[Federal Register Volume 87, Number 37 (Thursday, February 24, 2022)]
[Proposed Rules]
[Pages 10436-10501]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-03143]
[[Page 10435]]
Vol. 87
Thursday,
No. 37
February 24, 2022
Part II
Securities and Exchange Commission
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17 CFR Parts 232, 240 and 275
Shortening the Securities Transaction Settlement Cycle; Proposed Rule
Federal Register / Vol. 87 , No. 37 / Thursday, February 24, 2022 /
Proposed Rules
[[Page 10436]]
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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.
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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 [email protected]. 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.,\1\ 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.
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\1\ 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).
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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
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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.\2\ 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.\3\ 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.\4\
The Bachmann Report presented multiple recommendations to improve the
securities market by improving the safety and soundness of the National
C&S System.\5\ 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.
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\2\ 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.
\3\ See Levine, supra note 2, at 23-25.
\4\ 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'').
\5\ See id.
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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.'' \6\ 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.'' \7\ 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.'' \8\
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\6\ 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.
\7\ Id.
\8\ Id. at 6.
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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''),\9\ and in 2017, the Commission amended
the rule to require settlement within two business days (``T+2'').\10\
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.
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\9\ 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.
\10\ Exchange Act Release No. 80295 (Mar. 22, 2017), 82 FR
15564, 15601 (Mar. 29, 2017) (``T+2 Adopting Release'').
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These two episodes have highlighted potential vulnerabilities in the
U.S. securities market that shortening the standard settlement cycle
could help mitigate.\11\ 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.\12\ 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.\13\
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\11\ 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.
\12\ 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).
\13\ 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.
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On December 1, 2021, the Depository Trust and Clearing Corporation
(``DTCC''),\14\ the Investment Company Institute (``ICI''),\15\ the
Securities Industry and Financial Markets Association (``SIFMA''),\16\
and Deloitte & Touche LLP (``Deloitte'') \17\ published a report that
presented industry recommendations to implement a T+1 standard
settlement cycle in the U.S.\18\ 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.\19\ 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.
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\14\ 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.
\15\ 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.
\16\ SIFMA is a trade association for broker-dealers, investment
banks, and asset managers operating in the U.S. and global capital
markets.
\17\ See infra note 18.
\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).
\19\ 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.
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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,\20\ 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,\21\ although many of them were
subsequently achieved.
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\20\ 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).
\21\ 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.
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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.\22\ 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.'' \23\ 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.
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\22\ 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.
\23\ Id. at 9.
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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.\24\
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\24\ Id.
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In 2014, DTCC, ICI, SIFMA, and other market participants formed an
Industry Steering Group (``ISG'') to facilitate a transition to
T+2.\25\ 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.\26\ 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.\27\ The
ISG White Paper also included an implementation timeline that targeted
the transition for the end of the third quarter of 2017.
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\25\ 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.
\26\ 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.
\27\ Deloitte & ISG, T+2 Industry Implementation Playbook (Dec.
18, 2015) (``T+2 Playbook''), http://www.ust2.com/pdfs/T2-Playbook-12-21-15.pdf.
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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.\28\ 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.\29\
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\28\ 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.
\29\ Id.
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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.\30\ 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,\31\ three CMSPs,\32\ 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.
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\30\ 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'').
\31\ NSCC and DTC are subsidiaries of DTCC and each a clearing
agency registered with the Commission. See supra note 14.
\32\ 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.
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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.\33\ 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.\34\ 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.
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\33\ T+2 Adopting Release, supra note 10, at 15582.
\34\ Id. at 15582-83.
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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.\35\ 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.\36\ 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.
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\35\ T+2 Proposing Release, supra note 30, at 69243-46.
\36\ 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.
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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,\37\ 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
[[Page 10440]]
clearing agency that provides CCP services for transactions in U.S.
equity securities to its members.\38\ 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; \39\ and (3) netting to reduce NSCC's overall exposure to
its counterparties.\40\
---------------------------------------------------------------------------
\37\ T+2 Proposing Release, supra note 30, at 69243.
\38\ 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.
\39\ 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).
\40\ 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.\41\
---------------------------------------------------------------------------
\41\ 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.\42\
---------------------------------------------------------------------------
\42\ 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.\43\ 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.
---------------------------------------------------------------------------
\43\ 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.\44\
---------------------------------------------------------------------------
\44\ 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.\45\ 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.
---------------------------------------------------------------------------
\45\ 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.\46\ 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.
---------------------------------------------------------------------------
\46\ 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.
[[Page 10441]]
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.\47\ 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.
---------------------------------------------------------------------------
\47\ 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.\48\
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.\49\ By contrast, the settlement of retail investor trades
generally occurs directly with the investor's broker-dealer,\50\
without relying on a separate custodian bank or prime broker.
---------------------------------------------------------------------------
\48\ 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.
\49\ See T+2 Proposing Release, supra note 30, at 69247
(discussing the same).
\50\ 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.\51\ 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.
---------------------------------------------------------------------------
\51\ 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
[[Page 10442]]
[GRAPHIC] [TIFF OMITTED] TP24FE22.000
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.\52\ Further discussion of institutional trades
and the use of block trades by institutional investors follows below.
---------------------------------------------------------------------------
\52\ 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.\53\ 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.\54\
---------------------------------------------------------------------------
\53\ 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.
\54\ An electronic copy of the execution details is sometimes
referred to as a ``notice of execution.''
---------------------------------------------------------------------------
[[Page 10443]]
[GRAPHIC] [TIFF OMITTED] TP24FE22.001
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,\55\ 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.\56\ Whichever the mechanism, achieving an
affirmed confirmation by the end of trade date is considered a
securities industry best practice.\57\ According to data from DTCC,
however, only 68% of trades are affirmed on trade date.\58\ Figure 2
illustrates a scenario where the institutional investor does not rely
on a CMSP to complete the confirmation/affirmation process.
---------------------------------------------------------------------------
\55\ See T+1 Report, supra note 18, at 5.
\56\ 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.
\57\ See T+1 Report, supra note 18, at 8-9.
\58\ 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.
(c) Use of Block Trades
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
[[Page 10444]]
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.
[GRAPHIC] [TIFF OMITTED] TP24FE22.002
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.''
\59\ 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.\60\
---------------------------------------------------------------------------
\59\ 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.
\60\ 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.\61\
[[Page 10445]]
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.
---------------------------------------------------------------------------
\61\ 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.\62\
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%.\63\ DTCC also contended that achieving T+1 could be
largely supported by using existing systems and available tools and
procedures.\64\ With respect to a T+0 settlement cycle, DTCC
distinguished between netted T+0 settlement and real-time gross
settlement,\65\ 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.\66\ 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.'' \67\ 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.\68\ 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.\69\
---------------------------------------------------------------------------
\62\ 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.
\63\ Id. at 5, 8.
\64\ Id. at 5.
\65\ 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).
\66\ See, e.g., DTCC, Same-Day Settlement (SDS), https://www.dtcc.com/sds.
\67\ DTCC White Paper, supra note 61, at 7.
\68\ Id.
\69\ 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'') \70\ 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.\71\ 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.'' \72\
---------------------------------------------------------------------------
\70\ 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.
\71\ Id.
\72\ 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.\73\ 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.\74\
---------------------------------------------------------------------------
\73\ See T+1 Report, supra note 18.
\74\ 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.\75\
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.\76\
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.\77\ 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.''
\78\ 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.\79\ 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.
---------------------------------------------------------------------------
\75\ Id. at 10.
\76\ Id.
\77\ Id.
\78\ Id.
\79\ 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.\80\ 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.\81\ Second, the
Commission proposes three additional rules applicable, respectively, to
broker-
[[Page 10446]]
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.
---------------------------------------------------------------------------
\80\ See infra Part III.A.1.
\81\ 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.\82\ 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.\83\ Application of Rule
15c6-1(a) extends to the purchase and sale of securities issued by
investment companies (including mutual funds),\84\ private-label
mortgage-backed securities, and limited partnership interests that are
listed on an exchange.\85\
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\82\ 17 CFR 240.15c6-1(a).
\83\ 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).
\84\ 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.
\85\ 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.
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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.\86\ 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.'' \87\ The override
provision in 15c6-1(a) continues to be intended to apply only to these
unusual transactions.\88\
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\86\ 17 CFR 240.15c6-1(a).
\87\ 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.
\88\ To date, the Commission has not identified instances
indicating a risk of overuse of this provision.
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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.\89\
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.\90\ 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.\91\ Under
the exemption, an ADR is considered a separate security from the
underlying security.\92\ 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
[[Page 10447]]
foreign security, only the foreign security will be exempt from Rule
15c6-1.\93\ 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 \94\) that is funded by or participates in a ``separate
account'' (as defined in Section 2(a)(37) of the Investment Company Act
\95\), 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'').\96\
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\89\ 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.
\90\ 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.
\91\ Id.
\92\ Id. at n.7.
\93\ Id.
\94\ 15 U.S.C. 80a-2(a)(17).
\95\ 15 U.S.C. 80a-2(a)(37).
\96\ 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.
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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'').\97\ 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.
---------------------------------------------------------------------------
\97\ 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.\98\
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\98\ 17 CFR 240.15c6-1(d).
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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.\99\ 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\
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\99\ 17 CFR 240.15c6-1(a).
\100\ See supra note 88.
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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).
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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.
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\104\ See infra Part V (analyzing the economic effects of
shortening the standard settlement cycle to T+1).
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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.
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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
[[Page 10448]]
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.
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\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.
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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.
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\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.
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\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.
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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\
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\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.
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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.
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\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).
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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.
[[Page 10449]]
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\
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\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.
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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
[[Page 10450]]
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.
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\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.
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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.
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\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 infra Part IV (discussing the same).
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3. Is the current scope of securities covered by Rule 15c6-1,
including the exclusions provided in the text of Rule 15c6-1(a), still
appropriate in light of the Commission's proposal to shorten the
standard settlement cycle to T+1? Are there any asset classes,
securities as defined in Section 3(a)(10) of the Exchange Act, or types
of securities transactions for which the proposed amendment to Rule
15c6-1(a) would present compliance problems for broker-dealers? What
would be the quantitative and qualitative impacts of maintaining those
exclusions?
4. The Commission requests that commenters provide information
regarding securities transactions that, in today's T+2 settlement
environment, generally settle later than T+2. To what extent does this
occur, and what are the circumstances that motivate market participants
to settle later than T+2? If Rule 15c6-1(a) is amended to shorten the
standard settlement cycle from T+2 to T+1, would market participants
continue to settle such securities transactions on a longer settlement
cycle? Would market participants who frequently settle certain
securities transactions later than T+2 settle such transactions later
than T+1 if the Commission adopts the proposed amendment to Rule 15c6-
1(a)? Conversely, under what circumstances are securities transactions
settled on an expedited basis (i.e., on timeframes less than T+2), and
how often how common is such settlement? What are the circumstances
that motivate earlier settlements? If Rule 15c6-1(a) is amended to
shorten the standard settlement cycle from T+2 to T+1, how will the
proposed amendment affect these expedited settlement decisions?
5. To what extent do market participants currently rely on the
override provision in Rule 15c6-1(a)? Would market participants expect
use of the provision to increase or decrease in a T+1 environment? Why
or why not?
6. As noted above, the Commission previously issued an order that
exempted security-based swaps from the requirements under Rule 15c6-1,
and
[[Page 10451]]
subsequently extended that exemptive relief on several occasions, but
the exemptive relief that previously covered compliance with Rule 15c6-
1 expired in 2020.\136\ Should the Commission issue a new order
providing exemptive relief from compliance with Rule 15c6-1 for
transactions in security-based swaps? If so, why or why not?
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\136\ See supra note 83.
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7. Should the Commission amend any other provisions of Rule 15c6-1
(other than the proposed amendments to the rule) for the purposes of
shortening the standard settlement cycle to T+1? If so, which
provisions and why?
8. Are the conditions set forth in the Commission's exemptive order
for securities traded outside the U.S. still appropriate? \137\ If not,
why not? If the exemption should be modified, how should it be modified
and why?
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\137\ See supra note 90 and accompanying text.
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9. Are the conditions set forth in the Commission's exemptive order
for insurance contracts still appropriate? \138\ If not, why not? If
the exemption should be modified, how should it be modified and why?
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\138\ See supra note 96 and accompanying text.
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10. Should the Commission provide exemptive relief under Rule 15c6-
1(b) for any other securities or types of transactions?
11. Would shortening the standard settlement cycle to T+1 as
proposed make it difficult for broker-dealers to comply with the
requirements of Rule 15c6-1? Please provide examples.
12. How would retail investors be impacted by new processes that
broker-dealers may implement in support of a T+1 standard settlement
cycle? For example, do commenters believe that broker-dealers would
require changes to the way that retail investors fund their accounts in
a T+1 environment? If so, how? Would shortening the standard settlement
cycle to T+1 result in retail investors encountering ongoing costs due
to a delay in their ability to make investments? Would shortening the
standard settlement cycle to T+1 result in any benefits to retail
investors?
13. How would institutional investors be impacted by new processes
that broker-dealers may implement in support of a T+1 standard
settlement cycle? For example, do market participants anticipate an
increase in prefunding requirements for institutional investors in a
T+1 environment?
14. What impact, if any, would the proposed amendment to Rule 15c6-
1(a) have on market participants who engage in cross-border
transactions? To what extent would shortening the standard settlement
cycle in the U.S. to T+1 result in increased or decreased operational
costs to market participants? To what extent would shortening the
standard settlement cycle for securities transactions in the U.S.
increase or decrease risks associated with cross-border transactions or
related transactions, such as financing transactions?
15. What impact, if any, would the proposed amendment to Rule 15c6-
1(a) have on market participants who engage in trading activity across
various financial product classes, each potentially involving a
different settlement cycle? For example, what would be the impact on
market participants conducting transactions in U.S. equities and U.S.
commercial paper on the same day? Alternatively, are there benefits to
alignment of the settlement timeframes across most U.S. security types
to one day? For example, options and government securities currently
settle on T+1 while equities, corporate bonds, and municipal debt
settle on T+2.
16. What impact, if any, would the proposal have on trading
involving derivatives and exchange-traded products (``ETPs'')? \139\
Would shortening the settlement cycle for ETPs affect the costs of
creating or redeeming shares in ETPs that hold portfolio securities
that are on a different settlement cycle, such as net capital charges
related to collateral requirements? \140\ If so, would such a change in
costs affect the efficiency or effectiveness of the arbitrage between
an ETP's secondary market price and the value of its underlying assets?
Would such a change lead to other downstream effects, such as an
increase in the use of cash or custom baskets? \141\ Similarly, would
the proposed amendments affect transactions in derivatives instruments
if a derivative were to settle on a different timeframe than its
underlying reference assets?
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\139\ ETPs constitute a diverse class of financial products that
seek to provide investors with exposure to financial instruments,
financial benchmarks, or investment strategies across a wide range
of asset classes. ETP trading occurs on national securities
exchanges and other secondary markets that are regulated by the
Commission under the Exchange Act, making ETPs widely available to
market participants, from individual investors to institutional
investors, including hedge funds and pension funds. The largest
category of ETPs are ETFs, which are open-end fund vehicles or UITs
that are registered investment companies under the Investment
Company Act. See Request for Comment on Exchange-Traded Products,
Exchange Act Release No. 75165 (June 12, 2015), 80 FR 34729 (June
17, 2015).
\140\ For example, the way a market participant executes a
creation or redemption of an ETF share resembles a stock trade in
the secondary market. A market participant typically referred to as
an ``Authorized Participant'' or ``AP'' submits an order to create
or redeem (``CR'') ETF shares much like an investor submits an order
to his broker to buy or sell a stock. Also, similar to a stock
trade, the CR order settles on a T+2 settlement cycle through NSCC.
See ICI, 20 ICI Research Perspective, no. 5, Sept. 2014, at 14,
https://www.ici.org/pdf/per20-05.pdf; see also DTCC, Exchange Traded
Fund (ETF) Processing, http://www.dtcc.com/clearing-services/equities-trade-capture/etf; DTCC, ETF and CNS Processing Facts,
https://dtcclearning.com/content/220-equities-clearing/exchange-traded-fund-etf/about-etf/3613-etf-cns-processing-facts.html.
\141\ Rule 6c-11 under the Investment Company Act permits ETFs
to use ``custom baskets'' if their basket policies and procedures:
(i) Set forth detailed parameters for the construction and
acceptance of custom baskets that are in the best interest of the
ETF and its shareholders, including the process for any revisions
to, or deviations from, those parameters; and (ii) specify the
titles or roles of the employees of the ETF's investment adviser who
are required to review each custom basket for compliance with those
parameters. See infra note 257 and accompanying text (further
discussing the creation unit purchase and redemption process for
ETFs).
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17. What impact, if any, would shortening the standard settlement
cycle to T+1 have on the levels of liquidity risk that may currently
exist as a result of mismatches between the settlement cycles for
different markets? For example, would shortening the standard
settlement cycle to T+1 eliminate or reduce any liquidity risk that
mutual funds may face as a result of the mismatch between the current
T+1 settlement cycle for transactions in open-end mutual fund shares
that are settled through NSCC and the T+2 settlement cycle that is
applicable to many portfolio securities held by mutual funds?
18. The Commission solicits comment on the status and readiness of
the technology and processes currently used by market participants to
support a T+1 settlement cycle.
19. What impact would the Commission's proposed deletion of
paragraph (c) of Rule 15c6-1 have on underwriters, broker-dealers, and
other market participants?
20. Have the technological and operational capabilities of broker-
dealers and their service providers improved sufficiently to allow
prospectuses to be printed and delivered on time if the standard
settlement cycle for firm commitment offerings priced after 4:30 p.m.
is shortened to T+1? Please describe such improvements and why they
would or would not be sufficient to support shortening the standard
settlement cycle for such transactions.
21. Should the Commission shorten the standard settlement cycle for
firm commitment offerings priced after 4:30 p.m. to a time frame other
than T+1 (e.g., T+2, or T+3)? If so, why?
[[Page 10452]]
22. Would any additional technological and operational changes, if
any, be necessary for broker-dealers to print and deliver prospectuses
on time for firm commitment offerings priced after 4:30 p.m. if a T+1
standard settlement cycle is adopted for such transactions? What costs
would be associated with such improvements?
23. Would the Commission's proposed deletion of paragraph (c) of
Rule 15c6-1 decrease exposures of underwriters, dealers and investors
to market and credit risks related to the bifurcated settlement periods
for new issues and secondary market transactions? Please explain why or
why not.
24. With respect to corporate actions, in most cases the ex-date
will be the record date (``RD''), meaning that RD-1 will be the last
day that a purchaser will gain the dividend or entitlement.\142\ Given
the shorter timeframes, the Commission requests comments on this
dynamic and statements in the T+1 Report urging a concerted effort
among exchanges, other authorities, and issuers to standardize some
currently fragmented procedures to set up and announce corporate
actions.\143\
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\142\ See, e.g., ISITC Virtual Winter Forum, DTCC presentation
to Corporate Actions Working Group (Dec. 13, 2021).
\143\ T+1 Report, supra note 18, at 20.
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25. Regarding corporate actions that concern voluntary
reorganizations, the Commission solicits comments on the impact of a
T+1 settlement cycle on DTC's ``cover/protect'' process for certain
tenders, exchanges, or rights offerings.\144\ This procedure enables
DTC participants to allow their investors to make or change their final
elections until the end of an offer's expiration date; where an offer
allows, participants provide DTC with a notice of guaranteed delivery,
allowing later delivery of the shares or rights. How would this process
affect operations under a T+1 settlement cycle? Would any changes to
this process be needed?
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\144\ Id. at 19-20; see also ISITC Virtual Winter Forum, DTCC
presentation to Corporate Actions Working Group (Dec. 13, 2021).
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26. The Commission generally requests comment on the deadlines and
timeframes set forth in the T+1 Report. For example, the Commission
requests comment on their impact on DTC's IVORS function, used for
retiring a UIT by withdrawing assets and transferring them to a new
UIT.\145\
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\145\ See DTC, IVORS Service Guide, https://www.dtcc.com/~/
media/Files/Downloads/Settlement-Asset-Services/EDL/IVORS.pdf.
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27. If the Commission adopts the proposed deletion of paragraph (c)
of Rule 15c6-1 and the proposed conforming technical amendments to
paragraphs (a), (b) and (d) of the rule, should the Commission adopt
any additional amendments to Rule 15c6-1 in connection with such
changes?
B. New Requirement for ``Same-Day Affirmation''
As discussed in Part II.B.1, integral to completing the
institutional trade process is achieving an affirmed confirmation,
which can require a series of communications between a broker-dealer
and its institutional customer. Since 2000, market participants have
identified accelerating this process, which requires agreement among
the parties regarding the trade details that facilitate trade
allocation when needed, as well as trade confirmation and affirmation,
as one of the core building blocks to improve the speed, safety, and
efficiency of the trade settlement process, and ultimately to achieve
shorter settlement cycles.\146\ In particular, in the SIA Business Case
Report, the securities industry noted the need to prioritize ensuring
that a higher number and proportion of trades were confirmed and
affirmed on trade date.\147\ These improvements were considered
essential to compressing the settlement cycle and facilitating an
environment less prone to operational risk.\148\ This objective, where
broker-dealers and their institutional customers allocate, confirm, and
affirm the trade details necessary to achieve settlement by the end of
trade date has sometimes been referred to as ``same-day affirmation.''
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\146\ See SIA Business Case Report, supra note 21; BCG Study,
supra note 22; 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.
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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\
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\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.
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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\
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\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.
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[[Page 10453]]
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.
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\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.
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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.
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\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.
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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.
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\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.
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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,
[[Page 10454]]
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.
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\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.
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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.
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\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.
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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.
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\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.
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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
[[Page 10455]]
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.
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\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.
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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?
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\170\ See T+1 Report, supra note 18, at 26.
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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
[[Page 10456]]
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.
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\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).
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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.
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\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'').
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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\
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\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).
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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
[[Page 10457]]
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.
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\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.
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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\
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\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).
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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.
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\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'').
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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
[[Page 10458]]
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.
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\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.
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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 facilitate straight-
through processing for transactions involving broker-dealers and their
customers.
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.\184\ In the context of institutional trade processing
under this rule, straight-through processing occurs when a market
participant or its agent uses the facilities of a CMSP to enter trade
details and completes the trade allocation, confirmation, affirmation,
and/or matching processes without manual intervention. Under the rule,
a CMSP facilitates straight-through processing when its policies and
procedures enable its users to minimize or eliminate, to the greatest
extent that is technologically practicable, the need for manual input
of trade details or manual intervention to resolve errors and
exceptions that can prevent settlement of the trade. A CMSP also
facilitates straight-through processing when it enables, to the
greatest extent that is technologically practicable, the transmission
of messages regarding errors, exceptions, and settlement status
information among the parties to a trade and their settlement agents.
Under the rule, policies and procedures generally should establish a
holistic framework for facilitating straight-through processing, as
just described, on a CMSP-wide basis. CMSPs should also generally
consider and address how the services, systems, and any operational
requirements a CMSP applies to its users ensure that the CMSP's
policies and procedures advance the goal of achieving straight-through
processing for trades processed through it. For example, a CMSP's
policies and procedures generally should explain the criteria that the
CMSP applies to determine when a ``match'' has been achieved, including
any relevant tolerances that it or its users might apply to achieve a
match, and the extent to which such criteria should be standardized or
customized. With respect to the use of electronic trade confirmation
services, which often rely on legacy technologies, a CMSP's policies
and procedures generally should establish a timeline for transitioning
users away from manual processes to matching services that reduce a
party's reliance on the manual, often sequential, entry and
reconciliation of trade information.
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\184\ See SIA Business Case Report, supra note 21, at app. E
(defining ``straight-through processing'').
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The Commission believes that increasing the efficiency of using a
CMSP can reduce the risk that a trade will fail to settle, as well as
the costs associated with correcting errors that result from the use of
manual processes and data entry, thereby improving the overall
efficiency of the National C&S System. CMSPs have become increasingly
connected to a wide variety of market participants in the U.S.,\185\
increasing the need to reduce risks and inefficiencies that may result
from use of a CMSP's services. Because the proposed rule would preclude
reliance on service offerings at CMSPs that rely on manual processing,
the Commission preliminarily believes the proposed rule will better
position CMSPs to provide services that not only reduce risk generally
but also help facilitate an orderly transition to a T+1 standard
settlement cycle,\186\ as well as potential further shortening of the
settlement cycle in the future.
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\185\ See, e.g., DTCC, About DTCC Institutional Trade
Processing, https://www.dtcc.com/about/businesses-and-subsidiaries/dtccitp (noting that DTCC ITP, parent to DTCC ITP Matching, serves
6,000 financial services firms in 52 countries).
\186\ As discussed in Part III.B.2, 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. See supra note 164.
Proposed Rule 17Ad-27 is consistent with, and should help promote,
efforts to shorten the processing time for institutional trades in a
T+1 environment.
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The Commission has taken a ``policies and procedures'' approach in
developing the proposed rule because it preliminarily believes such an
approach will remain effective over time as CMSPs consider and offer
new technologies and operations to improve the settlement of
institutional trades. The Commission also believes that improving the
CMSP's systems to facilitate straight-through processing can help
market participants consider additional ways to make their own systems
more efficient. In addition, a ``policies and procedures'' approach can
help ensure that a CMSP considers in a holistic fashion how the
obligations it applies to its users will advance the implementation of
methodologies, operational capabilities, systems, or services that
support straight-through processing.
In considering how to develop policies and procedures that
facilitate straight-through processing, a CMSP generally should
consider the full range of operations and services related to the
processing of institutional trades for settlement. For example, as
noted above, the CMSP often acts as a communication platform for
different market participants to transmit messages regarding errors,
exceptions, and settlement status information among the parties to a
trade and their settlement agents. Under proposed Rule 17Ad-27, a CMSP
also generally should consider the extent to which its policies,
procedures, and processes restrict, inhibit, or delay the ability of
users to transmit such messages to any agent that assists said users in
preparing or submitting the trade for settlement. In the Commission's
view, the CMSP generally should consider having policies and procedures
that promote the onward transmission of messages among the relevant
parties to a transaction to ensure timely settlement and reduce the
potential for errors. Similarly, in structuring its process for
submitting transactions for settlement, the CMSP generally should
consider ensuring that its systems, operational requirements, and the
other choices it makes in designing its services enable and incentivize
prompt and accurate settlement without manual intervention.
As explained above, the Commission recognizes it may not be
technologically or operationally practicable to eliminate all manual
processes immediately. Indeed, the Commission believes that in certain
circumstances, the parties to a trade may need to engage in manual
interventions to ensure the accuracy of trade information and minimize
operational or other risks that may prevent settlement, and proposed
Rule 17Ad-27 does not require CMSPs to remove a manual processes if
doing so would clearly undermine the prompt and accurate clearance and
settlement of
[[Page 10459]]
securities transactions. However, pursuant to the policies and
procedures approach described above, where a CMSP continues to permit
manual reconciliation or other types of human intervention, it
generally should explain in its policies and procedures why those
manual processes remain necessary as part of its systems and processes.
