staff experience, the Commission believes many advisers send allocations and affirmations electronically to brokers or dealers, and many records are already consistently date and time stamped to the nearest minute using either a local time zone or a centralized time zone, such as

coordinated universal time, or “UTC.”

177

The Commission believes that date and time stamping these records to the nearest minute would evidence that the advisers have met their obligations to timely achieve a matched trade.

177

See

U.S. Naval Observatory, Systems of Time,

https://www.cnmoc.usff.navy.mil/Organization/United-States-Naval-Observatory/Precise-Time-Department/The-USNO-Master-Clock/Definitions-of-Systems-of-Time/

. The Commission understands that some firms have systems that date and time stamp records with greater precision. Certainly as volumes increase and the timeframes to complete operational activities, such as settlement, shorten, the Commission believes from a practical perspective that many firms will find value in having increased precision in the time stamps on trade-related activities.

The Commission recognizes that requiring these records and adding time and date stamps to records would, however, add additional costs and burdens for those advisers that do not currently maintain these records or do not use electronic systems to send allocations and affirmations to brokers or dealers or maintain confirmations. For example, some advisers may incur costs to update their processes to accommodate these records. For advisers that use third parties to perform or communicate allocations or affirmations, they also could incur costs associated with directing the third parties to electronically copy the adviser on any allocations or affirmations.

178

For additional discussion on this and other initial costs and burdens of the proposed amendment to Rule 204-2,

see infra

Part V.C.5.b).

We believe that requiring these records and requiring a time and date stamp of all affirmations and any applicable allocations (but not confirmations) would help advisers establish that they have timely met contractual obligations under proposed Rule 15c6-2 and ultimately help ensure that trades involving such advisers would timely settle on T+1. In addition, we believe the proposed requirement would aid the Commission staff in preparing for examinations of investment advisers and assessing adviser compliance.

1. Request for Comment

We request comment on the proposed amendment to the investment adviser recordkeeping rule:

47. Should the Commission amend Rule 204-2 to specifically correspond to the proposed Rule 15c6-2 and require advisers that are parties to contracts under proposed Rule 15c6-2 to retain records of the documents described in that rule?

48. Should the Commission require that these records be retained under a different provision of the recordkeeping rule? For example, should the Commission instead amend Rule 204-2(a)(3) (requiring advisers to retain “memorandums” of orders) to explicitly include these records? If so, the determination of whether to maintain the relevant allocations, confirmation, and affirmations would depend on if they were part of an “order.” Given that certain orders may never be executed, and that certain executed trades potentially might not have orders associated with them, would including the requirement in the recordkeeping requirement related to “orders” result in advisers not retaining some allocations, confirmations, and affirmations? Separately, would maintaining the proposed records under Rule 204-2(a)(3) create confusion about whether advisers need to maintain originals and/or duplicate copies of relevant allocations, confirmations, and affirmations, when the specified record is the memorandum? Or, do advisers currently maintain records of allocations, confirmations, and affirmations under this provision to document the orders they describe in the memoranda?

49. Should the Commission require time and date stamping of the allocations and affirmations to the nearest minute, as proposed? Would advisers need to make system changes to accomplish such time and date stamping of allocations and affirmations? Is there an approach other than time and date stamping that would allow Commission staff to verify that an adviser has completed the steps necessary to facilitate settlement in a timely manner? Should the Commission require time and date stamping of just the affirmation or just the allocation? Is the requirement to time and date stamp the allocation or affirmation when it is “sent to the broker or dealer” clear? Should we require the time and date stamp at a different point in time? If so, when?

50. Should we require time and date stamping of receipt of the confirmation as well? What additional costs or burdens would such time stamping incur?

51. Under what circumstances do third parties, such as prime brokers or custodians, affirm trades instead of advisers, and in those instances do the third parties send copies of the affirmations to the advisers? Does this happen for all accounts an adviser manages or only some accounts and why?

52. If advisers are matching adviser records to confirmations, some trades will not match. In other instances, an adviser may receive a confirmation for a trade that the adviser does not “know,” such as when an adviser did not execute a trade or when the adviser's trading desk has not notified the adviser's middle or back office. In such cases, do advisers proactively notify the broker-dealer that the trade does not match (often referred to as “don't know” or sending a “DK”)? Should the proposed rule be more specific about recordkeeping when an adviser does not agree with or does not “know” a trade for which a confirmation was received? How often do trades not match? How frequently do advisers receive confirmations they do not “know?”

D. New Requirement for CMSPs To Facilitate Straight-Through Processing

Because of the rising volume of transactions for which CMSPs provide matching and other services,

179

CMSPs have become increasingly critical to the functioning of the securities market.

180

As described in Part II.B.1, CMSPs facilitate communications among a broker-dealer, an institutional investor or its investment adviser, and the institutional investor's custodian to reach agreement on the details of a securities transaction, enabling the trade allocation, confirmation, affirmation, and/or the matching of institutional trades. Once the trade details have been agreed among the parties or matched by the CMSP, the CMSP can then facilitate settlement of the transaction.

179

See, e.g.,

Press Release, DTCC, Over 1,800 Firms Agree to Leverage U.S. Institutional Trade Matching Capabilities in DTCC's CTM (Oct. 12, 2021),

https://www.dtcc.com/news/2021/october/12/over-1800-firms-agree-to-leverage-dtccs-ctm;

DTCC's Trade Processing Suite Traffics One Billion Trades, Traders Magazine (Feb. 13, 2017),

https://www.tradersmagazine.com/departments/clearing/dtccs-trade-processing-suite-traffics-one-billion-trades/.

180

CMSPs are clearing agencies as defined in Section 3(a)(23) of the Exchange Act, and as such, are required to register as a clearing agency or obtain an exemption from registration. The Commission has currently exempted three CMSPs from the registration requirement. The Commission also has adopted rules that apply to both registered and exempt clearing agencies, including CMSPs operating pursuant to an exemption from registration.

See, e.g.,

Regulation Systems Compliance and Integrity, Exchange Act Release No. 73639 (Nov. 19, 2014), 79 FR 72252 (Dec. 5, 2014) (“Regulation SCI Adopting Release”).

While the introduction of new technologies and streamlined operations such as those offered by CMSPs have improved the efficiency of post-trade processing over time, the Commission believes more should be done to facilitate further improvements, particularly with respect to the processing of institutional trades. Currently, some SRO rules require the use of CMSP services for institutional

trade processing.

181

The Commission has previously explained that a shortened settlement cycle may lead to expanded use of CMSPs, as well as increased focus on enhancing the services and operations of the CMSPs themselves.

182

In particular, the Commission believes that eliminating the use of tools that encourage or require manual processing, alongside the continued development and implementation of more efficient automated systems in the institutional trade processing environment, is essential to reducing risk and costs to ensure the prompt and accurate clearance and settlement of securities transactions.

183

Below is a discussion of the elements of the proposed rule.

181

See e.g.,

FINRA Rule 11860 (requiring a broker-dealer to use a registered clearing agency, a CMSP, or a qualified vendor to complete delivery-versus-payment transactions with their customers).

182

T+2 Proposing Release,

supra

note 30, at 69258.

183

See

T+1 Report,

supra

note 18, at 9.

1. Policies and Procedures To Facilitate Straight-Through Processing

Proposed Rule 17Ad-27 would require a CMSP to establish, implement, maintain and enforce policies and procedures to facil

This text is long and has been trimmed here. Open the source document for the complete record.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.