SEC Takes to T+2

Beginning September 5, 2017, the day after Labor Day, all securities transactions involving broker-dealers, which include the routine buying and selling of securities on all levels, will have to close no later than the second business day following the date of the purchase contract, unless otherwise expressly agreed to by the parties. This amendment marks the first change to the standard settlement cycle since the adoption in 1993 of Rule 15c6-1 under the Securities Exchange Act of 1934, which established T+3 as the standard settlement cycle.

Shortening the settlement cycle is expected to decrease credit, market and liquidity risk for broker-dealers, clearing agencies and other market participants by reducing the time period that parties are exposed to trades and counterparty risk and improving the market by shrinking the number of unsettled trades overall. Market participants were overwhelmingly in favor of the change. In addition to reducing market and transaction risk, the new rule will also mean quicker access to capital for sellers, which could have a positive ripple effect on operations, though the flip side is that buyers will have to be prepared to deliver funds quicker.

Advancements in technology and market practices and operations in recent years are expected to ease the transition to a T+2 settlement cycle, but there will nevertheless be some costs associated with various parties updating their operations to accommodate shortened settlements. It is expected that market participants will need to update their trading systems, confirmation/affirmation systems and other servicing functions, as well as their reference data, to accommodate T+2 trades. The shorter window for error may also cause brokers to charge higher fees going forward for failed trades. The SEC expects that, industry wide, initial compliance costs will fall somewhere in the range of $687 million to $4.2 billion.

The T+2 mandate will apply to underwritten offerings of equity, corporate debt and municipal bonds.  However, in its issuing release, the SEC affirmed that the amended rule does not change the current permission for parties in a firm commitment underwritten offering to agree to an alternate settlement cycle, which is common practice in certain transactions. Moreover, at least one commenter suggested that a shorter settlement cycle may increase the number of offerings that agree to an alternate, extended settlement cycle. Two business days may not provide sufficient time to complete and execute documents required for many offerings, particularly for complex or heavily documented transactions, including convertible debt, preferred equity and fixed income securities. Alternate settlement cycles can also provide issuers with greater flexibility to access the capital markets on their own terms and provide issuers and investors the time needed to finalize any desired hedging arrangements.

While underwritten offerings of common stock may adjust after a transition period to the T+2 standard, in part to align with the settlement cycle for trades on the secondary market, we expect offerings of other securities that currently close on a T+3 timeframe or opt to close on longer timeframes will continue to do so. Consistent with current practice, any offering that elects an extended settlement cycle would continue to provide disclosure to that effect in its offering documents.

Despite the urging of some in the industry, the SEC declined to shorten the standard settlement cycle further than T+2, but it has left the door open to do so in the future. In its issuing release, the SEC noted that while a further reduction to a T+1 settlement cycle could result in an even larger reduction in settlement-related risk, the agency believes the costs of implementation are too high at this time. However, given the possible benefits and market interest, the SEC’s staff has committed to preparing a report by September 2020 analyzing the impact of transitioning to T+2 settlements and examining the potential benefits of an even shorter settlement cycle. Further, at least one SEC Commissioner has expressed public support for further shortening the standard settlement cycle. It may be that T+2 is just the next stop on the way to even more rapid or even instantaneous security trades.