In addition, the CMSP should consider developing processes that
ultimately would eliminate the underlying issues that drive the use of
manual processes in order to facilitate a more automated approach.
2. Annual Report on Straight-Through Processing
Proposed Rule 17Ad-27 also would require a CMSP to submit every
twelve months to the Commission a report that describes the following:
(a) The CMSP's current policies and procedures for facilitating
straight-through processing; (b) its progress in facilitating straight-
through processing during the twelve month period covered by the
report; and (c) the steps the CMSP intends to take to facilitate and
promote straight-through processing during the twelve month period that
follows the period covered by the report. The Commission preliminarily
intends to make this annual report publicly available on its website to
enable the public to review and analyze progress on achieving straight-
through processing. A CMSP would submit this report to the Commission
using the Commission's Electronic Data Gathering, Analysis, and
Retrieval system (``EDGAR''), and would tag the information in the
report using the structured (i.e., machine-readable) Inline eXtensible
Business Reporting Language (``XBRL'').\187\
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\187\ This requirement would be implemented by including a
cross-reference to Regulation S-T in proposed Rule 17Ad-27, and by
revising Regulation S-T to include the proposed straight-through
processing reports. Pursuant to Rule 301 of Regulation S-T, the
EDGAR Filer Manual is incorporated by reference into the
Commission's rules. In conjunction with the EDGAR Filer Manual,
Regulation S-T governs the electronic submission of documents filed
with the Commission.
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The Commission believes that the proposed reporting requirement
would enable the Commission to evaluate actions taken by the CMSP to
ensure compliance with the rule and to help fulfill the Commission's
responsibility for oversight of the National C&S System, both as it
relates to the CMSP specifically and the National C&S System more
generally. The proposed requirement would also inform the Commission
and the public, particularly the direct and indirect users of the CMSP,
as to the progress being made each year to advance implementation of
straight-through processing with respect to the allocation,
confirmation, affirmation, and matching of institutional trades, the
communication of messages among the parties to the transactions, and
the availability of service offerings that reduce or eliminate the need
for manual processing. In particular, the Commission preliminarily
believes that a CMSP generally should include in its report a summary
of key settlement data relevant to its straight-through processing
objective. Such data could include the rates of allocation,
confirmation, affirmation, and/or matching achieved via straight-
through processing. In describing its progress in facilitating
straight-through processing, the CMSP could also identify common or
best practices that facilitate straight-through processing. In
addition, after the CMSP has submitted its initial report, in
subsequent years a CMSP generally should include in its report an
assessment of how its progress in facilitating straight-through
processing during the twelve month period covered by the report under
paragraph (b) compares to the steps it intended to take to facilitate
straight-through processing under paragraph (c) from the prior year's
report.
Because this information would be useful to the industry and the
general public in considering potential ways to increase the
availability of straight-through processing, the Commission believes
that the report should be made public. The Commission preliminarily
believes that the proposed requirement generally would not require the
disclosure of proprietary information, trade secrets, or personally
identifiable information. To the extent that an annual report includes
confidential commercial or financial information, a CMSP could request
confidential treatment of those specific portions of the report.\188\
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\188\ See 17 CFR 240.24b-2.
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As the National C&S System continues to evolve, the Commission
believes that CMSPs will continue to play an increasingly critical role
in efforts to facilitate the prompt and accurate clearance and
settlement of securities transactions and to eliminate inefficient and
costly procedures that effect the settlement of securities
transactions, particularly institutional transactions. Furthermore,
because of the CMSP's role in submitting matched or confirmed and
affirmed trades for overnight positioning of settling transactions, the
Commission believes that a CMSP generally should evaluate how it
participates in that process and consider how it can support
improvements to the timing and manner of settlement obligations (e.g.,
intraday) to increase efficiency in the National C&S System.
Requiring CMSPs to file the reports on EDGAR would provide the
Commission and the public with a centralized, publicly accessible
electronic database for the reports, facilitating the use of the
reported data on straight-through processing. Moreover, requiring
Inline XBRL tagging of the reported disclosures, which would
specifically comprise an Inline XBRL block text tag for each of the
three required narrative disclosures as well as detail tags for
individual data points, would make the disclosures more easily
available and accessible to and reusable by market participants and the
Commission for retrieval, aggregation, and comparison across different
CMSPs and time periods, as compared to an unstructured PDF, HTML, or
ASCII format requirement for the reports.\189\ Detail tags could be
helpful to the extent the reports disclose individual data points,
including the rates of allocation, confirmation, affirmation, and/or
matching achieved via straight-through processing.
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\189\ See Release No. 33-10514 (June 28, 2018), 83 FR 40846,
40847 (Aug. 16, 2018). Inline XBRL allows filers to embed XBRL data
directly into an HTML document, eliminating the need to tag a copy
of the information in a separate XBRL exhibit. Id. at 40851.
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The Commission is proposing a 12-month requirement in the rule
because the Commission preliminarily believes that a yearly review and
report on progress with respect to straight-through processing is the
appropriate timescale on which the CMSP should consider, develop, and
implement iterative improvements over time, while also ensuring that
progress towards straight-through processing is expeditious.
Specifically, a 12-month period would provide the CMSP with a
sufficient look-back period to complete a meaningful review on an
organization-wide basis and time to test and implement material changes
to technologies and procedures. An annual reporting requirement, as
opposed to a monthly or semi-annual requirement, should help ensure
that the information provided to the Commission reflects meaningful and
substantive progress by the CMSP, as opposed to focusing the
Commission's attention on smaller, technical changes in services and
policies that would be less relevant to improving the Commission's
understanding of the overall progress towards achieving straight-
through processing by the CMSP. The
[[Page 10460]]
Commission believes that the reporting requirement should continue
indefinitely because changes in technology will require ongoing review
and consideration of how such changes might impact policies and
procedures to facilitate straight-through processing.
3. Request for Comment
The Commission requests comment on all aspects of proposed Rule
17Ad-27, as well as the following specific topics:
53. Is the proposed policies and procedures approach appropriate
and sufficient to achieve the proposed rule's stated objectives? Why or
why not? Would more specific or directive requirements, such as those
discussed above be more effective at facilitating straight-through
processing than the proposed policies and procedures approach? Please
explain why or why not.
54. Is proposed Rule 17Ad-27 consistent with the approach to RVP/
DVP settlement set forth in FINRA Rule 11860 and, more generally, the
UPC set forth in the FINRA Rule 11000 series? \190\ If not, please
explain.
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\190\ See supra note 171 and accompanying text (describing the
UPC).
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55. Is the proposed use of the term ``straight-through processing''
clear and understandable? Why or why not? Should the Commission define
the term for purposes of the proposed rule? If so, please describe the
elements that the Commission should consider including in the
definition to make it clear and understandable.
56. Should the Commission require a CMSP to enable the users of its
service to complete the matching, confirmation, or affirmation of
securities transactions as soon as technologically practicable?
Alternatively, should the Commission impose a specific deadline on such
a requirement, such as requiring that these processes be completed
within a certain number of minutes or hours? Should the Commission
require specific deadlines, when using a CMSP, for completing each of
the allocation, confirmation, affirmation, or matching processes? Why
or why not? If the Commission were to impose a specific deadline, what
would be the appropriate deadline for each process--allocation,
confirmation, affirmation, and matching?
57. Should the Commission require a CMSP to forward or otherwise
submit a transaction for settlement as soon as technologically and
operationally practicable, as if using fully automated systems? Should
the Commission specify to whom a CMSP should forward such information
to facilitate straight-through processing? To what extent do CMSPs not
forward such trade information as soon as technologically practicable?
Are certain parties excluded? What are the reasons preventing such
forwarding of trade information?
58. Is it appropriate for proposed Rule 17Ad-27 to require a CMSP
to retire any electronic trade confirmation services, where the users
of a CMSP may transmit sequential messages back and forth to achieve
allocation, confirmation, and affirmation of a transaction? If so,
should the rule be modified to accommodate electronic trade
confirmation services offered by CMSPs? Why or why not?
59. More generally, are electronic trade confirmation services
consistent with the concept of ``straight-through processing?'' Why or
why not? Please explain.
60. With regard to the proposed requirement for a CMSP to provide
an annual report, does the proposed rule include the appropriate
aspects or level of detail that should be included in such a report?
Why or why not? Should the Commission require that the public report be
issued in a machine-readable data language? Why or why not?
61. Are the time periods (i.e., every 12 months) described in the
rule concerning the submission and content of the annual report
sufficiently clear? If not, please explain.
62. Should a CMSP be required to tag its annual report using Inline
XBRL? Why or why not? Rather than requiring block text tags for the
narrative disclosures as well as detail tags of individual data points
(including those nested within the narrative disclosures), should we
only require block text tags for the narrative disclosures? Should the
annual report be tagged in an open structured data language other than
Inline XBRL? If so, what open structured data language should be used
and why?
63. Is EDGAR an appropriate submission mechanism for the annual
report? Why or why not? Should the Commission use an alternative
submission mechanism, such as the Electronic Form Filing System
(``EFFS'')? An EFFS submission requirement would not be compatible with
a requirement to use Inline XBRL or other open structured data language
for the annual report.
64. Should the Commission make public the annual report required to
be submitted to the Commission under the proposed rule? Why or why not?
Would making the report public alter the type or detail of information
included by the CMSP in the report or in its policies and procedures?
If so, why? If the public availability of any information required
under the proposed rule would raise issues related to confidentiality
or the proprietary nature of the CMSP's operations, please explain.
65. CMSPs generally allow their users to define the criteria that
will constitute a ``match,'' and the users may set different tolerances
under those criteria depending on their business strategy. Should a
CMSPs be required to disclose in the annual report its matching
criteria? Should a CMSP be required to disclose data regarding
confirmations, affirmations, and/or matches in its annual report, such
as the percentage of successful confirmations, affirmations, and/or
matches achieved on trade date, or the average time users take to
achieve confirmation, affirmation, and/or a match from trade
submission? Should a CMSP be required to disclose any other data to
help facilitate straight-through processing, such as average time to
submit a trade to a registered clearing agency for settlement, or the
average number of messages that a CMSP transmits among the parties to a
trade before the trade is submitted to a registered clearing agency for
settlement? Please explain.
66. More generally, should CMSPs be required to make their policies
and procedures for straight-through processing public? Please explain
why or why not?
67. The Commission has issued exemptive orders for three CMSPs,
pursuant to which each CMSP is subject to a series of operational and
interoperability conditions.\191\ Should the Commission amend the
respective exemptive orders to add conditions similar to the proposed
requirements in Rule 17Ad-27 instead of adopting this proposal? Why or
why not?
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\191\ See supra note 32 (providing citations to the exemptive
orders for DTCC ITP Matching, BSTP, and SS&C).
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68. In the Matching Release, the Commission stated that, even
though matching services fall within the Exchange Act definition of
``clearing agency,'' it was of the view that an entity that limits its
clearing agency functions to providing matching services need not be
subject to the full panoply of clearing agency regulation.\192\ The
Commission offered two alternative approaches for regulation: Limited
registration or conditional exemptions. Since the Matching Release, the
Commission has approved three conditional exemptions
[[Page 10461]]
for CMSPs, as noted in the above question, with the goal of
facilitating competition in the provision of matching services.\193\
Has the Commission's approach to the regulation of CMSPs facilitated
competition in the provision of matching services? If so, why or why
not? To what extent does competition among CMSPs help promote either a
shortened settlement cycle or straight-through processing? Please
explain.
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\192\ Exchange Act Release No. 39829 (Apr. 6, 1998), 63 FR
17943, 17947 (Apr. 13, 1998) (``Matching Release'').
\193\ See, e.g., BSTP and SS&C Order, supra note 32, at 75397-
400 (noting the Commission's interest in facilitating competition
among CMSPs).
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69. Are there any other steps that the Commission should take to
enhance the ability of the CMSPs to promote straight-through processing
or increase efficiency in the settlement of securities transactions?
E. Impact on Certain Commission Rules and Guidance and SRO Rules
The proposed rules and rule amendments may affect compliance with
other existing Commission rules and guidance that reference the
settlement cycle or settlement processes in establishing requirements
for market participants. Below is a preliminary list of rules
identified by the Commission. The Commission preliminarily believes
that no changes to these rules are necessary to adopt the proposed
rules. The Commission solicits comment on the potential impacts of
shortening the settlement cycle to T+1 on each of the below rules.
1. Regulation SHO Under the Exchange Act
As with the adoption of a T+2 standard settlement cycle, several
provisions of Regulation SHO may be impacted by shortening the
settlement cycle to T+1 because certain provisions use ``trade date''
and ``settlement date'' to determine the timeframes for compliance
relating to sales of equity securities and fails to deliver on
settlement date. Since these references are not to a particular
settlement cycle (e.g., ``T+2''), the timeframes for these provisions
change in tandem with changes in the standard settlement cycle.
(a) Rule 204
Shortening the standard settlement cycle to T+1 would reduce the
timeframes to effect the closeout of a fail-to-deliver position under
17 CFR 242.204 (``Rule 204'').\194\ Under Rule 204,\195\ a participant
of a registered clearing agency must deliver securities to a registered
clearing agency for clearance and settlement on a long or short sale in
any equity security by settlement date, or if a participant has a fail-
to-deliver position, the participant shall, by no later than the
beginning of regular trading hours on the applicable closeout date,
immediately close out the fail-to-deliver position by borrowing or
purchasing securities of like kind and quantity.\196\
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\194\ 17 CFR 242.204.
\195\ For purposes of Regulation SHO, the term ``participant''
has the same meaning as in Section 3(a)(24) of the Exchange Act, 15
U.S.C. 78c(a)(24). See Amendments to Regulation SHO, Exchange Act
Release No. 60388 (July 27, 2009), 74 FR 38266, 38268 n.34 (July 31,
2009) (``Rule 204 Adopting Release''). Section 3(a)(24) of the
Exchange Act defines ``participant'' to mean, when used with respect
to a clearing agency, any person who uses a clearing agency to clear
or settle securities transactions or to transfer, pledge, lend, or
hypothecate securities. Such term does not include a person whose
only use of a clearing agency is (A) through another person who is a
participant or (B) as a pledgee of securities.
\196\ 17 CFR 242.204(a).
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The applicable closeout date for a fail-to-deliver position differs
depending on whether the position results from a short sale, a long
sale, or bona fide market making activity. If a fail-to-deliver
position results from a short sale, the participant must close out the
fail-to-deliver position by no later than the beginning of regular
trading hours on the settlement day following the settlement date.\197\
Under the current T+2 standard settlement cycle, the applicable
closeout date for short sales is required by the beginning of regular
trading hours on T+3. In a T+1 settlement cycle, the existing closeout
requirement for fail-to-deliver positions resulting from short sales
would be reduced from T+3 to T+2.\198\
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\197\ Id.
\198\ See 17 CFR 242.204(g)(1).
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If a fail-to-deliver position results from a long sale or bona fide
market making activity, the participant must close out the fail-to-
deliver position by no later than the beginning of regular trading
hours on the third consecutive settlement day following the settlement
date.\199\ Under the current T+2 standard settlement cycle, the
closeout for long sales or bona fide market making activity is required
by the beginning of regular trading hours on T+5. If the Commission
adopts a T+1 standard settlement cycle, this closeout requirement would
be shortened from T+5 to T+4.
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\199\ See 17 CFR 242.204(a)(1), (a)(3).
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(b) Rule 200(g)
Shortening the standard settlement cycle to T+1 may also impact the
application of 17 CFR 242.200(g) (``Rule 200(g)''). Specifically, a T+1
settlement cycle may change when a broker-dealer would need to initiate
a bona fide recall of a loaned security to be able to mark the sale of
such loaned but recalled security ``long'' for purposes of Rule
200(g)(1). Under Rule 200(g), a broker-dealer must mark all sell orders
of any equity security as ``long,'' ``short,'' or ``short exempt.''
\200\ Rule 200(g)(1) stipulates that a broker-dealer may only mark a
sale as ``long'' if the seller is ``deemed to own'' the security being
sold under 17 CFR 242.200 (a) through (f) and either (i) the security
is in the broker-dealer's physical possession or control; or (ii) it is
reasonably expected that the security will be in the broker-dealer's
possession or control by settlement of the transaction.\201\
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\200\ See 17 CFR 242.200(g).
\201\ See 17 CFR 242.200(g)(1).
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The Commission has provided guidance on when a person that sells a
loaned but recalled security would be ``deemed to own'' the security
and be able to mark the sale ``long.'' \202\ The guidance was given
when the standard settlement cycle was T+3. Under those circumstances,
the Commission indicated that, if a person that has loaned a security
to another person sells the security and a bona fide recall of the
security is initiated within two business days after trade date, the
person that has loaned the security will be ``deemed to own'' the
security for purposes of Rule 200(g)(1), and such sale will not be
treated as a short sale for purposes of Rule 204. The Commission also
stated that a broker-dealer may mark such orders as ``long'' sales
provided such marking is also in compliance with Rule 200(c) of
Regulation SHO, and thus the closeout requirement of Rule 204.\203\
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\202\ See Rule 204 Adopting Release, supra note 195, at n.55.
\203\ See id.; see also 17 CFR 242.200(c).
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This guidance was predicated on the Commission's belief that, under
then current industry standards, recalls for loaned securities would
likely be delivered within three business days after the initiation of
a recall. In that case, a broker-dealer that initiated a bona fide
recall by T+2 would receive delivery of loaned securities by T+5 and
then be able to close out any failure to deliver on a ``long'' sale of
the loaned but recalled securities by the beginning of regular trading
hours on T+6, as then required by Rule 204 in a T+3 environment.
Under a T+2 standard settlement cycle, the closeout period for
sales marked ``long'' is T+5, and so recalls of loaned securities need
to be delivered by T+4 to be available to close out any fails on sales
marked ``long'' by the beginning of regular trading hours on
[[Page 10462]]
T+5. To meet this timeframe, a number of broker-dealers have securities
lending agreements that set the period of delivery for delivering
loaned but recalled securities to two settlement days after initiation
of a recall. Under such an agreement, a bona fide recall by no later
than T+2 would result in the delivery of such loaned securities by T+4
and in time to close out any fails on sales marked long by the
beginning of regular trading hours on T+5. For those broker-dealers
that lend securities pursuant to securities lending agreements that
have a recall period of three business days after recall, a broker-
dealer would need to initiate a bona fide recall by T+1 to receive
delivery of the loaned security by T+4 and in time to close out any
fails on sales marked long by the beginning of regular trading hours on
T+5.
If a T+1 settlement cycle is implemented, closeout of a failure of
a sale marked ``long'' would be required by the beginning of regular
trading hours on T+4. With this further shortened timeframe, recalls of
loaned securities would need to be delivered by T+3 to be available to
close out any fails on sales marked ``long'' by the beginning of
regular trading hours on T+4. Accordingly, under a T+1 settlement
cycle, broker-dealers that lend securities pursuant to a recall period
of three business days would need to initiate a bona fide recall on
trade date (i.e., T+0), and those brokers that lend securities pursuant
to a recall period of two business days would need to initiate a bona
fide recall by T+1, in order to close out any failure to deliver on
sales marked ``long'' by the beginning of regular trading hours in T+4.
The Commission understands, however, that under a T+1 standard
settlement cycle, at least some broker-dealers would be likely to
modify their securities lending agreements to shorten the recall period
to one settlement day after the initiation of the recall.\204\ Under
such agreements, a bona fide recall would need to be initiated by T+2
in order to meet the applicable closeout period for long sales. Figure
4 provides a diagram of close-out scenarios in a T+1 environment.
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\204\ See T+1 Report, supra note 18, at 24-25.
[GRAPHIC] [TIFF OMITTED] TP24FE22.003
2. Financial Responsibility Rules Under the Exchange Act
Certain provisions of the Commission's broker-dealer financial
responsibility rules \205\ reference explicitly or implicitly the
settlement date of a securities transaction. For example, paragraph (m)
of Exchange Act Rule 15c3-3 references the settlement date to prescribe
the timeframe in which a broker-dealer must complete certain sell
orders on behalf of customers.\206\ Specifically, Rule 15c3-3(m)
provides that if a broker-dealer executes a sell order of a customer
(other than an order to execute a sale of securities which the seller
does not own) and if for any reason whatever the broker-dealer has not
obtained possession of the securities from the customer within ten
business days after the settlement date, the broker-dealer must
immediately close the transaction with the customer by purchasing
securities of like kind and quantity.\207\ In addition, settlement date
is incorporated into paragraph (c)(9) of Exchange Act Rule 15c3-1,\208\
which
[[Page 10463]]
defines what it means to ``promptly transmit'' funds and ``promptly
deliver'' securities within the meaning of paragraphs (a)(2)(i) and
(a)(2)(v) of Rule 15c3-1.\209\ The concepts of promptly transmitting
funds and promptly delivering securities are incorporated in other
provisions of the financial responsibility rules as well, including
paragraphs (k)(1)(iii), (k)(2)(i), and (k)(2)(ii) of Rule 15c3-3,\210\
paragraph (e)(1)(A) of Rule 17a-5,\211\ and paragraph (a)(3) of Rule
17a-13.\212\
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\205\ For purposes of this release, the term ``financial
responsibility rules'' includes any rule adopted by the Commission
pursuant to Sections 8, 15(c)(3), 17(a) or 17(e)(1)(A) of the
Exchange Act, any rule adopted by the Commission relating to
hypothecation or lending of customer securities, or any rule adopted
by the Commission relating to the protection of funds or securities.
The Commission's broker-dealer financial responsibility rules
include 17 CFR 240.15c3-1, 15c3-3, 17a-3, 17a-4, 17a-5, 17a-11, and
17a-13.
\206\ 17 CFR 240.15c3-3(m).
\207\ However, paragraph (m) of Rule 15c3-3 provides that the
term ``customer'' for the purpose of paragraph (m) does not include
a broker or dealer who maintains an omnibus credit account with
another broker or dealer in compliance with Rule 7(f) of Regulation
T (12 CFR 220.7(f)).
\208\ 17 CFR 240.15c3-1(c)(9).
\209\ 17 CFR 240.15c3-1(a)(2)(i), (a)(2)(v).
\210\ 17 CFR 240.15c3-3(k)(1)(iii), (k)(2)(i)-(ii).
\211\ 17 CFR 240.17a-5(e)(1)(A).
\212\ 17 CFR 240.17a-13(a)(3).
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The Commission acknowledges that shortening the standard settlement
cycle to T+1 will effectively reduce the number of days (from 12
business days to 11 business days) that a broker-dealer will have to
obtain possession of customer securities before being required to close
out a customer transaction under Rule 15c3-3(m). The operations
supporting the processing of customer orders by broker-dealers and the
technology supporting those operations have developed substantially
since 1972, when the Commission adopted paragraph (m) of Rule 15c3-
3.\213\ Based on staff experience, the Commission believes that these
developments have resulted in a lower frequency of broker-dealers
failing to obtain possession of the securities from their customers
within 10 business days after the settlement date. Therefore, the
Commission believes that these developments in technology and broker-
dealer operations diminish the potential for customers to be adversely
affected by the change from 12 business days to 11 business days.
Accordingly, the Commission believes that the change from 12 business
days to 11 business days would not materially burden broker-dealers or
their customers,\214\ and the Commission believes that it is
unnecessary to amend Rule 15c3-3(m), or any of the broker-dealer
financial responsibility rules, at this time.
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\213\ See Broker-Dealers; Maintenance of Certain Basic Reserves,
Exchange Act Release No. 9856 (Nov. 10, 1972), 37 FR 25224 (Nov. 29,
1972) (``Rule 15c3-3 Adopting Release'').
\214\ See infra Part V.C.3 (discussing the economic implications
of shortening the settlement cycle on Rule 15c3-3).
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The Commission solicits comment regarding the effect that
shortening the standard settlement cycle from T+2 to T+1 could have on
the ability of broker-dealers to comply with the Commission's financial
responsibility rules.
3. Rule 10b-10 Under the Exchange Act
Providing customers with confirmations pursuant to Rule 10b-10
serves a significant investor protection function.\215\ Confirmations
provide customers with a means of verifying the terms of their
transactions, alerting investors to potential conflicts of interest
with their broker-dealers, acting as a safeguard against fraud, and
providing investors a means to evaluate the costs of their transactions
and the quality of their broker-dealers' execution.\216\
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\215\ 17 CFR 240.10b-10.
\216\ See Confirmation Requirements for Transactions of Security
Futures Products Effected in Futures Accounts, Exchange Act Release
No. 46471 (Sept. 6, 2002), 67 FR 58302, 58303 (Sept. 13, 2002).
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Although Rule 10b-10 does not directly refer to the settlement
cycle, it requires that a broker-dealer send a customer a written
confirmation disclosing specified information ``at or before
completion'' of the transaction, which Rule 10b-10 defines to have the
meaning provided in the definition of the term in Rule 15c1-1 under the
Exchange Act.\217\ Generally, Rule 15c1-1 defines ``completion of the
transaction'' to mean the time when: (i) A customer purchasing a
security pays for any part of the purchase price after payment is
requested or notification is given that payment is due; (ii) a security
is delivered or transferred to a customer who purchases and makes
payment for it before payment is requested or notification is given
that payment is due; (iii) a security is delivered or transferred to a
broker-dealer from a customer who sells the security and delivers it to
the broker-dealer after delivery is requested or notification is given
that delivery is due; or (iv) a broker-dealer makes payment to a
customer who sells a security and delivers it to the broker-dealer
before delivery is requested or notification is given that delivery is
due.\218\
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\217\ See 17 CFR 240.10b-10(d)(2).
\218\ See 17 CFR 240.15c1-1(b).
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When first adopting Rule 15c6-1 in 1993 to establish a T+3
settlement cycle, the Commission noted that broker-dealers typically
send customer confirmations on the day after the trade date.\219\ When
adopting a T+2 settlement cycle in 2017, the Commission stated that,
while broker-dealers may continue to send physical customer
confirmations on the day after the trade date, broker-dealers may also
send electronic confirmations to customers on the trade date.
Accordingly, the Commission noted its belief that implementation of a
T+2 settlement cycle would not create problems with regard to a broker-
dealer's ability to comply with the requirement under Rule 10b-10 to
send a confirmation ``at or before completion'' of the transaction, but
acknowledged that broker-dealers would have a shorter timeframe to
comply with the requirements of Rule 10b-10 in a T+2 settlement
cycle.\220\ With respect to a T+1 standard settlement cycle, the
Commission similarly believes that T+1 would not create a compliance
issue for broker-dealers under Rule 10b-10, although broker-dealers
would have a further shortened timeframe to do so in a T+1 settlement
cycle. In addition, as explained in Part III.D, proposed Rule 15c6-2
also would not alter the requirements of Rule 10b-10.\221\
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\219\ T+3 Adopting Release, supra note 9, at 52908.
\220\ T+2 Adopting Release, supra note 10, at 15579.
\221\ See supra Part III.B.1 (discussing the relationship
between a ``confirmation'' under proposed Rule 15c6-2 and existing
Rule 10b-10).
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The Commission solicits comment on the extent to which the T+1 rule
proposals may impact compliance with Rule 10b-10. In the T+1 Report,
the ISC recommends clarifying what constitutes ``delivery'' for
electronic confirmations under Rule 10b-10. The Commission has
previously provided such guidance.\222\ The Commission therefore
solicits comment on whether this guidance needs to be updated in a T+1
environment.
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\222\ See generally Use of Electronic Media for Delivery
Purposes, Exchange Act Release No. 36345 (Oct. 6, 1995) (``1995
Release'') (providing Commission views on the use of electronic
media to deliver information to investors, with a focus on
electronic delivery of prospectuses, annual reports to security
holders and proxy solicitation materials under the federal
securities laws); Use of Electronic Media by Broker-Dealers,
Transfer Agents, and Investment Advisers for Delivery of
Information, Exchange Act Release No. 37182 (May 9, 1996) (``1996
Release'') (providing Commission views on electronic delivery of
required information by broker-dealers, transfer agents and
investment advisers); Use of Electronic Media, Exchange Act Release
No. 42728 (Apr. 28, 2000) (``2000 Release'') (providing updated
interpretive guidance on the use of electronic media to deliver
documents on matters such as telephonic and global consent; issuer
liability for website content; and legal principles that should be
considered in conducting online offerings). Under the guidance, the
Commission's framework for electronic delivery consists of the
following elements: (1) Notice to the investor that information is
available electronically; (2) access to information comparable to
that which would have been provided in paper form and that is not so
burdensome that the intended recipients cannot effectively access
it; and (3) evidence to show delivery (i.e., reason to believe that
electronically delivered information will result in the satisfaction
of the delivery requirements under the federal securities laws). See
1996 Release at 24646-47.
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[[Page 10464]]
4. Prospectus Delivery and ``Access Versus Delivery''
Broker-dealers have to comply with prospectus delivery obligations
under the Securities Act.\223\ As discussed in Part III.A.4, Securities
Act Rule 172 implements 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.\224\
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\223\ 15 U.S.C. 77a et seq. Section 5(b)(2) of the Securities
Act makes it unlawful to deliver (i.e., as part of settlement) a
security ``unless accompanied or preceded'' by a prospectus that
meets the requirements of Section 10(a) of the Act (known as a
``final prospectus''). 15 U.S.C. 77e(b)(2).
\224\ 15 U.S.C. 77e(b)(2); 17 CFR 230.172. Under Securities Act
Rule 172(b), an obligation under Section 5(b)(2) of the Securities
Act to have a prospectus that satisfies the requirements of Section
10(a) of the Act precede or accompany the delivery of a security in
a registered offering is satisfied only if the conditions specified
in paragraph (c) of Rule 172 are met. 17 CFR 230.172(b). Pursuant to
Rule 172(d), ``access equals delivery'' generally is not available
to the offerings of most registered investment companies (e.g.,
mutual funds), business combination transactions, or offerings
registered on Form S-8. 17 CFR 230.172(d). The Commission recently
amended Rule 172 to allow registered closed-end funds and business
development companies to rely on the rule. See Securities Offering
Reform for Closed-End Investment Companies, Investment Company Act
Release No. 33836 (Apr. 8, 2020), 85 FR 33353 (June 1, 2020).
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The Commission preliminarily believes that, if a T+1 standard
settlement cycle is implemented, such a standard settlement cycle would
not raise any significant legal or operational concerns for issuers or
broker-dealers to comply with the prospectus delivery obligations under
the Securities Act.
The Commission requests comment on whether commenters believe any
specific legal or operational concerns would arise for issuers or
broker-dealers to comply with the prospectus delivery obligations under
the Securities Act if the settlement cycle is shortened to T+1. The
Commission asks that commenters identify specific examples of the
circumstances in which such legal or operational difficulties could
occur.
The Commission also requests comment on the extent to which the T+1
rule proposals may impact compliance with the prospectus delivery
requirements under the Securities Act.
5. Changes to SRO Rules and Operations
As with the T+2 transition, the Commission anticipates that the
proposed transition to T+1 would again require changes to SRO rules and
operations to achieve consistency with a T+1 standard settlement cycle.
Certain SRO rules reference existing Rule 15c6-1 or currently define
``regular way'' settlement as occurring on T+2 and, as such, may need
to be amended in connection with shortening the standard settlement
cycle to T+1. Certain timeframes or deadlines in SRO rules also may
refer to the settlement date, either expressly or indirectly. In such
cases, the SROs may need to amend these rules in connection with
shortening the settlement cycle to T+1.\225\
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\225\ The T+1 Report similarly indicates that SROs will likely
need to update their rules to facilitate a transition to a T+1
standard settlement cycle. T+1 Report, supra note 18, at 35-36.
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Because the Commission is also proposing two other rule changes to
facilitate a T+1 standard settlement cycle, SRO rules and operations
may be affected to a greater extent than occurred during the T+2
transition. For example, while elements of FINRA Rule 11860 could be
used to facilitate compliance with proposed Rule 15c6-2, FINRA Rule
11860 currently requires that affirmations be completed no later than
the day after trade date and may need to be amended to align with the
requirements in proposed Rule 15c6-2.
The Commission solicits comment on the extent to which the T+1 rule
proposals may impact existing SRO rules and operations.
F. Proposed Compliance Date
Industry planning and testing was critical to ensuring an orderly
transition from a T+3 standard settlement cycle to T+2, and the
Commission anticipates that planning and testing would again be
critical to ensuring an orderly transition to a T+1 standard settlement
cycle, if adopted. Accordingly, the Commission recognizes that the
compliance date for the above rule proposals, if adopted, must allow
sufficient time for broker-dealers, investment advisers, clearing
agencies, and other market participants to plan for, implement, and
test changes to their systems, operations, policies, and procedures in
a manner that allows for an orderly transition. The Commission also
recognizes that the compliance date must provide sufficient time for
broker-dealers and other market participants to engage in outreach and
education regarding the transition to ensure that, among other things,
their customers, including individual retail investors, have time to
prepare for operational or other changes related to a T+1 standard
settlement cycle.
The Commission is mindful that failure to appropriately implement
an orderly transition to T+1, if a T+1 standard settlement cycle is
adopted, may heighten certain operational risks for the U.S. securities
markets. However, the Commission is also mindful that delaying the
transition to a T+1 standard settlement cycle further than is necessary
would delay the realization of the risk reducing and other benefits
expected under a T+1 standard settlement cycle.\226\ The DTCC White
Paper contemplated that a transition to T+1 is achievable in the second
half of 2023,\227\ and the T+1 Report states that a T+1 transition is
achievable in the first half of 2024. The T+1 Report estimates that
planning for testing will begin in Q4 2022, that industry-wide testing
will begin in Q2 2023, and that industry-wide testing will need to
occur for one full year before implementation of a T+1 standard
settlement cycle.\228\ The T+1 Report also states that, once
``regulatory certainty and guidance is achieved, the industry
anticipates a lengthy and necessary amount of time will be required for
T+1 implementation.'' \229\
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\226\ See infra Part V.C (discussing the anticipated benefits of
a T+1 standard settlement cycle).
\227\ DTCC White Paper, supra note 61, at 8.
\228\ T+1 Report, supra note 18, at Fig. 1.
\229\ T+1 Report, supra note 18, at 6-7.
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With these dates and considerations in mind, the Commission
believes that market participants should prepare expeditiously for a
T+1 transition and proposes a compliance date of March 31, 2024.\230\
If the proposed rules and rule amendments presented in this release are
adopted as proposed, the Commission believes that the systems and
operational changes necessary at the industry level can be planned,
tested, and implemented in advance of March 31, 2024. Although the T+1
Report estimates that planning for testing will not begin until Q4
2022, and that industry-wide testing will not begin until Q2 2023,\231\
the Commission believes that market participants can implement a T+1
standard settlement cycle by the earlier end of the T+1 Report's
overall time table. Specifically, planning for testing could begin
sooner than Q4 2022, so that industry-wide testing can begin in early
2023 and conclude in early 2024, in advance of the proposed compliance
date.
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\230\ Notwithstanding the proposed compliance date, market
participants could still coordinate to establish an earlier T+1
transition date as needed to ensure effective planning, testing, and
implementation.
\231\ T+1 Report, supra note 18, at Fig. 1.
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70. The Commission solicits comment on whether the proposed March
31, 2024 compliance date is appropriate for each of the four proposed
rules (Rule 15c6-1, Rule 15c6-2, Rule 17Ad-27,
[[Page 10465]]
and the amendment to Rule 204-2(a)). How many months would market
participants need to plan, test, and implement a transition to T+1?
What data points would market participants use to assess the timing for
planning, testing, and implementation? Are any specific operational or
technological issues raised by the proposed compliance date? To what
extent does the proposed compliance date align or not align with
typical practices related to the planning and testing of systems or
other technology changes among affected parties, such as market
participants, broker-dealers, investment advisers, or clearing
agencies? For example, to achieve a compliance date of March 31, 2024,
to what extent, if any, would these parties (and market participants
more generally) have to consider an implementation date that is earlier
than March 31, 2024? Why? Please explain.
71. What is the extent of planning and testing necessary to achieve
an orderly transition to a T+1 standard settlement cycle, if adopted?
In responding to this request for comment, commenters should provide
specific data and any other relevant information necessary to explain
the extent of industry-wide planning and testing that would be required
to ensure an orderly transition to the proposed T+1 settlement cycle by
March 31, 2024.
72. The Commission has proposed a single compliance date applicable
to each of the four proposed rules. Would staggering the compliance
dates for these rules help facilitate an orderly transition to a T+1
settlement cycle, if adopted? For example, should the compliance date
for Rule 15c6-2, if adopted, fall before the compliance date for Rule
15c6-1, to ensure an orderly transition to a T+1 settlement cycle, if
adopted? If staggering would be appropriate, what would be an
appropriate schedule of compliance dates? Would staggering the
compliance dates introduce impediments to an orderly T+1 settlement
cycle transition? If so, please describe.
IV. Pathways to T+0
The Commission uses T+0 in this release to refer to settlement that
is complete by the end of trade date.\232\ This has sometimes been
referred to as same-day settlement. In the Commission's preliminary
view, same-day settlement could occur pursuant to at least three
different models: (i) Netted settlement at the end of the day on T+0;
(ii) real-time settlement, where transactions are settled in real time
or near real time and presumably on a gross basis (i.e., without any
netting applied to reduce the overall number of open positions); and
(iii) ``rolling'' settlement, where trades are netted and settled
intraday on a recurring basis. In this release, the Commission uses T+0
to refer specifically to netted settlement at the end of the day on
T+0. The Commission believes that this model of same-day settlement is
currently the most appropriate to consider applying to the standard
settlement cycle after implementation of T+1, if adopted, because it
retains a core element of the existing settlement infrastructure--
namely, the application of multilateral netting at the end of trade
date to reduce the overall number of open positions before completing
settlement.\233\
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\232\ See supra note 12 and accompanying text.
\233\ In Part IV.B, the Commission solicits comment on the
merits of this model versus the others described, as well as any
other potential settlement models.
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The Commission preliminarily believes that implementing a T+0
standard settlement cycle would have similar benefits of market,
credit, and liquidity risk reduction that were realized in the
shortening of the settlement cycle from T+3 to T+2 and are expected in
moving from a T+2 to a T+1 standard settlement cycle. In particular,
shortening from a T+2 standard settlement cycle to a T+0 standard might
result in a larger reduction in certain settlement risks than would
result from shortening to a T+1 standard because the risks associated
with counterparty default tend to increase with time.\234\ Similarly,
because price volatility is a concave function of time,\235\ the
shorter settlement cycle in a T+0 environment will reduce expected
price volatility to a greater extent than in a T+1 environment.\236\ In
addition, assuming constant trading volume, the volume of unsettled
trades for a T+0 settlement cycle could be roughly half that from a T+1
settlement cycle, and, as a result, for any given adverse movement in
prices, the financial losses resulting from counterparty default could
be half that expected in a T+1 settlement cycle.\237\
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\234\ See T+2 Adopting Release, supra note 10, at 15598.
\235\ If price changes are uncorrelated across time periods then
the variance of price change over T periods is T times the variance
over a single period. Therefore, the standard deviation of price
changes over T periods is T1/2 times the standard
deviation over a single period.
\236\ See id.
\237\ See id.
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The Commission believes that now is the time to begin identifying
potential paths to achieving T+0. Thus, the Commission is actively
assessing the benefits and costs associated with accelerating the
standard settlement cycle to T+0. As the securities industry plans how
to implement a T+1 standard settlement cycle, this process should
include consideration of the potential paths to achieving T+0 to help
ensure that investments in new technology and operations undertaken to
achieve T+1 can maximize the value of such investments over the long
term. In this way, the transition to a T+1 settlement cycle can be a
useful step in identifying potential paths to T+0.
The Commission is also mindful of some perceived challenges to
implementing a T+0 standard settlement cycle in the immediate future
identified by market participants. As discussed above,\238\ the T+1
Report states that T+0 is ``not achievable in the short term given the
current state of the settlement ecosystem'' and would require an
``overall modernization'' of modern-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.\239\ The T+1 Report
identified ``key areas'' that industry groups determined would be
impacted by a move to T+0 settlement, including 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.
---------------------------------------------------------------------------
\238\ See supra notes 76-79 and accompanying text.
\239\ T+1 Report, supra note 18, at 10; see also supra notes 76-
77 and accompanying text (discussing the same).
---------------------------------------------------------------------------
To advance the discussion of developing and achieving a T+0
standard settlement cycle, the Commission solicits comment on potential
approaches to overcoming the operational and other barriers identified
by market participants for shortening the standard settlement cycle
beyond T+1. Specifically, the Commission in Part IV.A discusses three
potential approaches that could be used to implement a T+0 settlement
cycle, and solicits comment on all aspects of the approaches described.
The Commission also discusses in Part IV.B the operational and other
challenges that market participants have identified for implementing
T+0, and solicits comment on the building blocks necessary to address
or resolve those challenges to enable a T+0 settlement cycle.
[[Page 10466]]
A. Possible Approaches to Achieving T+0
To facilitate discussion of T+0 settlement, the Commission has
identified three possible approaches or frameworks for considering how
to implement T+0 settlement. These are presented not as an exhaustive,
complete, or discrete list of pathways but rather as example cases that
help illustrate the range of potential approaches, or combination of
approaches, that might be useful in facilitating investments that
improve the efficiency of the National C&S System, including the
ability to implement a T+0 standard settlement cycle. The Commission
provides these examples to help facilitate comment on the implications
of a T+0 standard settlement cycle and the mechanics of implementation,
as well as their potential impact on the challenges identified in Part
IV.B. Comments received will help inform any future proposals.
1. Wide-Scale Implementation
One possible path to shortening the settlement cycle from T+1 to
T+0 involves a wide effort, led by the Commission or an industry
working group, to develop and publish documents like the ISG White
Paper, the T+2 Playbook, and now the T+1 Report, in which industry
experts identify the full set of potential impediments to T+0, propose
solutions, and develop a timeline for education, testing, and
implementation.
While this approach would mirror past efforts to shorten the
settlement cycle, it necessarily requires industry-wide solutions to
the impediments identified with respect to T+0, such as those that may
be related to the considerations in Part IV.B. For this reason, the
Commission believes that it may be helpful to consider two alternative
paths to T+0: (i) An approach where implementation begins first with
technology and operational changes by key infrastructure providers; and
(ii) an approach where exchanges and clearing agencies offer pilots or
similar small-scale programs to establish T+0 as an optional settlement
cycle in certain circumstances.
2. Staggered Implementation Beginning With Key Infrastructure
An alternative approach to shortening the settlement cycle from T+1
to T+0 could begin by focusing efforts on improving key settlement
infrastructure to support wide-scale implementation of T+0 settlement
cycle. Such an approach could involve the development of industry-led
or academic research designed to identify the key improvements and to
promote engagement with respect to development and implementation.
Under this approach, a key assumption is that achieving a T+0
standard settlement cycle, or the benefits anticipated from it, may not
be possible until existing market infrastructure has sufficient
capacity to support the full range of market participants who would
settle their transactions on T+0, and that the challenges to achieving
T+0 derive, in part, from insufficient capacity or capability to serve
those market participants. Infrastructure providers have used this
approach in the past to develop, test, and implement new technologies
and services before wide-scale release. For example, as discussed in
Part II.C, following implementation of a T+2 standard settlement cycle,
DTCC began to pursue two sets of initiatives, accelerated settlement
and settlement optimization, designed to improve its own infrastructure
to support more efficient settlement processes. A similar effort
following implementation of T+1 could identify improvements to existing
infrastructure that could address the challenges identified in Part
IV.B. For example, infrastructure providers like DTCC could explore
mechanisms that expand the availability of money settlement, as
discussed further in Part IV.B.3, or reduce the timing challenges
associated with T+0 settlement, as discussed in Part IV.B.8.
3. Tiered Implementation Beginning With Pilot Programs
Exchanges and clearing agencies have often deployed new
technologies in targeted environments to test new functionality and
service offerings on a small scale. This approach could allow market
participants to test T+0 settlement in a targeted environment, such as
using a specific exchange or exchanges, specific securities, and/or
specific settlement services at a registered clearing agency. SROs
could consider pilot proposals that could help advance development of
the operational and technological resources necessary to enable T+0
settlement.
For example, DTCC began exploring the use of distributed ledger in
2015, completed its Project ION case study in 2020,\240\ and recently
announced plans to deploy its ION platform through its ``minimal viable
product'' pilot program.\241\ According to DTCC, the ION MVP program is
a mechanism for NSCC and DTC participants to test the use of
distributed ledger technology alongside ``classic'' settlement
infrastructure at NSCC and DTC.\242\ Similarly, BOX Exchange LLC
recently implemented its Boston Security Token Exchange (``BSTX'')
platform to enable access to accelerated settlement for certain
securities.\243\ In India, where the Securities and Exchange Board of
India recently announced plans to implement a T+1 settlement cycle, the
securities regulator plans to allow local stock exchanges to offer T+1
settlement on certain securities, while retaining a T+2 settlement
cycle for others. Each case presents examples where new technologies
are offered on a select basis, such as on certain exchanges or for
certain securities, in ways that could allow market participants to
begin to adapt to T+0 settlement on an incremental basis in a
controlled environment.
---------------------------------------------------------------------------
\240\ See DTCC, Project ION Case Study (May 2020), https://
www.dtcc.com/~/media/Files/Downloads/settlement-asset-services/user-
documentation/Project-ION-Paper-2020.pdf.
\241\ See Press Release, DTCC, DTCC's Project ION Platform Moves
to Development Phase Following Successful Pilot with Industry (Sept.
15, 2021), https://www.dtcc.com/news/2021/september/15/dtccs-project-ion-platform-moves-to-development-phase-following-successful-pilot-with-industry.
\242\ See id. To the extent that elements of the ION MVP program
constitute rules, policies, or procedures of NSCC or DTC, it may be
subject to the requirements for submitting proposed rule changes
under Section 19 of the Exchange Act and Rule 19b-4. See 15 U.S.C.
78s(b); 17 CFR 240.19b-4. To the extent that this proposal would
involve changes to rules, procedures, and operations that could
materially affect the nature or level of risk presented by NSCC or
DTC, they may also be required to submit an Advance Notice under the
Dodd-Frank Act. See 12 U.S.C. 5465(e)(1)(A); 17 CFR 240.19b-4(n).
\243\ See Exchange Act Release No. 94092 (Jan. 27, 2022), 87 FR
5881 (Feb. 2, 2022) (order approving a proposed rule change to adopt
rules governing the listing and trading of equity securities on BOX
Exchange LLC through a facility of BOX Exchange LLC to be known as
BSTX LLC).
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Such an approach potentially allows market participants to achieve
T+0 without having to first address all of the challenges described in
Part IV.B for all market participants, instead enabling experimentation
and innovation to find solutions for certain segments over time. This
could help minimize one challenge noted in the T+1 Report: That T+0
would likely require the adoption of new technologies, implementation
costs that 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.\244\
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\244\ See T+1 Report, supra note 18, at 10; see also supra notes
77-78 and accompanying text (discussing the same); infra note 385
and accompanying text (noting that some benefits may accrue to those
market participants with high market power).
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[[Page 10467]]
B. Issues To Consider for Implementing T+0
Below the Commission describes several challenges identified as
impediments to implementing a T+0 standard settlement cycle,
particularly in the short term. The Commission requests comment on
these challenges, as well as any comments identifying other challenges
or necessary building blocks associated with implementing T+0. More
generally, with respect to each of these topics, the Commission
solicits comment on ways to improve the efficiency of and reduce the
risks that can result from the post-trade processes implicated by each
of these challenges. The Commission is particularly interested in
commenters that identify potential methods or building blocks that can
enable T+0. In considering the below topics, the Commission also
requests that commenters assess whether the three approaches identified
in Part IV.A might affect the analysis of the below or otherwise reveal
potential methods for addressing and implementing them.
1. Maintaining Multilateral Netting at the End of Trade Date
As discussed in Part II.B.1, multilateral netting by the CCP is an
essential feature of the National C&S System. By substantially reducing
the volume and value of transactions in equity securities that need to
be settled each day, CCP netting unlocks substantial capital
efficiencies for market participants while, at the same time, reducing
credit, market, and liquidity risk in the National C&S System. While
the Commission continues to consider how new technologies and business
practices in the industry might further reduce risk and promote capital
efficiency, the Commission preliminarily believes that the capital
efficiencies and risk reduction benefits that result from the use of
multilateral netting make it unlikely that market participants could
cost-effectively implement a T+0 standard settlement cycle without the
continued use of multilateral netting in some form.\245\
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\245\ See infra Part V.B.1 (discussing the capital efficiencies
and risk reducing effects that result from the use of multilateral
netting).
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In particular, at this time the Commission believes that a
transition from T+1 settlement to real-time settlement could not be
achieved without substantial and significant changes to fundamental
elements of market structure and infrastructure because real-time
settlement, to the extent it requires gross settlement would prevent
the use of, or significantly reduce the utility of, multilateral
netting before settlement. If market participants develop technologies
and business practices that can support the use of a real-time
settlement system in the U.S. at some point in the future, the
Commission is interested in understanding how such technologies might
interact with existing infrastructure that provides multilateral
netting. Indeed, retaining multilateral netting in a T+0 environment
poses challenges that include accommodating the submission of trades
for clearing during and after the close of regular trading hours while
still producing netting results with sufficient time to enable market
participants to position their cash and securities to achieve final
settlement before money settlement systems close for the day.\246\ The
Commission observes that existing processes and computational tools
used to complete the processing and settlement of trades currently rely
on significantly more time than the few hours between the close of
regular trading hours and the close of money settlement systems on a
given day.
---------------------------------------------------------------------------
\246\ Part IV.B.3 discusses existing limitations in money
settlement infrastructure that may contribute to this challenge.
---------------------------------------------------------------------------
The Commission is interested in receiving public comments on both
the utility of centralized multilateral netting as a feature of the
National C&S System and any potential impediments or challenges
associated with retaining such netting functionality while shortening
the settlement cycle to T+0. The Commission is also interested in
receiving public comments on potential benefits or costs associated
with real-time settlement. In particular the Commission requests
comment on the following:
73. Is it possible to shorten the settlement cycle in the U.S.
markets to T+0 and retain multilateral netting? If so, what is the
earliest time on T+0 that market participants could be prepared to
settle their trades without eliminating multilateral netting, and what
changes, if any, to existing netting processes would be necessary to
move to a T+0 settlement cycle?
74. Could a real-time settlement model be successfully deployed in
the National C&S System in a way that compliments the use of
multilateral netting? If yes, please explain. For example, most
institutional trades that use bank custodians generally are not
submitted to CNS for netting. Would it be possible to settle those
trades in a real-time settlement model while other trading activity
would continue to rely on multilateral netting? Alternatively, would it
be beneficial to find ways to move more institutional trades into
multilateral netting processes, such as by expanding access to
multilateral netting systems to custodians? Why or why not? What are
the impediments to expanding access to custodians?
75. If real-time settlement is not possible without eliminating or
substantially curtailing multilateral netting activity, please explain.
76. If real-time settlement is not compatible with multilateral
netting, would the potential benefits of real-time gross settlement
still justify the elimination of multilateral netting in the National
C&S System? Please explain why or why not.
77. What impact would the elimination of multilateral netting have
on capital demands (e.g., margin requirements) imposed on market
participants in connection with their settlement obligations? To the
extent possible, please include any quantitative estimates or data that
may be relevant to the request for comment.
78. How would the elimination of multilateral netting impact
overall levels of market, liquidity and credit risk in the clearance
and settlement system and how might such risks be distributed among
market participants?
79. Are there disadvantages to multilateral netting and, if so,
what are they? Does multilateral netting mandate the use of agreed
timeframes to determine which trades will be included in netting (for
example, trades settling on or executed on a given day or within a
given hour)? Why or why not? Are there netting activities that
currently only happen once a day that might need to occur more often
for trades to settle at the end of trade date? If so, what are they and
are there benefits, costs or risks to performing these activities more
than once a day?
80. Does multilateral netting foster or require the use of batch
processing? Does multilateral netting necessitate sequential processing
activities that impede the adoption of same-day settlement? Why or why
not? For example, do introducing broker-dealers that maintain omnibus
accounts at clearing broker-dealers need to net their activity prior to
submitting net trades to their clearing broker-dealers who, in turn,
have a dependency before being able to calculate their own net figures?
Are there computational or other technology upgrades that could be
employed to accelerate these processes so that they could continue to
function effectively under the shortened timeframes available in a T+0
environment? Are there other settlement
[[Page 10468]]
models, such as those deploying intraday or rolling settlement, that
could improve the settlement process in such a way that facilitates an
effective multilateral netting process at the end of the day in a T+0
environment?
2. Achieving Same-Day Settlement Processing
Moving settlement to the end of trade date would significantly
compress the array of operational activities and processes required to
achieve settlement, raising questions about whether the current
arrangement of settlement processes can support T+0 settlement.
For example, in the current T+2 settlement environment, DTC
processes certain transactions for settlement during the day on
settlement date and other transactions the night before settlement date
(``S-1'') during the so-called ``night cycle,'' which begins at 8:30
p.m. on S-1. Processing transactions during the night cycle allows for
earlier settlement of certain transactions that are included in the
night cycle, thereby reducing counterparty risk and, with respect to
transactions that are cleared through NSCC, enables such transactions
to be removed from members' marginable portfolios, which in turn
reduces such members' NSCC margin requirements.
DTC uses a process called the ``Night Batch Process'' to control
the order of processing of transactions in the night cycle.\247\ During
the Night Batch Process, DTC evaluates each participant's available
positions, transaction priority and risk management controls, and
identifies the transaction processing order that optimizes the number
of transactions processed for settlement. The Night Batch Process
allows DTC to run multiple processing scenarios until it identifies an
optimal processing scenario. At approximately 8:30 p.m. on S-1, DTC
subjects all transactions eligible for processing to the Night Batch
Process, which is run in an ``off-line'' batch that is not visible to
participants, allowing DTC to run multiple processing scenarios until
the optimal processing scenario is identified. The results of the Night
Batch Process are incorporated back into DTC's core processing
environment on a transaction-by-transaction basis.
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\247\ See DTC, Settlement Service Guide, at 68 (June 24, 2021),
https://www.dtcc.com/-/media/Files/Downloads/legal/service-guides/Settlement.pdf.
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Because trade date and settlement date would be the same day in a
T+0 environment, shortening the standard settlement cycle to T+0 would
require DTC and its participants to initiate and complete their
settlement processes much sooner relative to the time a trade is
executed and without the benefit of any overnight processes.
Compressing timeframes to achieve T+0 settlement necessarily removes
the ability to perform any settlement activities on S-1. This has
implications for how DTC conducts its existing ``night cycle'' process
but, more broadly, for all the market participants who collect trading
information that feeds into the night cycle process and any systems
that they run overnight to prepare for settlement. Moving to a T+0
settlement cycle would also impact the processing timeframes for
corporate actions.
The Commission requests public comment regarding the prospective
impact that shortening the settlement cycle to T+0 would have on
settlement processes such as those described above. In particular, the
Commission requests comment on the following:
81. Would shortening the standard settlement cycle to T+0 allow
sufficient time for settlement processes that are currently conducted
by DTC and its participants to be completed on a timeframe that is
compatible with timely settlement? If not, why not?
82. When would be the optimal time to complete existing processes
that occur on S-1 in a T+0 environment? More generally, how would
existing settlement processes that occur on S-1 need to change to
accommodate a T+0 standard settlement cycle?
83. What would be the impact on market participants (clearing
agencies, broker-dealers, buy side participants, retail investors,
etc.) of any changes in processes necessary to accommodate T+0?
84. What risks, if any, arise by the compression of the settlement
cycle to accommodate T+0, particularly as it relates to market, credit,
liquidity, and systemic risk? What are the associated costs of these
risks? How might these risks affect the market, trading behaviors,
investors (both retail and institutional), and innovation? Is
mitigation of these risks feasible, and if so, how?
3. Enhancing Money Settlement
To achieve final settlement on settlement date, DTCC and its
clearing agency participants rely on access to two systems operated by
the Federal Reserve Board, the National Settlement Service and
Fedwire.\248\ These systems settle the cash portions of securities
transactions. Final settlement at NSS and Fedwire currently must occur
by 6:30 p.m., leaving little time in a T+0 environment for market
participants to settle their positions in an end-of-day process after
most major U.S. stock exchanges typically close at 4:00 p.m. Although
Fedwire (but not NSS) reopens at 9:00 p.m., payments posted are
processed overnight and, like NSCC/DTC securities movements processed
during the night cycle, do not settle until the following day. NSS is
available throughout the trading day, although currently DTCC only
makes use of it at defined points during the day.
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\248\ See id. at 18-19.
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85. To achieve T+0, would NSS and FedWire services need to have
their availability expanded? If so, how? What timeframes (both minimum
and desired standards) would be necessary to accommodate T+0?
86. What other changes to NSS or FedWire, if any, would be
necessary to accommodate a T+0 settlement environment? If the available
windows for NSS or FedWire were to change, what changes would market
participants need to make to their own systems and processes to
accommodate such changes?
87. Are there ways to manage the money settlement process in a T+0
environment that do not require changes to NSS or FedWire? Please
explain.
4. Mutual Fund and ETF Processing
Purchases and redemptions of shares of open-end mutual funds
generally settle today on a T+1 basis, except for certain retail funds
and ETFs sold through intermediaries,\249\ which typically settle on
T+2. For open-end funds, several mutual fund families offer investors
the ability to open an account directly with the fund's transfer agent
and trade through that account. In other cases, orders are placed with
intermediaries, such as broker-dealers, banks and retirement plan
recordkeepers. Much of this intermediary activity is processed through
DTCC's Fund/SERV system, in which intermediaries submit orders through
Fund/SERV that are then routed to mutual fund transfer agents to be
executed at the current net asset value (``NAV'') \250\ next calculated
by the fund's administrator after receipt of the order, pursuant to
Rule 22c-1 of the Investment Company Act.\251\ These
[[Page 10469]]
orders may be submitted on an omnibus basis and in one of three ways:
As a request to purchase or redeem a given number of shares or units,
as a request to purchase or redeem a given U.S. dollar value, or as a
request to exchange a given number of shares/units or U.S. dollar value
for another fund. Because the NAV becomes the `price' for each order,
the net money to be paid or received at settlement cannot be calculated
until after the NAV has been calculated and published. Once the NAV is
available, the transfer agent is able to issue confirmations to the
intermediaries acknowledging receipt and execution of the orders
submitted. For orders submitted as share quantities, the net
confirmation includes not only the quantity executed, but the net
amount of money to be exchanged at settlement. For orders submitted as
U.S. dollar amounts, the transfer agent can calculate the quantity
purchased or redeemed and include it in the confirm. For exchanges of
shares in one fund for shares in another, the NAV of both funds is
required to determine both the quantity and the net settlement amount
for each fund.
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\249\ ETFs are investment companies registered under the
Investment Company Act. See 15 U.S.C. 80a-3(a)(1). Historically,
ETFs have been organized as open-end funds or UITs.
\250\ See 17 CFR 270.2a-4 (defining ``current net asset
value'').
\251\ Open-end funds are required by law to redeem their
securities on demand from shareholders at a price approximating
their proportionate share of the fund's NAV at the time of
redemption. See 15 U.S.C. 80a-22(d).
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In general, mutual fund families will utilize prices as of 4:00
p.m. ET to value the underlying holdings in each fund for the current
day.\252\ This is a critical input to the calculation of the NAV and,
as such, 4:00 p.m. ET is a dependency in the NAV calculation process.
Prior to 4:00 p.m. ET, fund administrators are able to reconcile
holdings to custodians, calculate and apply any income and expense
accruals, update the shares outstanding based on the prior day's
purchase and redemption activity and in general prepare for the receipt
of current-day prices. Once those prices are available, fund
administrators are able to apply prices to holdings, perform a variety
of validation checks on the prices and fund and ultimately calculate or
``strike'' the NAV, then submitting or publishing the NAV to pricing
vendors, newspapers and intermediaries. This tends to occur between
6:00 p.m. ET and 8:00 p.m. ET.
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\252\ As noted in Part IV.B.3, most major U.S. stock exchanges
typically close at 4:00 p.m. ET during standard (i.e., non-holiday)
trading hours.
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Once the day's NAV of a fund is available and each intermediary
calculates the settlement quantity or monetary amount for each
order,\253\ the intermediary aggregates and nets the amount of money to
be paid to or received from each fund's agent bank. These values are
aggregated and netted to determine a single payment or receipt per bank
and instructions are sent to the intermediary's bank to arrange for
payments.
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\253\ For example, if an order were placed as shares, the
intermediary would multiply the share quantity and the NAV to
determine the amount of money to be paid or received. If an order
were placed as a dollar amount, the intermediary would divide this
amount by the NAV to calculate the share quantity traded. (These
calculations may be further adjusted for commissions or other fees.)
Exchange transactions would require two calculations: One for the
redemption side of any exchange, and then a second calculation for
the subscription side of the exchange.
---------------------------------------------------------------------------
In the event an intermediary is an introducing broker, these
introducing broker calculations are then forwarded to the clearing
broker, which, in turn, aggregates values received from other
introducing brokers as well as any of its own order activity.
Ultimately the clearing broker determines a single net payment or
receipt for each agent bank representing all of the funds traded. The
clearing broker must receive calculations for all its introducing
brokers before it can finalize its own calculations.
Given the current timing of NAV calculation and publication, we
understand that many market participants are not able to calculate net
settlement amount or quantity traded until after 8:00 p.m. ET. This is
90 minutes later--to the extent this activity occurs on 8:00 p.m. ET--
than the time the Federal Reserve's NSS system, which moves the cash
necessary to effect settlement of securities transactions, closes at
6:30 p.m.\254\ Even when a NAV is available at 6:00 p.m. ET, there is
only a 30-minute window for intermediaries to obtain the NAV, calculate
settlement quantity or net amount, determine the net cash to be paid or
received for each fund, further determine the net payment or receipt
for each agent bank across all funds traded and to submit these values
to NSS prior to its close at 6:30 p.m. ET. In addition, if the
intermediary services other intermediaries at another omnibus ``tier,''
such as a clearing broker servicing one or more introducing brokers,
the intermediary must wait on calculations from others before
finalizing its own numbers and submitting instructions. This sequential
processing introduces a greater number of activities that must occur in
the approximately 30-minute window that would typically be available
for same-day settlement.
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\254\ See supra note 248 and accompanying text.
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As noted earlier, to receive a given day's NAV, intermediaries must
receive orders prior to the time at which the fund's NAV is calculated,
but intermediaries may not submit these orders to Fund/SERV or the
transfer agent until after the NAV calculation time, in some cases as
late as around 7:30 a.m. ET on T+1.\255\ The Commission understands
this is often the case with retirement plan recordkeepers who perform
compliance and other checks on orders before they are finalized for
submission to Fund/SERV. Such timing would require modification to
support end of day settlement on T+0.
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\255\ Per a 2017 ICI survey based on 3Q 2016 data, only 70% of
trade flow, including estimated trade flow, is known by funds or
their transfer agents around 5:00 p.m. ET and that number remains
rather constant until approximately 7:00 a.m. ET on T+1. See ICI,
Evaluating Swing Pricing: Operational Considerations, at 4 (June
2017), https://www.ici.org/system/files/attachments/pdf/ppr_17_swing_pricing_summary.pdf.
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Unlike mutual funds, ETFs do not sell or redeem individual shares.
Instead, APs that have contractual arrangements with the ETF purchase
and redeem ETF shares directly from the ETF in blocks called ``creation
units.'' An AP that purchases a creation unit of ETF shares directly
from the ETF deposits with the ETF a ``basket'' of securities and other
assets identified by the ETF that day, and then receives the creation
unit of ETF shares in return for those assets. After purchasing a
creation unit, the AP may hold the individual ETF shares, or sell some
or all of them in secondary market transactions. The redemption process
is the reverse of the purchase process: The AP redeems a creation unit
of ETF shares for a basket of securities and other assets. Secondary
market trading of ETF shares occurs at market-determined prices (i.e.,
at prices other than those described in the prospectus or based on
NAV), and the settlement values will be known at the time of execution,
similar to an exchange-traded equity security.\256\ Secondary market
ETF share transactions settle today on a T+2 basis. Currently, most
securities in a ``creation basket'' settle in a similar timeframe (T+2)
as the settlement time for a ``creation unit,'' which is also the same
as the settlement time for the ETF shares sold to APs, as well as ETF
shares traded in the secondary market.
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\256\ Purchases and sales of ETFs in the secondary market may
offset one another and do not always result in a primary market
transaction between the AP and the ETF to create or redeem units.
---------------------------------------------------------------------------
NAVs are calculated for ETF shares in a manner similar to the
process for open-end mutual funds, with comparable times for capturing
prices of underlying holdings and for publishing the NAVs. Secondary
market purchases and sales of ETF shares occur throughout the business
day and often occur at prices that differ from the ETF's
[[Page 10470]]
NAV.\257\ Those trading ETF shares in the secondary market during the
day will know their settlement amount almost immediately, because the
transaction price is the market price of the shares. Therefore,
secondary market ETF share transactions generally do not present the
same challenges presented by open-end mutual funds when considering
same-day settlement.\258\
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\257\ The combination of the creation and redemption process
with secondary market trading in ETF shares and underlying
securities provides arbitrage opportunities that are designed to
help keep the market price of ETF shares at or close to the NAV per
share of the ETF. See Exchange-Traded Funds, Investment Company Act
Release No. 33646 (Sept. 25, 2019), 84 FR 57162, 57165 n.31 (Oct.
24, 2019).
\258\ We understand that some institutional investors may opt to
place orders to trade ETFs at the end-of-day NAV. These are
generally placed with a market maker who may or may not be an AP.
The market maker will guarantee the end-of-day NAV price plus (or
less) a fee (depending on the direction of the trade) to cover
transaction costs and profit. The market makers can either trade
with the institutional investor as a proprietary or principal trade
or they can submit a creation/redemption as agent on behalf of the
institutional investor and deliver/receive cash or the basket in
exchange for the ETF shares. Under these circumstances, secondary
market investors in ETF shares would incur the same time compression
described above for open-end mutual funds to settle on a T+0 basis.
---------------------------------------------------------------------------
The Commission requests comment on the challenges open-end mutual
funds and ETFs might experience if U.S. markets were to adopt T+0
settlement.
88. Are there additional factors that may negatively affect same-
day settlement of open-end mutual funds and ETFs that we have not
described, and if so, what are they? Please provide as much detail as
possible.
89. Are fund administrators able to calculate and release NAVs any
earlier while still relying on 4:00 p.m. ET prices? What can they do to
optimize their processes, including the publication of the NAV?
90. Is our description of the netting across multiple omnibus
``tiers''--and the subsequent sequential processing that results--an
accurate portrayal? If so, how many tiers might exist that would
necessitate sequential processes and how long might each tier be
expected to need to perform its calculations to pass on to the next
tier? What factors influence this processing? Are there potential
solutions to this sequential processing challenge and, if so, what are
they? Are there ways in which intermediaries might process information
concurrently? If this description of netting across multiple omnibus
tiers does not capture current processes, please provide an explanation
of the way(s) it does occur today.
91. Could open-end mutual funds and ETFs settle on a T+1 basis even
if other security types, such as equities and corporate bonds, move to
T+0 settlement? If so, what risks would be introduced to open-end
mutual funds and ETFs from holding positions in securities that settle
on a T+0 basis when trades of the fund's shares occur on a T+1 basis?
Should these funds receive large amounts of purchases from investors,
would they wait a day for those purchase transactions to settle before
investing cash in securities? Would they rely on borrowing facilities
and, if so, does that introduce new issues or risks? For large
redemption requests by investors, would these funds have additional
time to liquidate underlying holdings or would they increase their cash
position in the interim?
92. Are there additional considerations for APs if securities in a
creation basket settle on a different basis than the shares of the ETF?
What are the current risks and considerations in this process where the
securities in a creation basket settle on a different basis than the
shares of the ETF itself, such as is the case with U.S. Treasury
securities, which commonly settle on a T+1 basis today while the ETF
shares settle on a T+2 basis?
93. What time do market intermediaries believe would be necessary
for open-end mutual funds and ETFs to publish NAVs in order to achieve
same-day settlement and why?
94. What are the reasons intermediaries do not submit orders to
purchase or sell mutual fund shares to Fund/SERV or the transfer agent
earlier on trade date? What are the reasons some intermediaries may be
delayed in the submission of those orders until T+1 in the current
environment? Please be as specific as possible and include data if
available on submission times. What would be needed to accelerate these
timeframes?
95. Would open-end mutual funds potentially establish an earlier
cut-off time for placing orders to purchase or sell fund shares than is
currently used (i.e., earlier than 4:00 p.m. ET) to capture prices for
NAV calculations, in order to speed the time at which a NAV can be
published? If so, what time might be most likely and why? If different
funds opted to use different times, would this create new market
opportunities for funds? What challenges would this introduce?
96. The Commission understands that some ETFs calculate NAVs more
than once per day. Are there unique challenges and opportunities these
funds may have with same-day settlement?
97. Currently, Rule 22c-1(a) of the Investment Company Act limits
the ability to transact in fund shares at a price other than ``a price
based on the current net asset value . . . which is next computed after
receipt of a tender of such security for redemption or of an order to
purchase or sell such security.'' In the event a fund elects to
calculate its NAV using intra-day prices for the underlying securities
held in the fund, such as utilizing 2:00 p.m. ET prices to value its
portfolio in order to produce a NAV earlier in the day to support same-
day settlement, how would this limitation impact the acceptance of
orders to purchase or redeem shares of the fund? Would a fund establish
a cut-off time for acceptance of orders that is based on the time when
a snapshot of prices is captured to value the fund's securities
positions? Would it be possible in different scenarios for investors to
have an information advantage and, if so, how? For funds that may
currently utilize prices for U.S. securities prior to the U.S. market
close, how has such an approach modified timelines and processes for
acceptance of orders and publication of the NAV?
98. If different funds adopt differing policies for the time to
capture prices or to publish NAVs, and subsequently impose different
cut-off times for receipt of orders pursuant to Rule 22c-1, would
intermediaries be able to accommodate such differences on a fund-
specific basis?
99. Might funds consider requiring orders to be received by the
fund's transfer agent, rather than an intermediary, by the cut-off
time? Are there other ways in which a movement to T+0 settlement would
affect transfer agents' processes, and if so, how should those
processes be changed?
100. If receipt by an intermediary is sufficient (as opposed to
requiring orders be received by the fund's transfer agent by the cut-
off time), as is the case today, how do intermediaries or others
monitor intermediary compliance?
101. Does monitoring of order receipt relative to cut-off times
differ by types of intermediaries? For example, are there different
processes to monitor ``authorized agents'' as opposed to other types of
intermediaries? What are the differences between ``authorized agents''
and other intermediaries?
102. If ETFs were to utilize an earlier time in the day to capture
prices of their portfolio investments for purpose of calculating the
ETF's shares' NAV (that is, the price that would form the basis for
APs' purchases and redemptions of creation units), how would this
affect
[[Page 10471]]
primary market transactions in ETF shares? Would this affect secondary
market ETF share transactions in any way, for example, transactions by
institutional investors who may opt to place orders to trade ETFs at
the end-of-day NAV?
103. Should the Commission consider elimination of omnibus
processing to facilitate the adoption of T+0 settlement for open-end
mutual funds? Since any investor account must be maintained by at least
one party, how does omnibus accounting by intermediaries rather than
maintaining investor-specific accounts at each fund's transfer agent
reduce costs to investors?
104. Are there any additional unique considerations for open-end
mutual funds or ETFs that hold non-U.S. securities if the Commission
were to adopt a same-day settlement standard while non-U.S. markets may
continue with longer settlement timeframes, including T+1 and T+2? What
potential liquidity impacts might such funds experience?
5. Institutional Trade Processing
As discussed throughout this release, while significant
improvements to the infrastructure for institutional trade processing
have decreased reliance on manual activities and enabled more
transparency into and standardization of trade information, several
operational and technology challenges continue to limit the speed,
accuracy, and efficiency of institutional trade processing, all of
which would be more acute in a T+0 environment.
As discussed previously, the T+1 Report recommends that allocations
for all institutional trades be made and communicated by 7:00 p.m. on
trade date and these trades be confirmed and affirmed by 9:00 p.m. ET
on trade date.\259\ The industry has identified a number of issues
related to the institutional trade process that would need to be
addressed in a T+1 settlement cycle, including, but not limited to,
trade systems and reference data, the trade allocations, confirmation
and affirmation cut-off times, batch cycle timing, migration to trade
date matching, and identification of automated vendor solutions to
alleviate manual processing.\260\ In addition, improvements in the
quality and standardization of settlement instructions, the quality of
static settlement data maintenance, the use of automation and the
expansion of straight-through processing capabilities would all help
facilitate higher affirmation rates and faster processing.
---------------------------------------------------------------------------
\259\ T+1 Report, supra note 18, at 13; see also supra note 164
and accompanying text (discussing the same). Additionally, the
industry has recommended the adoption of Commission or SRO rules
requiring: (i) Broker-dealers to obtain an agreement from their
customers at the outset of the relationship or at the time of the
trade to participate in and to comply with the operational
requirements of interoperable trade-match systems as a condition to
settling trades on an RVP/DVP basis; and (ii) investment managers to
participate in a trade-match system, similar to the way broker-
dealers and institutions are required by the SRO confirmation/
affirmation rules to participate in a confirmation/affirmation
system.
\260\ See supra note 259.
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As discussed in Part III.D, the Commission has previously explained
that a shortened settlement cycle may lead to increased reliance on the
use of CMSPs, with a focus on improving and accelerating the
allocation, confirmation, and affirmation processes and enhancing
efficiencies in the services and operations of the CMSPs.\261\ Improved
automation in the settlement process has enabled better straight-
through processing and contributed to increases in affirmation rates on
trade date and increases in settlement rates, with an attendant
decrease in exceptions and fails. Moving to T+1 may promote continued
improvements in technology and operations, encourage incremental
increases in the utilization by certain market participants of CMSPs,
and focus the industry on improving and accelerating the allocation,
confirmation and affirmation processes by completing those processes
earlier and more efficiently.
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\261\ See T+2 Proposing Release, supra note 30, at 69258.
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However, it is unclear whether addressing these issues would (i)
facilitate further shortening of the settlement cycle beyond T+1; (ii)
whether these issues would continue to be relevant in a T+0
environment; or (iii) whether new technologies or operational processes
would need to be designed and implemented to accommodate T+0 for
institutional trade processing. Accordingly, the Commission is
requesting comment on all issues pertaining to improving the
institutional trade processing in order to achieve a T+0 standard
settlement cycle. In addition, the Commission is seeking comment on the
following:
105. What operational, technological and regulatory issues related
to institutional trade processing should be considered in further
shortening of the settlement cycle to T+0, particularly any impediments
to investors and other market participants?
106. What, if anything, should the Commission do to facilitate T+0,
particularly as it relates to the standardization of reference data,
the use of standardized industry protocols by broker-dealers, asset
managers, and custodians, and the use of matching services?
107. Does moving to T+0 introduce any new risks in the processing
of institutional trades? If so, please describe such risks and whether
mitigation is possible. Can such risks be quantified?
108. What are the benefits and costs of settling institutional
trades in a T+0 environment? What are the relative challenges for the
different market participants involved? Do the benefits of T+0 accrue
to all participants--brokers, institutional customers, custodians, or
matching utilities? Do they accrue to large, medium, and small
entities?
109. How would the current systems and processes used in the
institutional post-trade process need to change to accommodate a T+0
settlement requirement?
110. Would any or all of the changes contemplated by the Industry
Working Group to address the building blocks considered essential for
institutional trade settlement in T+1 be useful should the settlement
cycle move to T+0?
111. How would the allocation, confirmation and affirmation process
be accomplished in a T+0 environment? In particular, what timeframes
would be necessary to ensure settlement on T+0? To what extent would
the roles of CMSPs, broker-dealers, or bank custodians need to change
to accommodate T+0 settlement? To what extent does the use of a
custodian foster or impair a transition to a T+0 settlement cycle?
Please explain.
112. What effect would T+0 have on the relationship between a
broker-dealer and its customer? What effect would T+0 have on the
relationship between an investor and its custodian?
6. Securities Lending
Both the ISG White Paper and the T+2 Playbook highlighted the
potential impact shortening the settlement to T+2 may have on
securities lending practices in the U.S. For example, the ISG White
Paper noted that securities lenders may have less time to recall loaned
securities, and securities borrowers should be cognizant of the reduced
timeframe between execution and settlement when loaning securities,
particularly when transacting in hard to borrow securities.\262\ The
ISC White Paper further stated that service providers may need to
update their
[[Page 10472]]
products and services to accurately process such transactions.\263\
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\262\ ISG White Paper, supra note 26, at 26.
\263\ Id.
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The T+2 Playbook included several recommendations regarding actions
firms should take to address the potential impact that shortening the
standard settlement cycle may have on securities lending practices in
the industry. For example, the T+2 Playbook recommended that market
participants' decisions to loan securities should take into account the
shortened settlement cycle, and stock borrow positions should be
evaluated to reduce exposure to counterparty risk based on the
shortened settlement cycle.\264\ More recently industry working groups
tasked with understanding industry requirements for shortening the
standard settlement cycle to T+1 have begun to analyze how shortening
the settlement cycle may require additional changes to securities
lending practices.\265\
---------------------------------------------------------------------------
\264\ T+2 Playbook, supra note 27, at 86.
\265\ T+1 Report, supra note 18, at 24-25.
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While market participants have yet to explore in significant detail
how shortening the settlement cycle to T+0 might impact securities
lending practices in the U.S. markets, the Commission preliminarily
believes that such a move would likely impact these practices further,
and may necessitate further changes to procedures, operations and
technologies that facilitate securities lending and borrowing.
Additionally, the Commission is interested in learning whether
shortening the standard settlement cycle to T+0 could impact overall
liquidity in the U.S. markets to the extent that market participants
may curtail their participation in the securities lending markets in
response to such a move.
The Commission is requesting public comment regarding all aspects
of the potential impact that shortening the settlement cycle to T+0
could have on securities lending in the U.S. In particular, the
Commission requests comment on the following:
113. To what extent would shortening the standard settlement cycle
to T+0 make it difficult for securities lenders to timely recall
securities on loan?
114. To what extent would the Commission need to amend Regulation
SHO to accommodate securities lending in a T+0 environment? Are there
changes to Regulation SHO that can be made to help facilitate lending
in a T+0 environment?
115. Please describe any technology changes that might be necessary
to support securities lending operations of market participants if the
settlement cycle were shortened to T+0. Please include in any comments
descriptions of existing technologies that may help the Commission
identify and understand the limitations, if any, of such technologies
with respect to a T+0 settlement cycle.
116. With respect to stock loan recalls, are there ways to improve
the level of coordination between investment managers and third-party
lending agents for underlying funds, and to facilitate partial stock
loan recalls from bulk lending positions aggregated from multiple
institutional investors? \266\
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\266\ See, e.g., ISITC Virtual Winter Forum, Securities Lending
Working Group discussion (Dec. 13, 2021).
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117. To what extent might securities lenders need to rely on
predictive analytics to make decisions regarding which securities to
recall before lenders can be sure such recalls will be necessary? What
additional costs, if any, might be associated with the increased use of
predictive analytics?
118. How might shortening the standard settlement cycle to T+0
impact market participants seeking to borrow securities in the U.S.
markets? Please include discussion regarding the possible impact on
market participants' ability to borrow securities that might be
difficult to borrow.
119. How might shortening the standard settlement cycle to T+0
impact the decisions of securities lenders and borrows to lend and
borrow securities, respectively?
120. What impact, if any, would shortening the standard settlement
cycle to T+0 have on the cost of borrowing securities in the U.S.?
121. What impact would shortening the settlement cycle to T+0 have
on costs related to loaning securities (e.g., investments in technology
improvements, analytics, etc.)?
122. To what extent might shortening the standard settlement cycle
to T+0 reduce revenue securities lenders generate from loaning
securities compared with a T+2 or T+1 settlement cycle?
123. What impact, if any, might a T+0 settlement cycle have on
overall liquidity in the U.S. markets if such a move were to reduce
securities lending activity?
124. Please describe any indirect impact that shortening the
standard settlement cycle to T+0 might have on market structure or
trading activity as a result of changes to securities lending in the
U.S. markets. For example, if shortening the settlement cycle to T+0
would reduce the availability of difficult to borrow securities, how
would such a reduction impact short selling practices in the U.S.
markets?
125. Please describe any other impacts that shortening the
settlement cycle to T+0 might have on securities lending markets in the
U.S.
7. Access to Funds and/or Prefunding of Transactions
A T+0 settlement cycle may increase prefunding requirements for
investors, shifting some costs from broker-dealers and banks to retail
and institutional investors.\267\ When purchasing securities in the
U.S. market, retail and institutional investors must be ready to
provide cash to settle their securities transaction. Cash is typically
held in a short-term sweep account, such as a money market fund (MMF)
or commingled vehicle, and therefore requires that the investor redeem
cash from the sweep vehicle to finance the securities transaction.
Alternatively, it may simply be held in a cash account. In some cases,
funds will be converted to USD from another currency through an FX
transaction. The specific needs, timing and arrangements vary for
retail versus institutional investors. Retail investors may fund their
securities transactions using cash accounts, and in such cases FINRA
rules permit the brokers to require the payment of purchase money to be
paid ``upon delivery,'' \268\ which functionally means no later than
settlement. Some brokers require their retail clients to prefund their
transactions--in other words, deposit sufficient cash for settlement in
their brokerage account before the broker acts on their orders and
executes a purchase trade. Alternatively, retail clients may be
permitted to fund transactions through use of a margin account. An
institutional investor is required, pursuant to its contractual
relationships with its brokers and custodians, to provide cash (or have
credit available) on the day that the custodian or broker receives the
purchased securities and credits them to the investor's account.
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\267\ This discussion concerns the settlement arrangements
between investors and their brokers or custodians. These
arrangements are separate from obligations of brokers and custodians
to NSCC and DTC.
\268\ See FINRA Rule 11330.
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In a T+0 environment, investors will not have time after markets
close to identify and obtain the cash necessary for settlement of a
securities transaction, as settlement of the securities transaction
will occur on the same day. This could have a number of potential
effects, and the Commission is requesting comment on the following:
[[Page 10473]]
126. Will there be a significant increase in prefunding
requirements for securities transactions across market participants?
Would some investors have to start planning in advance before the trade
date to accurately position necessary funds for redemption and
securities and cash for settlement? To what extent might retail
investors alter their funding behaviors or their use of margin accounts
in response to added prefunding requirements?
127. Would a prefunding requirement shift risk from the broker-
dealer and bank community to the investor, both retail and
institutional?
128. To the extent that an investor would need to redeem shares of
a money market fund to receive cash to settle a separate securities
transaction, how would such redemptions be effected? Would redemptions
of money market fund shares need to be effected in the morning of T+0
to receive cash to settle a separate securities transaction on the same
day?
129. How would this affect the borrowing of cash from clearing
members, prime brokers, custodians, and other liquidity providers when
an institutional investor cannot successfully redeem funds or otherwise
convert assets to cash in time to settle?
130. How would T+0 affect FX transactions used to finance the
settlement of transactions?
131. Could T+0 affect the volume of securities trading at various
points throughout the trading day?
8. Potential Mismatches of Settlement Cycles
The Commission preliminarily believes that shortening the standard
settlement cycle to T+0 could create mismatches between settlement
timeframes in different markets, or could increase the degree to which
certain settlement timeframes may already be mismatched at the time a
T+0 settlement cycle might be implemented. For example, most major
securities markets in non-U.S. jurisdictions currently settle
transactions on a T+2 basis, as do FX markets generally. When the
Commission amended Exchange Act Rule 15c6-1(a) in 2017 to shorten the
standard settlement cycle to T+2, several major securities markets had
already adopted a T+2 settlement cycle, and the move to T+2 in the U.S.
harmonized large portions of the U.S. settlement cycle with prevailing
settlement cycles in those markets.\269\
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\269\ See T+2 Proposing Release, supra note 30, at 69241-42.
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In the T+2 Adopting Release the Commission stated that the
prospective harmonization of the standard settlement cycle in the U.S.
with settlement cycles in foreign markets that settle transactions on a
T+2 settlement cycle may reduce the need for some market participants
engaging in cross-border and cross-asset transactions to hedge risks
stemming from mismatched settlement cycles and reduce related financing
and borrowing costs, resulting in additional benefits.\270\ The T+2
Adopting Release also noted that shortening the settlement cycle
further than T+2 at that time could increase funding costs for market
participants who rely on the settlement of FX transactions to fund
securities transactions that settle regular way.\271\
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\270\ T+2 Adopting Release, supra note 10, at 15574.
\271\ Id. at 15599. Both the T+2 Proposing Release and the T+2
Adopting Release stated that, because the settlement of FX
transactions occurs on T+2, market participants who seek to fund a
cross-border securities transaction with the proceeds of an FX
transaction would, in a T+1 or T+0 environment, be required to
settle the securities transaction before the proceeds of the FX
transaction become available and would be required to pre-fund
securities transactions in foreign currencies. Under these
circumstances, a market participant would either incur opportunity
costs and currency risk associated with holding FX reserves or be
exposed to price volatility by delaying securities transactions by
one business day to coordinate settlement of the securities and FX
legs. Id.
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Whether shortening the standard settlement cycle for securities
transactions in the U.S. to T+0 would in fact result in mismatched
settlement cycles vis-[agrave]-vis major foreign securities markets, or
the settlement cycle for FX transactions, may depend on future
developments that are unknown at this time, including the extent to
which settlement cycles in those markets might be shortening in
response to the implementation of a shorter settlement cycle for
securities in the U.S., or in response to other future developments in
global markets.
The Commission notes that mutual funds and investment advisers have
invested in markets with mismatched settlement cycles for many
years.\272\ Many investors evaluate an investment portfolio based on
traded positions without reference to pending or actual settlement
because entitlement to trade, receive income or corporate actions and
performance calculations generally are based on trade-date information.
Nonetheless, institutional and retail investors alike often consider
anticipated settlement dates when managing cash balances to ensure that
settlements do not conflict or create an unexpected shortfall of cash,
or an unplanned event that results in an uninvested cash balance.
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\272\ As noted earlier, U.S. equities securities have moved from
settling T+5 to T+3 and more recently to T+2, while U.S. Treasury
securities have settled on a T+1 basis throughout. Portfolios that
invest globally have encountered mismatched settlement cycles,
especially prior to October 6, 2014 when twenty-nine European
markets moved to T+2 settlement in an effort to harmonize settlement
times in Europe. See European Central Securities Depositories
Association, A Very Smooth Transition to T+2, https://ecsda.eu/archives/3793.
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The Commission is interested in receiving public comment regarding
the impact a T+0 standard settlement cycle in the U.S. securities
markets might have on global harmonization of settlement cycles,
including any indirect impact on market participants. Specifically the
Commission requests comment on the following:
132. Would shortening the standard settlement cycle to T+0 in the
U.S. securities markets result in decreased harmonization of settlement
cycles generally? Which markets would be impacted by such decreased
harmonization? Could solutions be applied to mitigate the effects of
de-harmonization? For example, to what extent could other asset
classes, such as FX, transition to a shorter settlement cycle? What are
the impediments to shortening settlement cycles for these other asset
classes? Could FX transactions transition to a T+0 settlement cycle?
Please explain.
133. Would certain non-U.S. markets move to a T+0 settlement cycle
in response to a prospective move to T+0 in the U.S.?
134. How might shortening the standard settlement cycle to T+0 in
the U.S. impact market participants who seek to fund cross-border
transactions with the proceeds of an FX transaction?
135. To what extent might any adverse impact from increased
settlement cycle mismatches be mitigated if the standard settlement
cycle in the U.S. is shortened to T+1 prior to a move to a T+0 standard
settlement cycle at a later time?
136. To what extent might monitoring of anticipated settlement-date
balances change if the U.S. moved to a T+1 settlement cycle? How would
such monitoring be impacted if the U.S. moved to a T+0 standard
settlement cycle?
9. Dematerialization
Currently the vast majority of securities asset classes trading in
the U.S. markets, including government securities, options, most mutual
fund securities, and some municipal bonds, are issued in book-entry
form only (i.e., dematerialized).\273\ In contrast, other
[[Page 10474]]
asset classes, such as listed equities, unlisted equities that have
been admitted as DTC-eligible, and some debt securities, can be
immobilized \274\ using DTC and dematerialized using the Direct
Registration System (``DRS'') services enabled by DTC's facilities, but
many issuers of these equity and debt securities continue to allow
their investors to obtain paper certificates.\275\
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\273\ Dematerialization of securities occurs where securities
owned by an investor are not represented by paper certificates, and
transfers of ownership of those securities are made through book-
entry movements. For more information on issues related to the use
of certificates in the U.S. Markets, see Concept Release, supra note
149, at 12932-34.
\274\ Immobilization of securities occurs where the underlying
certificate is kept in a securities depository (or held in custody
for the depository by the issuer's transfer agent) or at a custodian
and transfers of ownership are recorded through electronic book-
entry movements between the depository or custodian's internal
accounts. These types of securities are often referred to as being
held in ``street name.'' An issue is partially immobilized (as is
the case with most equity securities traded on an exchange), when
the street name positions beneficially owned by investors are linked
through chains of beneficial ownership through intermediaries (such
as brokers) to the certificate immobilized at the securities
depository, but certificates are still available to investors
directly registered on the issuer's books. Id. at 12931 n.107; see
also Exchange Act Release No. 76743 (Dec. 22, 2015), 80 FR 81948,
81952 n.39 (Dec. 31, 2015).
\275\ DRS facilitates and automates the process whereby an
investor, generally in equities, can establish a direct book-entry
position registered in the investor's own name on the issuer's
master securityholder file; such DRS issues are maintained by 61
transfer agents (as of December 31, 2021) that have been admitted to
DRS by DTC (out of a total, as of September 30, 2021, of 403
registered transfer agents). Where an issuer has authorized
ownership in book-entry form and is serviced by a transfer agent
that has been admitted by DTC as DRS-eligible and an investor
currently holds the securities in street name form in the investor's
broker-dealer account, the investor can arrange, assuming the
broker-dealer supports DRS servicing at DTC, to have its securities
electronically withdrawn from the account and forwarded to the
transfer agent. The procedure avoids the risks and custodial costs
of moving certificates; in response to the investor's instruction to
the broker-dealer, the investor's shares are changed into DRS form
when the transfer agent receives an electronic file from DTC
specifying the investor's details supplied by the broker-dealer,
cancels the prior registration in the name of DTC's Cede & Co.
nominee, and re-registers the securities directly in the investor's
name, with the investor receiving a statement. Conversely, if the
investor later elects to transfer the securities back to the
investor's broker-dealer account (i.e., change the form of ownership
of the securities from DRS back into street-name form held through
the broker-dealer account), the investor most commonly would request
the broker-dealer to withdraw the securities from DRS, with the
transfer agent re-registering the securities in the name of DTC's
nominee, and the broker-dealer crediting the securities to the
investor's account. Some frictions remain: DRS is not authorized by
all issuers and not available for all registered securities types; a
number of the transfer agents for DTC-eligible issues do not meet
DTC's qualifications to participate in DRS; some brokers may not
support DRS transfers or promptly process investors' instructions to
facilitate the transfer of securities into DRS form. See Concept
Release, supra note 139, at 12932.
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While the U.S. markets have made significant strides over the past
twenty years in achieving immobilization and dematerialization, many
industry representatives believe that the small percentage of
securities held in certificated form impose unnecessary risk and
expense to the industry and to investors.\276\ Moreover, the ISG
previously identified the dematerialization of securities certificates
as a necessary building block to achieve shorter settlement
timeframes.\277\ The industry has long asserted that, despite the
reduction in the use of paper certificates in the U.S. markets,
certificates continue to pose risks, create inefficiencies and increase
costs,\278\ many of which will be exacerbated as the settlement cycle
shortens. Fully transitioning from paper certificates to book-entry
(i.e., electronic records) would not only contribute to a more cost-
effective, efficient, secure, and resilient marketplace by addressing
operational issues related to record-keeping, inventory management,
resilience and controls, but would facilitate a more efficient
transition to shorter settlement cycles.\279\
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\276\ The processing of paper securities certificates has long
been identified as an inefficient and risk-laden mechanism by which
to hold and transfer ownership. Because paper certificates require
manual processing and multiple touchpoints between investors and
financial intermediaries, their use can result in significant delays
and expenses in processing securities transactions and can raise
risk concerns associated with lost, stolen, and forged certificates.
See id. at 12930-31; Transfer Agents Operating Direct Registration
System, Exchange Act Release No. 35038 (Dec. 1, 1994), 59 FR 63652,
63653 (Dec. 8, 1994) (``1994 Concept Release''); see also SIA
Business Case Report, supra note 21, at 10; BCG Study, supra note
22, at 59, 62; DTCC, From Physical to Digital: Advancing the
Dematerialization of U.S. Securities, at 4, 6 (Sept. 2020) (``DTCC
2020 Dematerialization White Paper''), https://www.dtcc.com/-/media/Files/PDFs/DTCC-Dematerialization-Whitepaper-092020.pdf.
\277\ See, e.g., William M. Martin, Jr., The Securities Markets:
A Report with Recommendations, Submitted to The Board of Governors
of the New York Stock Exchange (Aug. 5, 1971) (``Martin Report''),
https://www.sechistorical.org/collection/papers/1970/1971_0806_MartinReport.pdf.
\278\ Id. DTCC estimates that only a small portion of securities
positions remains certificated and states that requests for
certificates are declining, but also explains that the risks and
costs associated with processing the remaining certificates in the
marketplace are substantial and avoidable. See DTCC 2020
Dematerialization White Paper, supra note 276, at 4.
\279\ See DTCC 2020 Dematerialization White Paper, supra note
276, at 11.
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The Commission has long advocated a reduction in the use of
certificates in the trading environment by immobilizing or
dematerializing securities and has acknowledged that the use of
certificates increases the costs and risks of clearing and settling
securities for all parties processing the securities, including those
involved in the National C&S System.\280\ Most of these costs and risks
are ultimately borne by investors.\281\ For example, in response to the
COVID-19 pandemic, DTC suspended all physical securities processing
services for approximately six weeks to minimize the risk of
transmission of COVID-19 among its employees, who would otherwise be on
site at DTC's vault that holds physical securities on deposit.\282\
While this service disruption did not affect the electronic book-entry
settlement of securities transactions, DTC instituted alternative
methods of handling certain transactions, such as the use of letters of
possession and an emergency rider in connection with underwriting new
securities issues.\283\
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\280\ Concept Release, supra note 149, at 12934. The Commission
also stated in the Concept Release that, while investors should have
the ability to register securities in their own names, it was time
to explore ways to further reduce certificates in the trading
environment due to the significant risk, inefficiency, and cost
related to the use of securities certificates. Id. The possibility
exists that investors' attachment to the certificate may be based
more on sentiment than need, particularly in light of the fact that
today non-negotiable records of ownership (e.g., account statements)
evidence ownership of not only most securities issued in the U.S.
but also other financial assets, such as money in bank accounts. See
id. at 12934-35. DRS allows an investor to have securities
registered in the investor's name without having a certificate
issued to the investor and the ability to electronically transfer
securities between the investor's broker-dealer and the issuer's
transfer agent without the risk and delays associated with the use
of certificates. Id. at 12932.
\281\ Id. at 12934.
\282\ See, e.g., DTCC, Important Notice (May 14, 2020), https://www.dtcc.com/-/media/Files/pdf/2020/5/14/13402-20.pdf; DTCC,
Important Notice (Apr. 8, 2020), https://www.dtcc.com/-/media/Files/pdf/2020/4/8/13276-20.pdf.
\283\ See, e.g., DTCC, Important Notice (Mar. 12, 2020), https://www.dtcc.com/-/media/Files/pdf/2020/3/13/13099-20.pdf.
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The COVID-19 pandemic has highlighted the importance of continuing
to immobilize or dematerialize the U.S. market to decrease risks and
costs associated with physical certificates, but the Commission
preliminarily believes that dematerialization is not a prerequisite to
shortening the settlement cycle. Mechanisms in place today to
facilitate immobilizing paper certificates can adequately address the
risk and efficiency issues associated with such certificates (as
evidenced by the COVID-19 example above), and can accommodate shorter
settlement cycles, up to and including T+0. In particular, DRS provides
a viable alternative to street-name holding for those investors who do
not want to hold securities at a broker-dealer or who want their
securities registered in their own
[[Page 10475]]
name.\284\ Investors can use the linkages enabled by DTC to transfer
their securities back and forth between DRS at the transfer agent and
book-entry form on the books of a broker-dealer as it suits their
needs.\285\
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\284\ Due to the expanded use in today's market, DRS is
considered a viable alternative to holding physical certificates,
allowing transfers to be made relatively quickly and without the
risk and delays associated with the use of certificates. See DTCC
2020 Dematerialization White Paper, supra note 276, at 4 n.2.
\285\ Specifically, DTC participants can use the linkages
enabled by DTC and qualified FAST transfer agents to withdraw
securities electronically. Upon the investor's request, a broker can
use DRS, if available for the particular securities issue, to
transfer securities from the broker's account (where it is in DTC's
nominee registration) to be held in an investor's own name on the
transfer agent's book. DTC's balance in that security drops and the
investor receives a statement of its holdings, rather than a
certificate.
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The key issues appear to be processing time and access to transfers
between DRS at the transfer agent and book-entry form at the broker-
dealer. With regard to processing time, the Commission is concerned
that broker-dealer processes, whereby an investor requests that its
broker-dealer change the investor's form of ownership from certificate
form into street name form at the broker-dealer, can take days or
weeks. Those processing timeframes will need to be significantly
compressed or completed in real time to accommodate T+0. Broker-dealers
might require investors to complete the process of transferring paper
certificates into book-entry either through the transfer agent or the
broker-dealer prior to trade execution, thereby allowing the broker-
dealer assurances the securities can be delivered in time for
settlement. With regard to access, only investors who have an issuer
and transfer agent that offer DRS services can move their securities
between DRS at the transfer agent and book-entry form at the broker-
dealer.
The Commission is seeking comment on these issues, as well as a
number of other issues related to the consideration of
dematerialization as a building block to achieving T+0.
137. Is the elimination of the paper certificate necessary to
achieve T+0? If so, why? If not, why?
138. Would further dematerialization, immobilization, or some
combination thereof, without the elimination of the paper certificate,
be sufficient to facilitate a T+0 settlement cycle? Please describe how
and why this would or would not be the case.
139. If further dematerialization or immobilization is necessary to
achieve T+0 settlement, what needs to be done on either an operational
or regulatory basis to achieve such an objective? Please be as specific
as possible, particularly where your answer relates to regulatory
initiatives. For example, should the Commission consider mandating the
dematerialization of certain types of securities? If so, which
securities? Should such a mandate be limited to securities traded on an
exchange, or focused on particular asset classes?
140. Should any potential requirements regarding dematerialization
be imposed in stages or, instead, be comprehensive from the outset? For
example, should such requirements be phased by addressing: (i) First,
newly listed companies, (ii) then, new issues of securities by all
listed companies, and (iii) all outstanding securities?
141. In order to better accommodate a T+0 environment, what
changes, if any, would need to be made to broker-dealer processes for
responding to investor requests to transfer investors' paper
certificates into holdings in street-name book-entry form at the
broker-dealer?
142. Do laws in other jurisdictions present any barriers to
achieving complete dematerialization, such as laws that require an
issuer to issue certificates or prohibit book-entry ownership? If so,
please describe the jurisdictions and the specific laws that raise
potential issues.
143. What are the costs and benefits with requiring investors who
hold paper certificates to complete the transfer of such securities
into book-entry prior to the execution of a trade?
V. Economic Analysis
The Commission is mindful of the economic effects that may result
from the proposed amendments, including the benefits, costs, and the
effects on efficiency, competition, and capital formation.\286\ This
section analyzes the expected economic effects of the proposed rules
relative to the current baseline, which consists of the current market
and regulatory framework.
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\286\ Exchange Act Section 3(f) requires the Commission, when it
is engaged in rulemaking pursuant to the Exchange Act and is
required to consider or determine whether an action is necessary or
appropriate in the public interest, to consider, in addition to the
protection of investors, whether the action will promote efficiency,
competition, and capital formation. See 15 U.S.C. 78c(f). In
addition, Exchange Act Section 23(a)(2) requires the Commission,
when making rules pursuant to the Exchange Act, to consider among
other matters the impact that any such rule would have on
competition and not to adopt any rule that would impose a burden on
competition that is not necessary or appropriate in furtherance of
the purposes of the Exchange Act. See 15 U.S.C. 78w(a)(2).
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This economic analysis begins with a discussion of the risks
inherent in the settlement cycle and how a reduction in the cycle's
length may affect the management and mitigation of these risks. Next,
it discusses market frictions that potentially impair the ability of
market participants to shorten the settlement cycle in the absence of a
Commission rule. These settlement cycle risks and market frictions
frame our subsequent analysis of the rule's benefits and costs. The
Commission preliminarily believes that the proposed amendment to
Exchange Act Rule 15c6-1(a) and the proposed deletion of Exchange Act
Rule 15c6-1(c) ameliorate some or all of these market frictions and
thus reduce the risks inherent in the settlement process.
The Commission preliminarily believes that, to successfully shorten
the settlement timeframes to T+1 while minimizing settlement fails in
the institutional trade processing environment, will require further
enhancing automation, standardization, and the percentage of trades
that are allocated, confirmed, and affirmed by the end of the trade
date.\287\ To this end the Commission is also proposing (i) new 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 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),\288\ (ii) an amendment to Rule 204-2
under the Advisers Act to require investment advisers that are parties
to agreements under Exchange Act Rule 15c6-2 to maintain a time stamped
record of confirmations received, and when allocations and affirmations
were sent to a broker or dealer,\289\ and (iii) new Rule 17Ad-27 under
the Exchange Act to require policies and procedures that require CMSPs
facilitate the ongoing development of operational and technological
improvements associated with institutional trade processing,
[[Page 10476]]
which may in turn also facilitate further shortening of the settlement
cycle in the future.\290\
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\287\ See supra Part III.B.2; infra Part V.C.
\288\ See supra Part III.B.
\289\ See supra Part III.C.
\290\ See supra Part III.D.
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The discussion of the economic effects of the proposed amendment to
Rule 15c6-1(a), the proposed deletion of Rule 15c6-1(c), the proposed
Rule 15c6-2, the proposed amendment to Rule 204-2, and the proposed
Rule 17Ad-27 begins with a baseline of current practices. The economic
analysis then discusses the likely economic effects of the proposal as
well as its effects on efficiency, competition, and capital formation.
The Commission has, where practicable, attempted to quantify the
economic effects expected to result from this proposal. In some cases,
however, data needed to quantify these economic effects is not
currently available or otherwise publicly available. As noted below,
the Commission is unable to quantify certain economic effects and
solicits comment, including estimates and data from interested parties,
that could help inform the estimates of the economic effects of the
proposal.
A. Background
As previously discussed, the proposed amendment to Rule 15c6-1(a)
would prohibit, unless otherwise expressly agreed to by both parties at
the time of the transaction, a broker-dealer from effecting or entering
into a contract for the purchase or sale of certain securities that
provides for payment of funds and delivery of securities later than the
first business day after the date of the contract subject to certain
exceptions provided in the rule. In its analysis of the economic
effects of the proposal, the Commission has considered the risks that
market participants, including broker-dealers, clearing agencies, and
institutional and retail investors are exposed to during the settlement
cycle and how those risks change with the length of the cycle.
The settlement cycle spans the time between when a trade is
executed and when cash and securities are delivered to the seller and
buyer, respectively. During this time, each party to a trade faces the
risk that its counterparty may fail to meet its obligations to deliver
cash or securities. When a counterparty fails to meet its obligations
to deliver cash or securities, the non-defaulting party may bear costs
as a result. For example, if the non-defaulting party chooses to enter
into a new transaction, it will be with a new counterparty and will
occur at a potentially different price.\291\ The length of the
settlement cycle influences this risk in two ways: (i) Through its
effect on counterparty exposures to price volatility, and (ii) through
its effect on the value of outstanding obligations.
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\291\ This applies to the general case of a transaction that is
not novated to a CCP. As described above, in its role as a CCP, NSCC
becomes counterparty to both initial parties to a centrally cleared
transaction. In the case of such transactions, while each initial
party is not exposed to the risk that its original counterparty
defaults, both are exposed to the risk of CCP default. Similarly,
the CCP is exposed to the risk that either initial party defaults.
---------------------------------------------------------------------------
First, additional time allows asset prices to move further away
from the price of the original trade. For example, in a simplified
model where daily asset returns are statistically independent, the
variance of an asset's return over t days is equal to t multiplied by
the daily variance of the asset's return. Thus when the daily variance
of returns is constant, the variance of returns increases linearly in
the number of days.\292\ In other words, the more days that elapse
between when a trade is executed and when a counterparty defaults, the
larger the variance of price change will be, and the more likely that
the asset's price will deviate from the execution price. The price
change could be positive or negative, but in the event of a price
increase, the buyer must pay more than the original execution price,
and in the event of a price decrease, the buyer may buy the security
for less than the original execution price.\293\
---------------------------------------------------------------------------
\292\ More generally, because total variance over multiple days
is equal to the sum of daily variances and variables related to the
correlation between daily returns, total variance increases with
time so long as daily returns are not highly negatively correlated.
See, e.g., Morris H. DeGroot, Probability and Statistics 216
(Addison-Wesley Publishing Co., 1986).
\293\ Similarly, a seller whose counterparty fails faces similar
risks with respect to the security price but in the opposite
direction.
---------------------------------------------------------------------------
Second, the length of the settlement cycle directly influences the
quantity of transactions awaiting settlement. For example, assuming no
change in transaction volumes, the volume of unsettled trades under a
T+1 settlement cycle is approximately half the volume of unsettled
trades under a T+2 settlement cycle.\294\ Thus, in the event of a
default, counterparties would have to enter into a new transaction, or
otherwise close out approximately half as many trades under a T+1
standard settlement cycle than under a T+2 standard. This means that
for a given adverse move in prices, the financial losses resulting from
a counterparty default will be approximately half as large under a T+1
standard settlement cycle.
---------------------------------------------------------------------------
\294\ The relationship is approximate because some trades may
settle early or, if both counterparties agree at the time of the
transaction, settle after the time limit in Rule 15c6-1(a).
---------------------------------------------------------------------------
Market participants manage and mitigate settlement risk in a number
of specific ways.\295\ Generally, these methods entail costs to market
participants. In some cases, these costs may be explicit. For instance,
clearing brokers typically explicitly charge introducing brokers to
clear trades. Other costs are implicit, such as the opportunity cost of
assets posted as collateral or limits placed on the trading activities
of a broker's customers.
---------------------------------------------------------------------------
\295\ See T+2 Proposing Release, supra note 30, at 69251
(discussing the entities that compose the clearance and settlement
infrastructure for U.S. securities markets).
---------------------------------------------------------------------------
The Commission acknowledges that, given current trading volumes and
complexity, certain market frictions may prevent securities markets
from shortening the settlement cycle in the absence of regulatory
intervention. The Commission has considered two key market frictions
related to investments required to implement a shorter settlement
cycle. The first is a coordination problem that arises when some of the
benefits of actions taken by one or more market participants are only
realized when other market participants take a similar action. For
example, under the current regulatory structure, if a particular
institutional investor were to make a technological investment to
reduce the time it requires to match and allocate trades without a
corresponding action by its clearing broker-dealers, the institutional
investor cannot fully realize the benefits of its investment, as the
settlement process is limited by the capabilities of the clearing
agency for trade matching and allocation. More generally, when every
market participant must bear the costs of an upgrade for the entire
market to enjoy a benefit, the result is a coordination problem, where
each market participant may be reluctant to make the necessary
investments until it can be reasonably certain that others will also do
so. In general, these coordination problems may be resolved if all
parties can credibly commit to the necessary infrastructure
investments. Regulatory intervention is one possible way of
coordinating market participants to undertake the investments necessary
to support a shorter settlement cycle. Such intervention could come
through Commission rulemaking or through a coordinated set of SRO rule
changes.
In addition to coordination problems, a second market friction
related to the settlement cycle involves situations where one market
participant's
[[Page 10477]]
investments result in benefits for other market participants. For
example, if a market participant invests in a technology that reduces
the error rate in its trade matching, not only does it benefit from
fewer errors, but its counterparties and other market participants may
also benefit from more robust trade matching. However, because market
participants do not necessarily take into account the benefits that may
accrue to other market participants (also known as ``externalities'')
when market participants choose the level of investment in their
systems, the level of investment in technologies that reduce errors
might be less than efficient for the entire market. More generally,
underinvestment may result because each participant only takes into
account its own costs and benefits when choosing which infrastructure
improvements or investments to make, and does not take into account the
costs and benefits that may accrue to its counterparties, other market
participants, or financial markets generally.
Moreover, because market participants that incur similar costs to
move to a shorter settlement cycle may nevertheless experience
different levels of economic benefits, there is likely heterogeneity
across market participants in the demand for a shorter settlement
cycle. This heterogeneity may exacerbate coordination problems and
underinvestment. Market participants that do not expect to receive
direct benefits from settling transactions earlier may lack incentives
to invest in infrastructure to support a shorter settlement cycle and
thus could make it difficult for the market as a whole to realize the
overall risk reduction that the Commission believes a shorter
settlement cycle may bring.
For example, the level and nature of settlement risk exposures vary
across different types of market participants. A market participant's
characteristics and trading strategies can influence the level of
settlement risk it faces. For example, large market participants will
generally be exposed to more settlement risk than small market
participants because they trade in larger volume. However, large market
participants also trade across a larger variety of assets and may face
less idiosyncratic risk in the event of counterparty default if the
portfolio of trades that may have to be replaced is diversified.\296\
As a corollary, a market participant who trades a single security in a
single direction against a given counterparty may face more
idiosyncratic risk in the event of counterparty failure than a market
participant who trades in both directions with that counterparty.
---------------------------------------------------------------------------
\296\ See Ananth Madhavan et al., Risky Business: The Clearance
and Settlement of Financial Transactions 4-5 (U. Pa. Wharton Sch.
Rodney L. White Ctr. for Fin. Res. Working Paper No. 40-88, 1988),
https://rodneywhitecenter.wharton.upenn.edu/wp-content/uploads/2014/04/8840.pdf; see also John H. Cochrane, Asset Pricing 15 (Princeton
Univ. Press rev. ed. 2009) (defining the idiosyncratic component of
any payoff as the part that is uncorrelated with the discount
factor).
---------------------------------------------------------------------------
Furthermore, the extent to which a market participant experiences
any economic benefits that may stem from a shortened standard
settlement cycle likely depends on the market participant's relative
bargaining power. While larger intermediaries may experience direct
benefits from a shorter settlement cycle as a result of being required
to post less collateral with a CCP, if they do not effectively compete
for customers through fees and services as a result of market power,
they may pass only a portion of these cost savings through to their
customers.\297\
---------------------------------------------------------------------------
\297\ See infra Parts V.C.1 (Benefits) and V.C.2 (Costs).
---------------------------------------------------------------------------
The Commission preliminarily believes that the proposed amendment
to Rule 15c6-1(a), which would shorten the standard settlement cycle
from T+2 to T+1 may mitigate the market frictions of coordination and
underinvestment described above. The Commission believes that by
mitigating these market frictions and for the reasons discussed below,
the transition to a shorter standard settlement cycle will reduce the
risks inherent in the clearance and settlement process.
The shorter standard settlement cycle might also affect the level
of operational risk in the National C&S System. Shortening the
settlement cycle by one day would reduce the time that market
participants have to resolve any errors that might occur in the
clearance and settlement process. Tighter operational timeframes and
linkages required under a shorter standard settlement cycle might
introduce new fragility that could affect market participants,
specifically an increased risk that operational issues could affect
transaction processing and related securities settlement.\298\
---------------------------------------------------------------------------
\298\ For example, the ability to compute an accurate net asset
value (``NAV'') within the settlement timeframe is a key component
for settlement of ETF transactions. See, e.g., Barrington Partners
White Paper, An Extraordinary Week: Shared Experiences from Inside
the Fund Accounting Systems Failure of 2015 (Nov. 2015), https://www.mfdf.org/docs/default-source/fromjoomla/uploads/blog_files/sharedexperiencefromfasystemfailure2015.pdf.
---------------------------------------------------------------------------
In part to lessen the likelihood that shortening the settlement
cycle might negatively affect operational risk, the Commission and
market participants have emphasized on multiple occasions the
importance of accelerating the institutional trade clearance and
settlement process by improving, among other things, the allocation,
confirmation and affirmation processes for the clearance and settlement
of institutional trades, as well as improvements to the provision of
central matching and electronic trade confirmation.\299\ A 2010 DTCC
paper published when the standard settlement cycle in the U.S. was
still T+3, described same-day affirmation as ``a prerequisite'' of
shortening the settlement cycle because of its impact on settlement
failure rates and operational risk.\300\ According to previously cited
statistics published by DTCC in 2011 regarding affirmation rates
achieved through industry utilization of a certain matching/ETC
provider, on average, 45% of trades were affirmed on trade date, 90%
were affirmed by T+1, and 92% were affirmed by noon on T+2.\301\
Currently, only about 68% of trades achieve affirmation by 12:00
midnight at the end of trade date.\302\ While these numbers have
improved over time, the improvements have been incremental and fallen
short of achieving an affirmed confirmation by the end of trade date as
is considered a securities industry best practice.\303\ Accordingly,
and as described more fully below, to achieve the maximum efficiency
and risk reduction that may result from completing the allocation,
confirmation and affirmation process on trade date, and to facilitate
shortening the settlement cycle to T+1 or shorter, the Commission is
proposing new Rule 15c6-2 under the Exchange Act to facilitate trade
date completion of institutional trade allocations, confirmations and
affirmations.
---------------------------------------------------------------------------
\299\ See supra Part III.B; see also supra notes 146-148 and
accompanying text.
\300\ See supra note 155.
\301\ See supra note 156.
\302\ See supra note 157.
\303\ See supra note 57.
---------------------------------------------------------------------------
B. Economic Baseline and Affected Parties
The Commission uses as its economic baseline the clearance and
settlement process as it exists at the time of this proposal. In
addition to the current process that is described in Part II.B above,
the baseline includes rules adopted by the Commission, including
Commission rules governing the clearance and settlement system, SRO
[[Page 10478]]
rules,\304\ as well as rules adopted by regulators in other
jurisdictions to regulate securities settlement in those jurisdictions.
The following section discusses several additional elements of the
baseline that are relevant for the economic analysis of the proposed
amendment to Rule 15c6-1(a) because they are related to the financial
risks faced by market participants that clear and settle transactions
and the specific means by which market participants manage these risks.
---------------------------------------------------------------------------
\304\ Certain SRO rules currently define ``regular way''
settlement as occurring on T+2 and, as such, would need to be
amended in connection with shortening the standard settlement cycle
to T+1. See, e.g., MSRB Rule G-12(b)(ii)(B); FINRA Rule 11320(b).
Further, certain timeframes or deadlines in SRO rules key off the
current settlement date, either expressly or indirectly. In such
cases, the SROs may also need to amend these rules. See supra Part
III.E.5 (further discussing the impact of the proposal on SRO rules
and operations).
---------------------------------------------------------------------------
1. Central Counterparties
NSCC, a subsidiary of DTCC, is a clearing agency registered with
the Commission that operates the CCP for U.S. equity securities
transactions.\305\ One way that NSCC mitigates the credit, market, and
liquidity risk that it assumes through its novation and guarantee of
trades as a CCP is by multilateral netting of securities trades'
delivery and payment obligations across its members. By offsetting its
members' obligations, NSCC reduces the aggregate market value of
securities and cash it must deliver to clearing members. While netting
reduces NSCC's settlement payment obligations by a daily average of
98%,\306\ it does not fully eliminate the risk posed by unsettled
trades because NSCC is responsible for payments or deliveries on any
trades that it cannot fully net. NSCC reported clearing an average of
approximately $2.251 trillion each day during the first quarter of
2021,\307\ suggesting an average net settlement obligation of
approximately $45 billion each day.\308\
---------------------------------------------------------------------------
\305\ A second DTCC subsidiary, DTC, also a clearing agency
registered with the Commission, operates a CSD with respect to
securities transactions in the U.S. in several types of eligible
securities including, among others, equities, warrants, rights,
corporate debt and notes, municipal bonds, government securities,
asset-backed securities, depositary receipts and money market
instruments.
\306\ See supra note 62.
\307\ See NSCC, Q1 2021 Fixed Income Clearing Corporation and
NSCC Quantitative Disclosure for Central Counterparties, at 20 (June
2021), http://www.dtcc.com/legal/policy-and-compliance.
\308\ Calculated as $2.251 trillion x 2% = $45.02 billion.
---------------------------------------------------------------------------
The aggregate settlement risk faced by NSCC is also a function of
the probability of clearing member default. NSCC manages the risk of
clearing member default by imposing certain financial responsibility
requirements on its members. For example, as of 2021, broker-dealer
members of NSCC that are not municipal securities brokers and do not
intend to clear and settle transactions for other broker-dealers must
have excess net capital of $500,000 over the minimum net capital
requirement imposed by the Commission and $1,000,000 over the minimum
net capital requirement if the broker-dealer member clears for other
broker-dealers.\309\ Furthermore, each NSCC member is subject to other
ongoing membership requirements, including a requirement to furnish
NSCC with assurances of the member's financial responsibility and
operational capability, including, but not limited to, periodic reports
of its financial and operational condition.\310\
---------------------------------------------------------------------------
\309\ For a description of NSCC's financial responsibility
requirements for registered broker-dealers, see NSCC Rules and
Procedures, at 336 (effective Jan. 24, 2022) (``NSCC Rules and
Procedures''), https://www.dtcc.com/~/media/Files/Downloads/legal/
rules/nscc_rules.pdf. Pursuant to Rule 11 and Addendum K to NSCC's
Rules and Procedures, NSCC guarantees the completion of CNS settling
trades (``NSCC trade guaranty'') that have been validated. Id. at
74-79, 363.
\310\ See, e.g., id. at 89.
---------------------------------------------------------------------------
In addition to managing the member default risk, NSCC also takes
steps to mitigate the impacts of a member default. For example, in the
normal course of business, CCPs are generally not exposed to market or
liquidity risk because they expect to receive every security from a
seller they are obligated to deliver to a buyer and they expect to
receive every payment from a buyer that they are obligated to deliver
to a seller. However, when a clearing member defaults, the CCP can no
longer expect the defaulting member to deliver securities or make
payments. CCPs mitigate this risk by requiring clearing members to make
contributions of financial resources to the CCP so that it may make
payments or deliver securities in the event of a member default. The
level of financial resources CCPs require clearing members to commit
may be based on, among other things, the market and liquidity risk of a
member's portfolio, the correlation between the assets in the member's
portfolio and the member's own default probability, and the liquidity
of the assets posted as collateral.
2. Market Participants--Investors, Broker-Dealers, and Custodians
As discussed in Part II.B, broker-dealers serve both retail and
institutional customers. Aggregate statistics from the Board of
Governors of the Federal Reserve System suggest that at the end of the
second quarter 2021, U.S. households held approximately 40% of the
value of corporate equity outstanding, and 57% of the value of mutual
fund shares outstanding, which provide a general picture of the share
of holdings by retail investors.\311\
---------------------------------------------------------------------------
\311\ See Board of Governors of the Federal Reserve System,
Statistical Release Z.1, Financial Accounts of the United States:
Flow of Funds, Balance Sheets, and Integrated Macroeconomic
Accounts, at 130 (Sept. 23, 2021), available at https://www.federalreserve.gov/releases/z1/20210923/z1.pdf.
---------------------------------------------------------------------------
In the third quarter of 2021, approximately 3,500 broker-dealers
filed FOCUS Reports \312\ with FINRA. These firms varied in size, with
median assets of approximately $1.3 million and average assets of
approximately $1.5 billion. The top 1% of broker-dealers held 81% of
the assets of broker-dealers overall, indicating a high degree of
concentration in the industry. Of the approximately 3,500 filers, as of
the end of 2020, 156 reported self-clearing public customer accounts,
while 1,126 reported acting as an introducing broker and sending orders
to another broker-dealer for clearing and not self-clearing. Broker-
dealers that identified themselves as self-clearing broker-dealers, on
average, had higher total assets than broker-dealers that identified
themselves as introducing broker-dealers. While the decision to self-
clear may be based on many factors, this evidence is consistent with
the argument that there may currently be high barriers to entry for
providing clearing services as a broker-dealer.
---------------------------------------------------------------------------
\312\ FOCUS Reports, or ``Financial and Operational Combined
Uniform Single'' Reports, are monthly, quarterly, and annual reports
that broker-dealers generally are required to file with the
Commission and/or SROs pursuant to Exchange Act Rule 17a-5, 17 CFR
240.17a-5.
---------------------------------------------------------------------------
Clearing broker-dealers face liquidity risks as they are obligated
to make payments to clearing agencies on behalf of customers who
purchase securities. As discussed in more detail below, because
customers of a clearing broker may default on their payment obligations
to the broker, particularly when the price of a purchased security
declines before settlement, clearing broker-dealers routinely seek to
reduce the risks posed by their customers. For example, clearing
broker-dealers may require customers to contribute financial resources
in the form of margin to margin accounts, to pre-fund purchases in cash
accounts, or may restrict the use of customers' unsettled funds. These
measures are in many ways analogous to measures taken by clearing
agencies to reduce and mitigate the risks posed by their clearing
members. In addition, clearing broker-dealers may also mitigate the
risks
[[Page 10479]]
posed by customers by charging higher transaction fees that reflect the
value of the customer's option to default, thereby causing customers to
internalize the cost of default that is inherent in the settlement
process.\313\ While not directly reducing the risk posed by customers
to clearing members, these higher transaction fees at least allocate to
customers a portion of the expected direct costs of customer default.
---------------------------------------------------------------------------
\313\ See infra Parts V.C.2 and V.C.4.
---------------------------------------------------------------------------
Another way the settlement cycle may affect transaction prices
involves the potential use of funds during the settlement cycle. To the
extent that buyers may use the cash to purchase securities during the
settlement cycle for other purposes, they may derive value from the
length of time it takes to settle a transaction. Testing this
hypothesis, studies have found that sellers demand compensation for the
benefit that buyers receive from deferring payment during the
settlement cycle and that this compensation is incorporated in equity
returns.\314\
---------------------------------------------------------------------------
\314\ See Victoria Lynn Messman, Securities Processing: The
Effects of a T+3 System on Security Prices (May 2011) (Ph.D.
dissertation, University of Tennessee--Knoxville), http://trace.tennessee.edu/utk_graddiss/1002/; Josef Lakonishok & Maurice
Levi, Weekend Effects on Stock Returns: A Note, 37 J. Fin. 883
(1982), https://www.jstor.org/stable/pdf/2327716.pdf; Ramon P.
DeGennaro, The Effect of Payment Delays on Stock Prices, 13 J. Fin.
Res. 133 (1990), http://onlinelibrary.wiley.com/doi/10.1111/j.1475-6803.1990.tb00543.x/abstract.
---------------------------------------------------------------------------
The settlement process also exposes investors to certain risks. The
length of the settlement cycle sets the minimum amount of time between
when an investor places an order to sell securities and when the
customer can expect to have access to the proceeds of that sale.
Investors take this into account when they plan transactions to meet
liquidity needs. For example, under T+2 settlement, investors who
experience liquidity shocks, such as unexpected expenses that must be
met within one day, could not rely on obtaining funding solely through
a sale of securities because the proceeds of the sale would not
typically be available until the end of the second day after the sale.
One possible strategy to deal with such a shock under T+2 settlement
would be to borrow to meet payment obligations on day T+1 and repay the
loan on the following day with the proceeds from a sale of securities,
incurring the cost of one day of interest. Another strategy that
investors may use is to hold financial resources to insure themselves
from liquidity shocks.
3. Investment Companies and Investment Advisers
Shares issued by investment companies may settle on different
timeframes. ETFs, certain closed-end funds, and mutual funds that are
sold by brokers generally settle on T+2.\315\ By contrast, mutual fund
shares that are directly purchased from the fund generally settle on
T+1. Mutual funds that settle on a different basis than the underlying
investments currently face liquidity risk as a result of a mismatch
between the timing of mutual fund share transaction settlement and the
timing of fund portfolio security transaction order settlements. Mutual
funds may manage these particular liquidity needs by, among other
methods, using cash reserves, back-up lines of credit, or interfund
lending facilities to provide cash to cover the settlement
mismatch.\316\ As of the end of 2020, there were 11,323 open-end funds
(including money market funds and ETFs).\317\ The assets of these funds
were approximately $29.3 trillion.\318\ Of the 11,323 funds noted,
2,296 were ETFs with combined assets of $5.5 trillion.\319\
---------------------------------------------------------------------------
\315\ See supra note 84.
\316\ See Open-End Fund Liquidity Risk Management Programs;
Swing Pricing; Re-Opening of Comment Period for Investment Company
Reporting Modernization Release, Investment Company Act Release No.
31835 (Sept. 22, 2015), 80 FR 62274, 62285 n.100 (Oct. 15, 2015).
\317\ See ICI, 2021 Investment Company Fact Book, at 40 (May
2021) (``2021 ICI Fact Book''), available at https://www.ici.org/.
This comprises 9,027 open-end mutual funds, including mutual funds
that invest primarily in other mutual funds, and 2,296 ETFs,
including ETFs that invest primarily in other ETFs.
\318\ See id. at 41.
\319\ See id. at 40-41.
---------------------------------------------------------------------------
Under Section 22(e) of the Investment Company Act, an open-end fund
generally is required to pay shareholders who tender shares for
redemption within seven days of their tender.\320\ Open-end fund shares
that are sold through broker-dealers must be redeemed within two days
of a redemption request because broker-dealers are subject to Rule
15c6-1(a).
---------------------------------------------------------------------------
\320\ 15 U.S.C. 80a-22(e).
---------------------------------------------------------------------------
Furthermore, Rule 22c-1 under the Investment Company Act,\321\ the
``forward pricing'' rule, requires funds, their principal underwriters,
and dealers to sell and redeem fund shares at a price based on the
current NAV next computed after receipt of an order to purchase or
redeem fund shares, even though cash proceeds from purchases may be
invested or fund assets may be sold in subsequent days in order to
satisfy purchase requests or meet redemption obligations.
---------------------------------------------------------------------------
\321\ 17 CFR 270.22c-1.
---------------------------------------------------------------------------
Based on Investment Adviser Registration Depository data as of
December 2020, approximately 13,804 advisers registered with the
Commission are required to maintain copies of certain books and records
relating to their advisory business. The Commission further estimates
that 2,521 registered advisers required to maintain copies of certain
books and records relating to their advisory business would not be
required to make and keep the proposed required records because they do
not have any institutional advisory clients.\322\ Therefore, the
remaining 11,283 of these advisers, or 81.74% of the total registered
advisers required to maintain copies of certain books and records
relating to their advisory business, would enter a contract with a
broker or dealer under proposed Rule 15c6-2 and therefore be subject to
the related proposed amendment to Rule 204-2 under the Advisers Act
(i.e., to retain copies of confirmations 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).
---------------------------------------------------------------------------
\322\ See infra note 425.
---------------------------------------------------------------------------
4. Current Market for Clearance and Settlement Services
As described in Part II.B, two affiliated entities, NSCC and DTC,
facilitate clearance and settlement activities in U.S. securities
markets in most instances. There is limited competition in the
provision of the services that these entities provide. NSCC is the CCP
for trades between broker-dealers involving equity securities,
corporate and municipal debt, and UITs for the U.S. market. DTC is the
CSD that provides custody and book-entry transfer services for the vast
majority of securities transactions in the U.S. market involving
equities, corporate and municipal debt, money market instruments, ADRs,
and ETFs. 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, thereby creating binding terms.\323\ As discussed
further in Part III.D, FINRA currently requires broker-dealers to use a
clearing agency, such as DTC or a CMSP, or a qualified vendor under the
[[Page 10480]]
rule to complete delivery-versus-payment transactions with their
customers.\324\
---------------------------------------------------------------------------
\323\ See supra Part II.B.1; see also T+2 Proposing Release,
supra note 30, at 69246.
\324\ See supra note 181 and accompanying text.
---------------------------------------------------------------------------
Broker-dealers compete to provide services to retail and
institutional customers. Based on the large number of broker-dealers,
there is likely a high degree of competition among broker-dealers.
However, the markets that broker-dealers serve may be segmented along
lines relevant for the analysis of competitive effects of the proposed
amendment to Rule 15c6-1(a). As noted above, the number of broker-
dealers that self-clear public customer accounts is smaller than the
set of broker-dealers that introduce and do not self-clear. This could
mean that introducing broker-dealers compete more intensively for
customers than clearing broker-dealers. Further, clearing broker-
dealers must meet requirements set by NSCC and DTC, such as financial
responsibility requirements and clearing fund requirements. These
requirements represent barriers to entry for brokers that may wish to
become clearing broker-dealers, limiting competition among such
entities.
Competition for customers affects how the costs associated with the
clearance and settlement process are allocated among market
participants. In managing the expected costs of risks from their
customers and the costs of compliance with SRO and Commission rules,
clearing broker-dealers decide what fraction of these costs to pass
through to their customers in the form of fees and margin requirements,
and what fraction of these costs to bear themselves. The level of
competition that a clearing broker-dealer faces for customers will
dictate the extent to which it is able to pass these costs through to
its customers.
In addition, several factors affect the current levels of
efficiency and capital formation in the various functions that make up
the market for clearance and settlement services. First, at a general
level, market participants occupying various positions in the clearance
and settlement system must post or hold liquid financial resources, and
the level of these resources is a function of the length of the
settlement cycle. For example, NSCC collects clearing fund
contributions from members to help ensure that it has sufficient
financial resources in the event that one of its members defaults on
its obligations to NSCC. As discussed above, the length of the
settlement cycle is one determinant of the size of NSCC's exposure to
clearing members. As another example, mutual funds may manage liquidity
needs by, among other methods, using cash reserves, back-up lines of
credit, or interfund lending facilities to provide cash. These
liquidity needs, in turn, are related to the mismatch between the
timing of mutual fund transaction order settlements and the timing of
fund portfolio security transaction order settlements.
Holding liquid assets solely for the purpose of mitigating
counterparty risk or liquidity needs that arise as part of the
settlement process could represent an allocative inefficiency. That is,
because firms that are required to hold these assets might prefer to
put them to alternative uses and because these assets may be more
efficiently allocated to other market participants who value them for
their fundamental risk and return characteristics rather than for their
value as collateral. To the extent that any intermediaries between
buyer and seller who facilitate clearance and settlement of the trade
bear costs as a result of inefficient allocation of collateral assets,
these inefficiencies may be reflected in higher transaction costs.
The settlement cycle may also have more direct impacts on
transaction costs. As noted above, clearing broker-dealers may charge
higher transaction fees to reflect the value of the customer's option
to default and these fees may cause customers to internalize the cost
of the default options inherent in the settlement process. However,
these fees also make transactions more costly and may influence the
willingness of market participants to efficiently share risks or to
supply liquidity to securities markets. Taken together, inefficiencies
in the allocation of resources and risks across market participants may
serve to impair capital formation.
Finally, market participants may make processing errors in the
clearance and settlement process.\325\ Market participants have stated
that manual processing and a lack of automation result in processing
errors.\326\ Although some of these errors may be resolved within the
settlement cycle and not result in a failed trade, those that are not
may result in failed trades, which appear in the failure to deliver
data.\327\ Further, market participants may incorporate the likelihood
that processing errors result in delays in payments or deliveries into
securities prices.\328\
---------------------------------------------------------------------------
\325\ See, e.g., Omgeo Study, supra note 155, at 12; see also
T+1 Report, supra note 18, at 26.
\326\ Matthew Stauffer, Managing Director, Head of Institutional
Trade Processing at DTCC, stated, ``The findings of our survey
highlight the benefits of leveraging automated post-trade solutions
to reduce the costs of operational functions and the risk inherent
in manual processes.'' 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;
\327\ See Statement by The Depository Trust & Clearing
Corporation, U.S. Securities and Exchange Commission Securities
Lending and Short Sales Roundtable, at 3 (Sept. 30, 2009), https://www.sec.gov/comments/4-590/4590-32.pdf; see also T+1 Report, supra
note 18, at 26.
\328\ See Messman, supra note 314.
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Figure 5 shows total fails to deliver in shares by month from
January 2016 through November 2021. The change in the U.S. settlement
cycle from T+3 to T+2 became effective in September 2017. Although
processing errors are only one reason a trade may result in a fail to
deliver, there is no marked change in the fails data around the
previous shortening of the settlement cycle.
[[Page 10481]]
[GRAPHIC] [TIFF OMITTED] TP24FE22.004
C. Analysis of Benefits, Costs, and Impact on Efficiency, Competition,
and Capital Formation
1. Benefits
The proposed amendment and new rules would likely yield benefits
associated with the reduction of risk in the settlement cycle. By
shortening the settlement cycle, the proposed amendment would reduce
both the aggregate market value of all unsettled trades and the amount
of time that CCPs or the counterparties to a trade may be subject to
market and credit risk from an unsettled trade.\329\ First, holding
transaction volumes constant, the market value of transactions awaiting
settlement at any given point in time under a T+1 settlement cycle will
be approximately one half lower than under the current T+2 settlement
cycle. Using the risk mitigation framework described in Part V.B.1,
based on published statistics from the first quarter of 2021 \330\ and
holding average dollar volumes constant, the aggregate notional value
of unsettled transactions at NSCC would fall from nearly $90 billion to
approximately $45 billion.\331\
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\329\ See supra Part III.A.2.
\330\ See supra note 307, at 14.
\331\ See id. at 20.
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Second, a market participant that experiences counterparty default
and enters into a new transaction under a T+2 settlement cycle is
exposed to more market risk than would be the case under a T+1
settlement cycle. As a result, market participants that are exposed to
market, credit, and liquidity risks would be exposed to less risk under
a T+1 settlement cycle. This reduction in risk may also extend to
mutual fund transactions conducted with broker-dealers that currently
settle on a T+2 basis.\332\ To the extent that these transactions
currently give rise to counterparty risk exposures between mutual funds
and broker-dealers, these exposures may decrease as a consequence of a
shorter settlement cycle. In addition, a shorter standard settlement
cycle would reduce liquidity risks that could arise by allowing
investors to obtain the proceeds of securities transactions sooner.
These risks affect all market participants, are difficult to diversify
away, and require resources to manage and mitigate.
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\332\ In today's environment, ETFs and certain closed-end funds
clear and settle on a T+2 basis. Open-end funds (i.e., mutual funds)
generally settle on a T+1 basis, except for certain retail funds
which typically settle on T+2. Thus, the proposed amendment to Rule
15c6-1(a) would require ETFs, closed-end funds, and mutual funds
settling on a T+2 basis to revise their settlement timeframes.
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CCPs require clearing members to post financial resources in order
to secure members' obligations to deliver cash and securities to the
CCP. Clearing members in turn impose fees on their customers, e.g.,
introducing broker-dealers, institutional investors, and retail
investors. The margin requirements required by the CCP are a function
of the risk posed to the CCP by the potential default of the clearing
member. That risk is a function of several factors including the value
of trades submitted for clearing but not yet settled and the volatility
of the securities prices that make up those unsettled trades. As these
factors are an increasing function of the time to settlement, by
reducing settlement from T+2 to T+1, a CCP may require less collateral
from its members, and the CCP's members may, in turn, reduce fees that
they may pass down to other market participants, including introducing
broker-dealers, institutional investors, and retail investors.
Any reduction in clearing broker-dealers' required margin would
provide multiple benefits. First, financial resources that are used to
mitigate the risks of the clearance and settlement process can be put
to alternative uses. Reducing the financial risks associated with the
overall clearance and settlement process would reduce the amount of
collateral required to mitigate these risks, which would reduce the
costs that market participants bear to manage and mitigate these risks
and the allocative inefficiencies that may stem
[[Page 10482]]
from risk management practices.\333\ Second, assets that are valuable
because they are particularly suited to meeting financial resource
obligations may be better allocated to market participants that hold
these assets for their fundamental risk and return characteristics.
This improvement in allocative efficiency may improve capital
formation.
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\333\ See supra Part V.B (further discussing financial resources
collected to mitigate and manage financial risks).
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A portion of the savings from less costly risk management under a
T+1 standard settlement cycle relative to a T+2 standard settlement
cycle may flow through to investors. Investors may be able to
profitably redeploy financial resources that were once needed to fund
higher clearing fees, for example.
Market participants might also individually benefit through reduced
clearing fund deposit requirements. In 2012, the BCG Study estimated
that cost reductions related to reduced clearing fund contributions
resulting from moving from a T+3 to a T+2 settlement cycle would amount
to $25 million per year.\334\ In addition, a shorter settlement cycle
might reduce liquidity risk by allowing investors to obtain the
proceeds of their securities transactions sooner. Reduced liquidity
risk may be a benefit to individual investors, but it may also reduce
the volatility of securities markets by reducing liquidity demands in
times of adverse market conditions, potentially reducing the
correlation between market prices and the risk management practices of
market participants.\335\
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\334\ See BCG Study, supra note 22, at 10. According to SIFMA,
average daily trading volume in U.S. equities grew from $253.1B in
2011 to $564.7B in 2021, an increase of 123%. See CBOE Exchange,
Inc., and SIFMA, US Equities and Related Statistics (Jan. 3, 2022),
https://www.sifma.org/resources/research/us-equity-and-related-securities-statistics/us-equities-and-related-statistics-sifma/.
Price volatility, as measured by the standard deviation of the
price, is concave in time, which means that as a period of time
increases, volatility will increase, but at a decreasing rate. This
suggests that the reduction in price volatility from moving from T+2
settlement to T+1 settlement is larger than the reduction in price
volatility from moving from T+3 settlement to T+2 settlement. These
two facts suggest that the estimated reduction in clearing fund
contributions would be more than $25 million per year.
\335\ See Peter F. Christoffersen & Francis X. Diebold, How
Relevant is Volatility Forecasting for Financial Risk Management?,
82 Rev. Econ. & Stat. 12 (2000), http://www.mitpressjournals.org/doi/abs/10.1162/003465300558597#.V6xeL_nR-JA. The paper shows that
volatility can be predicted in the short run, and concludes that
short run forecastable volatility would be useful for risk
management practices.
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Shortening the settlement cycle may reduce incentives for investors
to trade excessively in times of high volatility.\336\ Such incentives
exist because investors do not always bear the full cost of settlement
risk for their trades. Broker-dealers incur costs in managing
settlement risk with CCPs. Broker-dealers can recover the average cost
of risk management from their customers. However, if a particular trade
has above-average settlement risk, such as when market prices are
unusually volatile, it is difficult for broker-dealers to pass along
these higher costs to their customers because fees typically depend on
factors other than those such as market volatility that impact
settlement risk. In extreme cases broker-dealers may prevent a customer
from trading.\337\ Shortening the settlement cycle reduces the cost of
risk management and should reduce any such incentives to trade more
than they otherwise would if they bore the full cost of settlement risk
for their trades.
---------------------------------------------------------------------------
\336\ See Sam Schulhofer-Wohl, Externalities in securities
clearing and settlement: Should securities CCPs clear trades for
everyone? (Fed. Res. Bank Chi. Working Paper No. 2021-02, 2021).
\337\ This occurred in January 2021 following heightened
interest in certain ``meme'' stocks. See supra Part II.A; see also
Staff Report on Equity and Options Market Structure Conditions in
Early 2021, at 31-35 (Oct. 14, 2021), https://www.sec.gov/files/staff-report-equity-options-market-struction-conditions-early-2021.pdf.
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The benefits of harmonized settlement cycles may also accrue to
mutual funds. As described above,\338\ transactions in mutual fund
shares typically settle on a T+1 basis even when transactions in their
portfolio securities settle on a T+2 basis. As a result, there is a
one-day mismatch between when these funds make payments to shareholders
that redeem shares and when they receive cash proceeds for portfolio
securities they sell. This mismatch represents a source of liquidity
risk for mutual funds. Shortening the settlement cycle by one day will
mitigate the liquidity risk due to this mismatch. As a result, mutual
funds that settle on a T+1 basis may be able to reduce the size of cash
reserves or the size of back up credit facilities that some currently
use to manage liquidity risk from the mismatch in settlement cycles.
Further, mutual funds may be able to invest incoming cash more quickly
when funds have net subscriptions, because the settlement time for the
purchase of fund shares will be aligned with the settlement time for
portfolio investments, thus allowing funds to maximize their exposure
to their defined investment strategies.
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\338\ See supra note 332; see also supra Part V.B.3.
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The Commission preliminarily believes that these benefits are
unlikely to be substantially mitigated by the exceptions to Rule 15c6-
1(a) discussed in Part III.A. Market participants that rely on Rule
15c6-1(b) in order to transact in limited partnership interests that
are not listed on an exchange or for which quotations are not
disseminated through an automated quotation system of a registered
securities association would likely continue to rely on the exception
if the Commission adopts the proposed amendment to Rule 15c6-1(a).
There may be transactions covered by Rule 15c6-1(b) that in the past
did not make use of this exception because they settled within two
business days, but that may require use of this exception under the
proposed amendment to paragraph (a) of the rule because they require
more than one business day to settle. However, these markets are opaque
and the Commission does not have data on transactions in these
categories that currently settle within two days but that might make
use of this exception under the proposed amendment to Rule 15c6-1(a).
In addition, 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.\339\ Market participants relying
on this exemption are unlikely to be impacted by a shortening of the
standard settlement cycle to T+1.
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\339\ See supra note 90 and accompanying text.
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Finally, the extent to which different types of market participants
would experience any benefits that stem from the proposed amendment to
Rule 15c6-1(a) may depend on their market power. As discussed
above,\340\ the clearance and settlement system involves a number of
intermediaries that provide a range of services between the ultimate
buyer and seller of a security. Those market participants that have a
greater ability to negotiate with customers or service providers may be
able to retain a larger portion of the operational cost savings from a
shorter settlement cycle than others, as they may be able to use their
market power to avoid passing along the cost savings to their clients.
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\340\ See supra Part II.B.
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The Commission also proposes to delete Rule15c6-1(c) that
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.\341\
As discussed above, 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
[[Page 10483]]
(c).\342\ The Commission preliminarily believes that 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. 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. Further, should
there be a need to settle beyond T+1, perhaps because of complex
documentation requirements of certain types of offerings, the parties
to the transaction can agree to a longer settlement period pursuant to
paragraph (d) when they enter the transaction.
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\341\ See supra Part III.A.3.
\342\ T+1 Report, supra note 18, at 33-35.
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In addition to the amendment to Rule 15c6-1(a) and proposed
deletion of Rule 15c6-1(c), 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. First, the Commission proposes new Rule
15c6-2 to require that a broker-dealer enter into contracts with
institutional customers that can achieve the allocation, confirmation,
and affirmation of a securities transaction no later than the end of
trade date.\343\
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\343\ See supra Part III.B.1.
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The Commission preliminarily believes that implementing a T+1
standard settlement cycle, as well as any potential further shortening
beyond T+1, will necessitate significant increases in same-day
affirmation rates because timely affirmations will be critical to
achieving timely settlement. In this way, the Commission also
preliminarily believes that proposed Rule 15c6-2 should facilitate
timely settlement as a general matter because it will accelerate the
transmission and affirmation of trade data to trade date, improving the
accuracy and efficiency of institutional trade processing and reducing
the potential for settlement failures. The Commission further
anticipates that proposed Rule 15c6-2 would likely encourage further
development of automated and standardized practices among market
participants more generally, particularly those that continue to rely
on manual processes to achieve settlement.
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.
Market participants continue to use hundreds of ``local'' matching
platforms, and rely on inconsistent SSI data independently maintained
by broker-dealers, investment managers, custodians, sub-custodians, and
agents on separate databases. 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.\344\ 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. The total industry headcount
employed in managing today's pre-settlement and settlement fails
management process is in the thousands, and additional costs and risks
resulting from the inability to settle efficiently are
significant.\345\ The Commission believes that proposed Rule 15c6-2
should increase the percentage of trades that achieve an affirmed
confirmation on trade date and should help facilitate an orderly
transition to T+1. Proposed Rule 15c6-2 would also improve the
efficiency of the settlement cycle by incentivizing market participants
to commit to operational and technological upgrades that facilitate
same-day affirmation to eliminate, among other things, manual
operations, while also reducing operational risk and promoting
readiness for shortening the settlement cycle.
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\344\ See supra note 168.
\345\ See DTCC Modernizing Paper, supra note 59.
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Second, the Commission proposes to amend the recordkeeping
obligations of investment advisers to ensure that they are properly
documenting their related allocations and affirmations, as well as the
confirmations they receive from their broker-dealers.\346\ The proposed
amendment to Rule 204-2 would require advisers to time and date stamp
records of any allocation and each affirmation. The Commission believes
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 Commission believes the proposed
recordkeeping requirements would help advisers to establish that they
have met their obligations to achieve a matched trade.
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\346\ See supra Part III.C.
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Finally, the Commission proposes a requirement for CMSPs to
establish, implement, maintain, and enforce written policies and
procedures designed to facilitate straight-through processing.\347\
Under the rule, a CMSP facilitates straight-through processing when its
policies and procedures enable its users to minimize, to the greatest
extent that is technologically practicable, the need for manual input
of trade details or manual intervention to resolve errors and
exceptions that can prevent settlement of the trade.\348\
---------------------------------------------------------------------------
\347\ See supra Part III.D; see also supra Part III.D.1 (further
discussing the term ``straight-through processing'').
\348\ See supra note 347.
---------------------------------------------------------------------------
The Commission believes that increasing the efficiency of using a
CMSP can reduce costs and risks associated with processing
institutional trades and improve the efficiency of the National C&S
System. CMSPs have become increasingly connected to a wide variety of
market participants in the U.S.,\349\ increasing the need to reduce
risks and inefficiencies that may result from use of a CMSPs' systems.
Because the proposed rule would preclude reliance on service offerings
at CMSPs that rely on manual processing, the Commission preliminarily
believes the proposed rule will better position CMSPs to provide
services that not only reduce risk generally but also help facilitate
an orderly transition to a T+1 standard settlement cycle, as well as
potential further shortening of the settlement cycle in the future. The
proposed requirement would support the benefits derived from a
shortening of the settlement cycle and would mitigate any subsequent
potential increase in fails due to the reduced time to remediate any
errors in trades.
---------------------------------------------------------------------------
\349\ See supra note 185.
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Proposed Rule 17Ad-27 also would require a CMSP to submit every
twelve months to the Commission a report that describes the following:
(i) The CMSP's current policies and procedures for facilitating
straight-through processing;
[[Page 10484]]
(ii) its progress in facilitating straight-through processing during
the twelve month period covered by the report; and (iii) the steps the
CMSP intends to take to facilitate and promote straight-through
processing during the twelve month period that follows the period
covered by the report.\350\ The proposed requirement would also inform
the Commission and the public, particularly the direct and indirect
users of the CMSP, as to the progress being made each year to advance
implementation of straight-through processing with respect to the
allocation, confirmation, affirmation, and matching of institutional
trades, the communication of messages among the parties to the
transactions, and the availability of service offerings that reduce or
eliminate the need for manual processing.
---------------------------------------------------------------------------
\350\ See supra Part III.D.2.
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Proposed Rule 17Ad-27 would require the CMSP to file the report on
EDGAR using Inline XBRL, a structured (machine-readable) data language.
Requiring a centralized filing location and a machine-readable data
language for the reports would facilitate access, retrieval, analysis,
and comparison of the disclosed straight-through processing information
across different CMSPs and time periods by the Commission and the
public, thus potentially augmenting the informational benefits of the
report requirement.
2. Costs
The Commission preliminarily believes that compliance with a T+1
standard settlement cycle would involve initial fixed costs to update
systems and processes.\351\ The Commission does not have all of the
data necessary to form its own firm-level estimates of the costs of
updates to systems and processes, as the types of data needed to form
these estimates are difficult or impossible for the Commission to
collect. However, the Commission has used inputs provided by industry
studies discussed in this release to quantify these costs to the extent
possible in Part V.C.5. In addition, the Commission encourages
commenters to provide any information or data on the costs to market
participants of the proposed rule.
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\351\ Industry sources have suggested some updates to systems
and processes might yield operational cost savings after the initial
update. E.g., ``While there may be . . . up-front implementation
costs to transition the industry to T+1, the industry foresees long-
term cost reduction for market participants, and by extension, costs
borne by end investors, given the benefits of moving to T+1
settlement.'' T+1 Report, supra note 18, at 9; see infra Part
V.C.5.a) for industry estimates of the costs and benefits of the
proposed amendment to Rule 15c6-1(a).
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The operational cost burdens associated with the proposed amendment
to Rule 15c6-1(a) for different market participants might vary
depending on each market participant's degree of direct or indirect
inter-connectivity to the clearance and settlement process, regardless
of size. For example, market participants that internally manage more
of their own post-trade processes would directly incur more of the
upfront operational costs associated with the proposed amendment to
Rule 15c6-1(a), because they would be required to directly undertake
more of the upgrades and testing necessary for a T+1 standard
settlement cycle. As mentioned in Part II.B, other market participants
might outsource the clearance and settlement of their transactions to
third-party providers of back-office services. The exposures to the
operational costs associated with shortening the standard settlement
cycle would be indirect to the extent that third-party service
providers pass through the costs of infrastructure upgrades to their
customers. The degree to which customers bear operational costs depends
on their bargaining position relative to third-party providers. Large
customers with market power may be able to avoid internalizing these
costs, while small customers in a weaker negotiation position relative
to service providers may bear the bulk of these costs.
Further, changes to initial and ongoing operational costs may make
some self-clearing market participants alter their decision to continue
internally managing the clearance and settlement of their transactions.
Entities that currently internally manage their clearance and
settlement activity may prefer to restructure their businesses to rely
instead on third-party providers of clearance and settlement services
that may be able to amortize the initial fixed cost of upgrade across a
much larger volume of transaction activity.
In addition, the shortening of the settlement cycle may increase
the need for some market participants engaging in cross-border and
cross-asset transactions to hedge risks stemming from mismatched
settlement cycles, resulting in additional costs. For example, under
the proposed T+1 settlement cycle, a market participant selling a
security in European equity markets to fund a purchase of securities in
U.S. markets would face a one day lag between settlement in Europe and
settlement in the U.S. The market participant could choose between
bearing an additional day of market risk in the U.S. trading markets by
delaying the purchase by a day, or funding the purchase of U.S. shares
with short-term borrowing. Additionally, because the FX market has a
T+2 settlement cycle,\352\ the market participant would also be faced
with a choice between bearing an additional day of currency risk due to
the need to sell Euros as part of the transaction, or to incur the cost
related to hedging away this risk in the forward or futures market.
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\352\ See, e.g., CME Rulebook, Ch. 13, Sec. 1302 (```Spot FX
Transaction''' means a currency purchase and sale that is
bilaterally settled by the counterparties via an actual delivery of
the relevant currencies within two Business Days.''), https://www.cmegroup.com/rulebook/CME/. U.S. and Canadian dollar spot FX
transactions settle on the next business day. Id. Ch. 13, Appendix.
---------------------------------------------------------------------------
The way that different market participants would likely bear costs
as a result of the proposed amendment to Rule 15c6-1(a) may also vary
based on their business structure. For example, a shorter standard
settlement cycle will require payment for securities that settle
regular-way by T+1 rather than T+2. Generally, regardless of current
funding arrangements between investors and broker-dealers, removing one
business day between execution and settlement would mean that broker-
dealers could choose between requiring investors to fund the purchase
of securities one business day earlier while extending the same level
of credit they do under T+2 settlement, or providing an additional
business day of funding to investors. In other words, broker-dealers
could pass through some of the costs of a shorter standard settlement
cycle by imposing the same shorter cycle on investors, or they could
pass these costs on to investors by raising transactions fees to
compensate for the additional business day of funding the broker-dealer
may choose to provide. The extent to which these costs get passed
through to customers may depend on, among other things, the market
power of the broker-dealer. If a broker-dealer does not face
significant competition, its market power may enable it to recover the
entire initial investment cost from its customers. On the other hand, a
broker-dealer that faces perfect competition for its customers may be
unable to pass along any of these costs to its customers.\353\
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\353\ See supra Part V.C.1 for additional discussion regarding
the impact of broker-dealer market power. See infra Part V.C.5.b)(3)
for quantitative estimates of the costs to broker-dealers.
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However, broker-dealers that predominantly serve retail investors
may experience the burden of an earlier payment requirement differently
from broker-dealers with more institutional
[[Page 10485]]
clients or large custodian banks because of the way retail investors
fund their accounts. Retail investors may find it difficult to
accelerate payments associated with their transactions, which may cause
broker-dealers who are unwilling to extend additional credit to retail
investors to instead require that these investors pre-fund their
transactions.\354\ These broker-dealers may also experience costs
unrelated to funding choices. For instance, retail investors may
require additional or different services such as education regarding
the impact of the shorter standard settlement cycle.
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\354\ See infra Part V.C.5.b)(3) for additional discussion
regarding retail investors and their broker-dealers.
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Finally, a shorter settlement cycle may result in higher costs
associated with liquidating a defaulting member's position, as a
shorter horizon may result in larger price impacts, particularly for
less liquid assets. For example, when a clearing member defaults, NSCC
is obligated to fulfill its trade guarantee with the defaulting
member's counterparty. One way it accomplishes this is by liquidating
assets from clearing fund contributions from clearing members. However,
liquidating assets in shorter periods of time can have larger adverse
impacts on the prices of the assets. Shortening the standard settlement
cycle from two business days to one business day could reduce the
amount of time that NSCC would have to liquidate its assets, which may
exacerbate the price impact of liquidation.
3. Economic Implications Through Other Commission Rules
As noted in Part III.E, the proposed amendment to Rule 15c6-1(a),
by shortening the standard settlement cycle, could have an ancillary
impact on the means by which market participants comply with existing
regulatory obligations that relate to the settlement timeframe. The
Commission also provided illustrative examples of specific Commission
rules that include such requirements or are otherwise are keyed-off
settlement date, including Regulation SHO,\355\ and certain provisions
included in the Commission's financial responsibility
rules.356 357
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\355\ 17 CFR 242.200 et seq.
\356\ See supra Part III.E.2.
\357\ The Commission is also soliciting comment on the impact of
shortening the settlement cycle on compliance with Rule 10b-10 under
the Exchange Act and broker-dealer obligations with regard to
prospectus delivery. See supra Parts III.E.3 and III.E.4. However,
based on current practices and comments received by the Commission
to the T+2 proposing release, the Commission preliminarily believes
shortening the settlement cycle to T+1 will not impact compliance
with these rules. Id.
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Financial markets and regulatory requirements have evolved
significantly since the Commission adopted Rule 15c6-1 in 1993. Market
participants have responded to these developments in diverse ways,
including implementing a variety of systems and processes, some of
which may be unique to specific market participants and their
businesses, and some of which may be integrated throughout business
operations of certain market participants. Because of the broad variety
of ways in which market participants currently satisfy regulatory
obligations pursuant to Commission rules, in most circumstances it is
difficult to identify those practices that market participants would
need to change in order to meet these other obligations. Under these
circumstances, and without additional information, the Commission is
unable to provide an estimate of the ancillary economic impact that the
proposed amendment to Rule 15c6-1(a) would have on how market
participants comply with other Commission rules. The Commission invites
commenters to provide quantitative and qualitative information about
these potential economic effects.
In certain cases, based on information about current market
practices, the Commission preliminarily believes that the proposed
amendment to Rule 15c6-1(a) would be unlikely to change the means by
which market participants comply with existing regulatory requirements.
In these cases, the Commission believes that market participants would
not incur significant increased costs of compliance from such
regulatory requirements from shortening the settlement cycle to T+1.
In other cases, however, the proposed amendment may incrementally
increase the costs associated with complying with other Commission
rules where such rules potentially require broker-dealers to engage in
purchases of securities. Two examples of these types of rules are
Regulation SHO and the Commission's financial responsibility rules. In
most instances, Regulation SHO governs the timeframe in which a
``participant'' of a registered clearing agency must close out a fail
to deliver position by purchasing or borrowing securities.\358\
Similarly, some of the Commission's financial responsibility rules
relate to actions or notifications that reference the settlement date
of a transaction. For example, Exchange Act Rule 15c3-3(m) \359\ uses
the settlement date to prescribe the timeframe in which a broker-dealer
must complete certain sell orders on behalf of customers. As noted
above, the term ``settlement date'' is also incorporated into paragraph
(c)(9) of Rule 15c3-1,\360\ which explains what it means to ``promptly
transmit'' funds and ``promptly deliver'' securities within the meaning
of paragraphs (a)(2)(i) and (a)(2)(v) of Rule 15c3-1. As explained
above, the concepts of promptly transmitting funds and promptly
delivering securities are incorporated in other provisions of the
financial responsibility rules.\361\ Under the proposed amendment to
Rule 15c6-1(a), the timeframes included in these rules will be one
business day closer to the trade date.
---------------------------------------------------------------------------
\358\ See supra Part III.E.1.
\359\ 17 CFR 240.15c3-3(m).
\360\ 17 CFR 240.15c3-1(c)(9).
\361\ See, e.g., 17 CFR 240.15c3-1(a)(2)(i), (a)(2)(v); 17 CFR
240.15c3-3(k)(1)(iii), (k)(2)(i), (k)(2)(ii); 17 CFR 240.17a-
5(e)(1)(A); 17 CFR 240.17a-13(a)(3).
---------------------------------------------------------------------------
The Commission preliminarily believes that shortening these
timeframes would not materially affect the costs that broker-dealers
would likely incur to meet their Regulation SHO obligations and
obligations under the Commission's financial responsibility rules.
Nevertheless, the Commission acknowledges that a shorter settlement
cycle could affect the processes by which broker-dealers manage the
likelihood of incurring these obligations. For example, broker-dealers
may currently have in place inventory management systems that help them
avoid failing to deliver securities by T+2. Broker-dealers would likely
incur costs in order to update these systems to support a shorter
settlement cycle.
In cases where market participants will need to adjust the way in
which they comply with other Commission rules, the magnitude of the
costs associated with these adjustments is difficult to quantify. As
noted above, market participants employ a wide variety of strategies to
meet regulatory obligations. For example, broker-dealers may ensure
that they have securities available to meet their obligations by using
inventory management systems or they may choose instead to borrow
securities. An estimate of costs is further complicated by the
possibility that market participants could change their compliance
strategies in response to a shorter standard settlement cycle.
As with the T+2 transition, the Commission anticipates that the
proposed transition to T+1 would again require changes to SRO rules and
changes to the operations or market participants subject to those rules
to achieve consistency with a T+1 standard settlement cycle. Certain
SRO
[[Page 10486]]
rules reference existing Rule 15c6-1 or currently define ``regular
way'' settlement as occurring on T+2 and, as such, may need to be
amended in connection with shortening the standard settlement cycle to
T+1. Certain timeframes or deadlines in SRO rules also may refer to the
settlement date, either expressly or indirectly. In such cases, the
SROs may need to amend these rules in connection with shortening the
settlement cycle to T+1.\362\
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\362\ The T+1 Report similarly indicates that SROs will likely
need to update their rules to facilitate a transition to a T+1
standard settlement cycle. T+1 Report, supra note 18, at 35.
---------------------------------------------------------------------------
The Commission invites commenters to provide quantitative and
qualitative information about the impact of the proposed amendment to
Rule 15c6-1(a) on the costs associated with compliance with other
Commission rules.
4. Effect on Efficiency, Competition, and Capital Formation
Market participants may incur initial costs for the investments
necessary to comply with a shorter standard settlement cycle.\363\
However, these costs would likely differ across market participants and
these differences may exacerbate coordination problems. First, per-
transaction operational costs clearing members incur in connection with
the clearing services they provide may be higher for members that clear
fewer transactions than such costs are for members that clear a higher
volume of transactions. Thus, the extent to which many of the upgrades
necessary for a T+1 standard settlement cycle are optimal for a member
to adopt unilaterally may depend, in part, on the transaction volume
cleared by such member. For example, certain upgrades necessary for a
T+1 standard settlement cycle may result in economies of scale, where
large clearing members are able to comply with the proposed amendment
to Rule 15c6-1(a) at a lower per-transaction cost than smaller members.
As a result, larger members might take a short time to recover their
initial costs for upgrades; smaller members with lower transaction
volumes might take longer to recover their initial cost outlays and
might be more reluctant to make the upgrades in the absence of the
proposed amendment. These differences in cost per transaction may be
mitigated through the use of third-party service providers.
---------------------------------------------------------------------------
\363\ See supra Part V.C.2.
---------------------------------------------------------------------------
In addition, the Commission acknowledges that the upgrades
necessary to implement a shorter standard settlement cycle may produce
indirect economic effects. We analyze some of these indirect effects,
such as the impact on competition and third-party service providers, in
the following section.
A shorter settlement cycle might improve the efficiency of the
clearance and settlement process through several channels. First, the
Commission preliminarily believes that the primary effect that a
shorter settlement cycle would have on the efficiency of the settlement
process would be a reduction in the credit, market, and liquidity risks
that broker-dealers, CCPs, and other market participants are subject to
during the standard settlement cycle.\364\ A shorter standard
settlement cycle will generally reduce the volume of unsettled
transactions that could potentially pose settlement risk to
counterparties. Shortening the period between trade execution and
settlement would enable trades to be settled with less aggregate risk
to counterparties or the CCP. A shorter standard settlement cycle may
also decrease liquidity risk by enabling market participants to access
the proceeds of their transactions sooner, which may reduce the cost
market participants incur to handle idiosyncratic liquidity shocks
(i.e., liquidity shocks that are uncorrelated with the market). That
is, because the time interval between a purchase/sale of securities and
payment is reduced by one business day, market participants with
immediate payment obligations that they could cover by selling
securities would be required to obtain short-term funding for one less
day.\365\ As a result of reduced cost associated with covering their
liquidity needs, market participants may, under particular
circumstances, be able to shift assets that would otherwise be held as
liquid collateral towards more productive uses, improving allocative
efficiency.\366\
---------------------------------------------------------------------------
\364\ Reduction of these risks should result in the reduction of
margin requirements and other risk management activity that requires
resources that could be put to another use.
\365\ See supra Part V.B.2.
\366\ See supra Part V.A.
---------------------------------------------------------------------------
Second, a shorter standard settlement cycle may increase price
efficiency through its effect on credit risk exposures between
financial intermediaries and their customers. In particular, a prior
study noted that certain intermediaries that transact on behalf of
investors, such as broker-dealers, may be exposed to the risk that
their customers default on payment obligations when the price of
purchased securities declines during the settlement cycle.\367\ As a
result of the option to default on payment obligations, customers'
payoffs from securities purchases resemble European call options and,
from a theoretical standpoint, can be valued as such. Notably, the
value of European call options increases in the time to expiration
\368\ suggesting that the value of call options held by customers who
purchase securities is increasing in the length of the settlement
cycle. In order to compensate itself for the call option that it
writes, an intermediary may include the cost of these call options as
part of its transaction fee and this cost may become a component of
bid-ask spreads for securities transactions. By reducing the value of
customers' option to default by reducing the option's time to maturity,
a shorter standard settlement cycle may reduce transaction costs in
U.S. securities markets. In addition, to the extent that any benefit
buyers receive from deferring payment during the settlement cycle is
incorporated in securities returns,\369\ the proposed amendment to Rule
15c6-1(a) may reduce the extent to which such returns deviate from
returns consistent with changes in fundamentals.
---------------------------------------------------------------------------
\367\ See Madhavan et al., supra note 296.
\368\ All other things equal, an option with a longer time to
maturity is more likely to be in the money given that the variance
of the underlying security's price at the exercise date is higher.
\369\ See supra Part V.B.2.
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As discussed in more detail above, the Commission preliminarily
believes that the proposed amendment to Rule 15c6-1(a) would likely
require market participants to incur costs related to infrastructure
upgrades and would likely yield benefits to market participants,
largely in the form of reduced financial risks related to settlement.
As a result, the Commission preliminarily believes that the proposed
amendment to Rule 15c6-1(a) could affect competition in a number of
different, and potentially offsetting, ways.
The prospective reduction in financial risks related to shortening
the standard settlement cycle may represent a reduction in barriers to
entry for certain market participants.\370\ Reductions in the financial
resources required to cover an NSCC member's clearing fund requirements
that result from a shorter standard settlement cycle could encourage
financial firms that currently clear transactions through NSCC clearing
members to become clearing members themselves.
---------------------------------------------------------------------------
\370\ See supra Part V.C.1 for a discussion of the reduction in
credit, market, and liquidity risks to which NSCC would be subject
as a result of a shortening of the settlement cycle and the
subsequent reduction financial resources dedicated to mitigating
those risks.
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[[Page 10487]]
Their entry into the market could promote competition among NSCC
clearing members. Furthermore, if a reduction in settlement risks
results in lower transaction costs for the reasons discussed above,
market participants that were, on the margin, discouraged from
supplying liquidity to securities markets due to these costs could
choose to enter the market for liquidity suppliers, increasing
competition.
At the same time, the Commission acknowledges that the process
improvements required to enable a shorter standard settlement cycle
could adversely affect competition. Among clearing members, where such
process improvements might be necessary to comply with the shorter
standard settlement cycle required under the proposed amendment to Rule
15c6-1(a), the cost associated with compliance might increase barriers
to entry, because new firms would incur higher fixed costs associated
with a shorter standard settlement cycle if they wish to enter the
market. Clearing members might choose to comply by upgrading their
systems and processes or may choose instead to exit the market for
clearing services. The exit of clearing members could have negative
consequences for competition among clearing members. Clearing activity
tends to be concentrated among larger broker-dealers.\371\ Clearing
member exit could result in further concentration and additional market
power for those clearing members that remain.
---------------------------------------------------------------------------
\371\ See supra Part V.B.2.
---------------------------------------------------------------------------
Alternatively, some current clearing members may choose to comply
in part by outsourcing their operational needs to third-party service
providers. Use of third-party service providers may represent a
reasonable response to the operational costs associated with the
proposed amendment to Rule 15c6-1(a). To the extent that third-party
service providers are able to spread the fixed costs of compliance
across a larger volume of transactions than their clients, the
Commission preliminarily believes that the use of third-party service
providers might impose a smaller compliance cost on clearing members
than if these firms directly bore the costs of compliance. The
Commission preliminarily believes that this impact may stretch beyond
just clearing members. The use of third-party service providers may
mitigate the extent to which the proposed amendment to Rule 15c6-1(a)
raises barriers to entry for broker-dealers. Because these barriers to
entry may have adverse effects on competition between clearing members,
we preliminarily believe that the use of third-party service providers
may mitigate the adverse effects of the proposed amendment to Rule
15c6-1(a) on competition between broker-dealers.
Existing market power may also affect the distribution of
competitive impacts stemming from the proposed amendment to Rule 15c6-
1(a) across different types of market participants. While, as noted
above, reductions in the credit, market, and liquidity risks that
broker-dealers, CCPs, and other market participants are subject to
during the standard settlement cycle could promote competition among
clearing members and liquidity suppliers, these groups may benefit to
differing degrees, depending on the extent to which they are able to
capture the benefits of a shortened standard settlement cycle.
Finally, a shorter standard settlement cycle might also improve the
capital efficiency of the clearance and settlement process, which would
promote capital formation in U.S. securities markets and in the
financial system generally.\372\ A shorter standard settlement cycle
would reduce the amount of time that collateral must be held for a
given trade, thus freeing the collateral to be used elsewhere earlier.
For a given quantity of trading activity, collateral would also be
committed to clearing fund deposits for a shorter period of time. The
greater collateral efficiency promoted by a shorter settlement cycle
might also indirectly promote capital formation for market participants
in the financial system in general. Specifically, the improved capital
efficiency that would result from a shorter standard settlement cycle
would enable a given amount of collateral to support a larger amount of
financial activity.
---------------------------------------------------------------------------
\372\ See supra Part V.A for more discussion regarding capital
formation and efficiency.
---------------------------------------------------------------------------
5. Quantification of Direct and Indirect Effects of a T+1 Settlement
Cycle
In previous years, several industry groups have released estimates
for compliance costs associated with a shorter standard settlement
cycle, including the SIA, the ISC, and BCG.\373\ Although all of these
studies examined prior shortenings of the settlement cycle including
from T+5 to T+3 and from T+3 to T+2, in the absence of a current study
examining shortening from the current T+2 to T+1 they serve as a useful
rough initial estimate of the costs involved in a settlement cycle
shortening. The most recent of these, the BCG Study performed a cost-
benefit analysis of a T+2 standard settlement cycle. Below is a summary
of the cost estimates in the BCG Study and in the following
subsections, an evaluation of these estimates as part of the discussion
of the potential direct and indirect compliance costs related to the
proposed amendment to Rule 15c6-1(a). In addition, the Commission
encourages commenters to provide additional information to help
quantify the economic effects that we are currently unable to quantify
due to data limitations.
---------------------------------------------------------------------------
\373\ See SIA Business Case Report, supra note 21; see also ISG
White Paper, supra note 26; BCG Study, supra note 22. The SIA has
since merged with other groups to form SIFMA.
---------------------------------------------------------------------------
(a) Industry Estimates of Costs and Benefits
The BCG Study concluded that the transition to a T+2 settlement
cycle would cost approximately $550 million in incremental initial
investments across industry constituent groups,\374\ which would result
in annual operating savings of $170 million and $25 million in annual
return on reinvested capital from clearing fund reductions.\375\
---------------------------------------------------------------------------
\374\ The BCG Study generally refers to ``institutional broker-
dealers,'' ``retail broker-dealers,'' ``buy side'' firms, and
``custodian banks,'' without defining these particular groups. The
Commission uses these terms when referring to estimates provided by
the BCG Study but notes that its own definitions of various affected
parties may differ from those in the BCG Study.
\375\ See BCG Study, supra note 22, at 9-10.
---------------------------------------------------------------------------
The BCG Study also estimated that the average level of required
investments per firm could range from $1 to 5 million, with large
institutional broker-dealers incurring the largest amount of
investments on a per-firm basis, and buy side firms at the lower end of
the spectrum.\376\ The investment costs for ``other'' entities,
including DTCC, DTCC ITP Matching (US) LLC (f/k/a Omgeo Matching (US)
LLC), service bureaus, RICs and non-self-clearing broker-dealers
totaled $70 million for the entire group. Within this $70 million, DTCC
and Omgeo were estimated to have a compliance investment cost of $10
million each. The study's authors estimated that institutional broker-
dealers would have operational cost savings of approximately 5%, retail
broker-dealers of 2% to 4%, buy-side firms of 2% and custodial banks of
10% to 15% for an industry total operational cost savings of
approximately $170MM per year.\377\
---------------------------------------------------------------------------
\376\ Id. at 30-31.
\377\ See id. at 41.
---------------------------------------------------------------------------
The BCG Study also estimated the annual clearing fund reductions
resulting from reductions in clearing firms' clearing funds
requirements to be
[[Page 10488]]
$25 million per year.\378\ The study estimated this by considering the
reduction in clearing fund requirements and multiplied it by the
average Federal Funds target rate for the 10-year period up until 2008
(3.5%). The BCG Study also estimated the value of the risk reduction in
buy side exposure to the sell side. The implied savings were estimated
to be $200 million per year, but these values were not included in the
overall cost-benefit calculations.
---------------------------------------------------------------------------
\378\ See supra note 334 for a discussion of the impact of
increases in daily trading volume since the time of the BCG study on
this estimate.
---------------------------------------------------------------------------
Several factors limit the usefulness of the BCG Study's estimates
of potential costs and benefits of the proposed amendment to Rule 15c6-
1(a). First, a further shortening of the settlement cycle to T+1 may
require investments in new technology and processes that were not
necessary under the previous shortening to T+2. Second, technological
improvements, such as the increased use of computers and automation in
post-trade processes, that have been made since 2012, when the report
was first published, may have reduced the cost of the upgrades
necessary to comply with a shorter settlement cycle. This may, in turn,
reduce the costs associated with the proposed amendment,\379\ as a
larger portion of market participants may have already adopted many
processes that would reduce the cost of a transition to a shorter
settlement cycle. In addition, the BCG Study considered as a part of
its cost estimates operational cost savings as a result of improvements
to operational efficiency.
---------------------------------------------------------------------------
\379\ See supra Part V.A. While market participants may have
already made investments consistent with implementing a shorter
settlement cycle, the fact that these investments have not resulted
in a shorter settlement cycle is consistent with the existence of
coordination problems among market participants.
---------------------------------------------------------------------------
Lastly, the BCG Study was premised on survey responses by a subset
of market participants that may be affected by the rule. Surveys were
sent to 270 market participants and 70 responses were received,
including 20 institutional broker-dealers, prime brokers and
correspondent clearers; 12 retail broker-dealers; 17 buy side firms; 14
RIAs; and seven custodian banks. Given the low response rate, as well
as the uncertainty regarding the sample of market participants that was
asked to complete the survey, the Commission cannot conclude that the
cost estimates in the BCG Study are representative of the costs of all
market participants.\380\
---------------------------------------------------------------------------
\380\ See BCG Study, supra note 22, at 15.
---------------------------------------------------------------------------
(b) Estimates of Costs
The proposed amendment to Rule 15c6-1(a) would generate direct and
indirect costs for market participants, who may need to modify and/or
replace multiple systems and processes to comply with a T+1 standard
settlement cycle. As noted above, the T+2 Playbook included a timeline
with milestones and dependencies necessary for a transition to a T+2
settlement cycle, as well as activities that market participants should
consider in preparation for the transition and the Commission
preliminarily believes that this provides an initial guide to those
that would be necessary for a transition to T+1. The Commission
preliminarily believes that the majority of activities for migration to
a T+1 settlement cycle would stem from behavior modification of market
participants and systems testing, and thus the majority of the costs of
migration would be from labor.\381\ These modifications would include a
compression of the settlement timeline, as well as an increase in the
fees that brokers may impose on their customers for trade failures.
Although the T+2 Playbook did not include any direct estimates of the
compliance costs for a T+2 settlement cycle, the Commission utilizes
the timeline in the T+2 Playbook for specific actions necessary to
migrate to a T+2 settlement cycle to directly estimate the inputs
needed for migration, and form preliminary compliance cost estimates
for the shortening to T+2 and uses these as an estimate for the
shortening to T+1.
---------------------------------------------------------------------------
\381\ See id.
---------------------------------------------------------------------------
In addition, the T+2 Playbook, the ISC White Paper, and the BCG
Study identified several categories of actions that market participants
might need to take to comply with a T+2 settlement cycle and likely
also with a T+1 settlement cycle--processing, asset servicing, and
documentation.\382\ While the following cost estimates for these
remedial activities span industry-wide requirements for a migration to
a T+1 settlement cycle, the Commission does not anticipate each market
participant directly undertaking all of these activities for several
reasons. First, some market participants work with third-party service
providers to facilitate certain functions that may be impacted by a
shorter standard settlement cycle, such as trade processing and asset
servicing, and thus may only bear the costs of the requirements through
fees paid to those service providers. Second, certain costs might only
fall on specific categories of entities. For example, the costs of
updating the CNS and ID Net system would only directly fall on NSCC,
DTC, and members/participants of those clearing agencies. Finally, some
market participants may already have the processes and systems in place
to accommodate a T+1 standard settlement cycle or would be able to
adjust to a T+1 settlement cycle without incurring significant costs.
For example, some market participants may already have the systems and
processes in place to meet the requirements for same-day trade
affirmation and matching consistent with the requirements in proposed
Rule 15c6-2.\383\ These market participants may thus bear a
significantly lower cost to update their trade affirmation systems/
processes to settle on a T+1 standard settlement cycle.\384\
---------------------------------------------------------------------------
\382\ See T+2 Playbook, supra note 27, at 11.
\383\ See BCG Study, supra note 22, at 23.
\384\ The BCG Study, as it is based on survey responses from
market participants, does reflect the heterogeneity of compliance
costs for market participants.
---------------------------------------------------------------------------
The following section examines several categories of market
participants and estimate the compliance costs for each category. The
Commission's estimate of the number and type of personnel that may be
required is based on the scope of activities for a given category of
market participant necessary for the market participant to migrate to a
T+1 settlement cycle, the market participant's role within the
clearance and settlement process, and the amount of testing required to
minimize undue disruptions.\385\ Hourly salaries for personnel are from
SIFMA's Management and Professional Earnings in the Securities Industry
2013.\386\ These estimates use the timeline from the T+2 Playbook to
determine the length of time personnel would work on the activities
necessary to support a T+1 settlement cycle. The timeline provides an
indirect method to estimate the inputs necessary to migrate to a T+1
settlement cycle, rather than relying directly on survey response
estimates. The Commission acknowledges many entities are already
undertaking activities to support a migration to a T+1 settlement cycle
in anticipation of
[[Page 10489]]
the proposed amendment. However, to the extent that the costs of these
activities have already been incurred, the Commission considers these
costs sunk, and they are not included in the analysis below.
---------------------------------------------------------------------------
\385\ For example, FMUs that play a critical role in the
clearance and settlement infrastructure would require more testing
associated with a T+1 standard settlement cycle than institutional
investors.
\386\ To monetize the internal costs, the Commission staff used
data from SIFMA publications, modified by Commission staff to
account for an 1800 hour work-year and multiplied by 5.35
(professionals) or 2.93 (office) to account for bonuses, firm size,
employee benefits and overhead. See SIFMA, Management and
Professional Earnings in the Security Industry--2013 (Oct. 7, 2013),
https://www.sifma.org/resources/research/management-and-professional-earnings-in-the-securities-industry-2013/; SIFMA,
Office Salaries in the Securities Industry--2013 (Oct. 7, 2013),
https://www.sifma.org/resources/research/office-salaries-in-the-securities-industry/. These figures have been adjusted for inflation
using data published by the Bureau of Labor Statistics.
---------------------------------------------------------------------------
(1) FMUs--CCPs and CSDs
CNS, NSCC/DTC's ID Net service, and other systems would require
adjustment to support a T+1 standard settlement cycle. According to the
T+2 Playbook and the ISC White Paper, regulation-dependent planning,
implementation, testing, and migration activities associated with the
transition to a T+2 settlement cycle could last up to five
quarters.\387\ The Commission preliminarily believes that these
activities would impose a one-time compliance cost of $12.6 million
\388\ for DTC and NSCC each. After this initial compliance cost, the
Commission preliminarily expects that both DTCC and NSCC would incur
minimal ongoing costs from the transition to a T+1 standard settlement
cycle, because the Commission believes that the majority of costs would
stem from pre-migration activities, such as implementation, updates to
systems and processes, and testing.
---------------------------------------------------------------------------
\387\ See T+2 Playbook, supra note 27, at 11.
\388\ The estimate is based on the T+2 Playbook timeline, which
estimates regulation-dependent implementation activity, industry
testing, and migration lasting five quarters. The Commission assumes
10 operations specialists (at $149 per hour), 10 programmers (at
$295 per hour), and 1 senior operations manager (at $397/hour),
working 40 hours per week. (10 x $149 + 10 x $295 + 1 x $397) x 5 x
13 x 40 = $12,575,000.
---------------------------------------------------------------------------
(2) Matching/ETC Providers--Exempt Clearing Agencies
Matching/ETC Providers may need to adapt their trade processing
systems to comply with a T+1 settlement cycle. This may include actions
such as updating reference data, configuring trade match systems, and
configuring trade affirmation systems to affirm trades on T+0.
Matching/ETC Providers would also need to conduct testing and assess
post-migration activities. The Commission preliminarily estimates that
these activities would impose a one-time compliance cost of up to $12.6
million \389\ for each Matching/ETC Provider. However, the Commission
acknowledges that some ETC providers may have a higher cost burden than
others based on the volume of transactions that they process. The
Commission expects that ETC providers would incur minimal ongoing costs
after the initial transition to a T+1 settlement cycle because the
Commission preliminarily believes that the majority of the costs of
migration to a T+1 settlement cycle entail behavioral changes of market
participants and pre-migration testing.
---------------------------------------------------------------------------
\389\ The estimate is based on the T+2 Playbook timeline, which
estimates regulation-dependent implementation activity for trade
systems, matching, affirmation, testing, and post-migration testing
lasting five quarters. The Commission assumes 10 operations
specialists (at $149 per hour), 10 programmers (at $295 per hour),
and 1 senior operations manager (at $397/hour), working 40 hours per
week. (10 x $149 + 10 x $295 + 1 x $397) x 5 x 13 x 40 =
$12,575,000.
---------------------------------------------------------------------------
(3) Market Participants--Investors, Broker-Dealers, Investment
Advisers, and Bank Custodians
The overall compliance costs that a market participant incurs would
depend on the extent to which it is directly involved in functions
related to clearance and settlement including trade confirmation/
affirmation, asset servicing, and other activities. For example, retail
investors may bear few (if any) direct costs in a transition to a T+1
standard settlement cycle, because their respective broker-dealer
handles the back-office functions of each transaction. However, as is
discussed below, this does not imply that retail investors would not
face indirect costs from the transition, such as those passed through
from broker-dealers or banks.
Institutional investors may need to configure systems and update
reference data, which may also include updates to trade funding and
processing mechanisms, to operate in a T+1 environment. The Commission
preliminarily estimates that this would require an initial expenditure
of $2.67 million per entity.\390\ However, these costs may vary
depending on the extent to which a particular institutional investor
has already automated its processes. The Commission preliminarily
expects institutional investors would incur minimal ongoing direct
compliance costs after the initial transition to a T+1 standard
settlement cycle.
---------------------------------------------------------------------------
\390\ The estimate is based on the T+2 Playbook timeline, which
estimates regulation-dependent implementation activity for trade
systems, reference data, and testing activity to last four quarters.
We assume 2 operations specialists (at $149 per hour), 2 programmers
(at $295 per hour), and 1 senior operations manager (at $397 per
hour), working 40 hours per week. (2 x $149 + 2 x $195 + 1 x $397) x
4 x 13 x 40 = $2,673,400.
---------------------------------------------------------------------------
Broker-dealers that serve institutional investors would not only
need to configure their trading systems and update reference data, but
may also need to update trade confirmation/affirmation systems,
documentation, cashiering and asset servicing functions, depending on
the roles they assume with respect to their clients. The Commission
preliminarily estimates that, on average, each of these broker-dealers
would incur an initial compliance cost of $5.44 million.\391\ The
Commission preliminarily expects that these broker-dealers would incur
minimal ongoing direct compliance costs after the initial transition to
a T+1 standard settlement cycle.
---------------------------------------------------------------------------
\391\ The estimate is based on the T+2 Playbook timeline, which
estimates regulation-dependent implementation activity for trade
systems, reference data, documentation, asset servicing, and testing
to last four quarters. We assume 5 operations specialists (at $149
per hour), 5 programmers (at $295 per hour), and 1 senior operations
manager (at $397 per hour), working 40 hours per week. (5 x $149 + 5
x $256 + 1 x $345) x 4 x 13 x 40 = $4,721,600.
---------------------------------------------------------------------------
Broker-dealers that serve retail customers may also need to spend
significant resources to educate their clients about the shorter
settlement cycle. The Commission preliminarily estimates that these
broker-dealers would incur an initial compliance cost of $9.91 million
each.\392\ However, unlike previously mentioned market participants,
the Commission expects that broker-dealers that serve retail investors
may face significant one-time compliance costs after the initial
transition to T+1. Retail investors may require additional education
and customer service, which may impose costs on their broker-dealers.
The Commission preliminarily believes that a reasonable upper bound for
the costs associated with this requirement is $30,000 per broker-
dealer.\393\ Assuming all clearing and introducing broker-dealers must
educate retail customers, the upper bound for the costs of retail
investor education would be approximately $40.6 million.\394\
---------------------------------------------------------------------------
\392\ The estimate is based on the T+2 Playbook timeline, which
estimates regulation-dependent implementation activity for trade
systems, reference data, documentation, asset servicing, customer
education and testing to last five quarters. We assume 5 operations
specialists (at $149 per hour), 5 programmers (at $295 per hour), 5
trainers (at $239 per hour) and 1 senior operations manager (at $397
per hour), working 40 hours per week. (5 x $149 + 5 x $295 + 5 x
$239 + 1 x $397) x 5 x 13 x 40 = $9,914,000.
\393\ This estimate is based on the assumption that a broker-
dealer chooses to educate customers using a 10-minute video that
takes at most $3,000 per minute to produce. See Crowdfunding,
Exchange Act Release No. 76324 (Oct. 30, 2015), 80 FR 71388, 71529 &
n.1683 (Nov. 16, 2015).
\394\ Calculated as $30,000 per broker-dealer x (156 broker-
dealers reporting as self-clearing + 1,126 broker-dealers reporting
as introducing but not self-clearing + 71 broker-dealers reporting
as introducing and self-clearing) = $40,590,000.
---------------------------------------------------------------------------
Custodian banks would need to update their asset servicing
functions to comply with a shorter settlement cycle. The Commission
preliminarily estimates that custodian banks would incur an initial
compliance cost of $1.34
[[Page 10490]]
million,\395\ and expects custodian banks to incur minimal ongoing
compliance costs after the initial transition because the Commission
preliminarily believes that most of the costs would stem from pre-
migration updates and testing.
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\395\ The estimate is based on the T+2 Playbook timeline, which
estimates regulation-dependent implementation activity for asset
servicing and testing to last two quarters. We assume 2 operations
specialists (at $149 per hour), 2 programmers (at $295 per hour),
and 1 senior operations manager (at $397 per hour), working 40 hours
per week. (2 x $149 + 2 x $295 + 1 x $397) x 2 x 13 x 40 =
$1,336,700.
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The proposed amendment to Rule 204-2 would require investment
advisers to maintain records of allocations (if any), confirmations or
affirmations if the adviser is a party to a contract under that rule.
Based on Form ADV filings as of December 2020, approximately 13,804
advisers registered with the Commission are required to maintain copies
of certain books and records relating to their advisory business.\396\
The Commission further estimates that 2,521 registered advisers
required to maintain copies of certain books and records relating to
their advisory business would not be required to make and keep the
proposed required records because they do not have any institutional
advisory clients.\397\ Therefore, the remaining 11,283 of these
advisers would be subject to the related proposed amendment to Rule
204-2 under the Advisers Act, would enter a contract with a broker or
dealer under proposed Rule 15c6-2 and therefore be subject to the
related proposed recordkeeping amendment.
---------------------------------------------------------------------------
\396\ See infra note 424.
\397\ See id.
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As discussed above, based on staff experience, the Commission
believes that many advisers already have recordkeeping processes in
place to retain records of confirmations received, and allocations and
affirmations sent to brokers or dealers. The Commission believes these
are customary and usual business practices for many advisers, but that
some small and mid-size advisers do not currently retain these records.
Further, the Commission believes that the vast majority of these books
and records are kept in electronic fashion with an ability to capture a
date and time stamp, such as in a trade order management or other
recordkeeping system, through system logs of file transfers, email
archiving or as part of DTC's Institutional Trade Processing services,
but that some advisers maintain paper records (e.g., confirmations)
and/or communicate allocations by telephone. In addition, as noted in
Section III.C, above, we believe that up to 70% of institutional trades
are affirmed by custodians, and therefore advisers may not retain or
have access to the affirmations these custodians sent to brokers or
dealers.\398\
---------------------------------------------------------------------------
\398\ See DTCC ITP Forum Remarks, supra note 58.
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For those advisers maintaining date and time stamped electronic
records already, we estimate no incremental compliance costs. We
estimate that the proposed amendments to rule 204-2 would result in an
initial one-time compliance cost of approximately $30,500 for the small
and mid-size advisers \399\ that we estimate do not currently maintain
these records, which we amortize over three years for an estimated
annual cost of approximately $10,167.\400\ In addition, we believe that
only a small number of advisers, or 1% of advisers that have
institutional clients, do not send allocations or affirmations
electronically to brokers or dealers (e.g., they communicate them by
telephone).\401\ We estimate that these advisers will incur initial
one-time costs of approximately $16,000 updating their policies and
procedures and training their personnel to send these communications
through their existing electronic systems, which we amortize over three
years for an estimated annual cost of approximately $5,333.\402\
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\399\ For purposes of the Paperwork Reduction Act, infra section
VI, we estimated the number of small and mid-sized advisers based on
Form ADV Items 2.A.(2) (for mid-sized advisers) and 12 (for small
advisers).
\400\ The estimate assumes that the proposed amendments to Rule
204-2 would result in an initial increase in the collection of
information burden estimate by 2 hours for the small and medium size
advisers that have institutional clients that we estimate do not
currently maintain these records. We estimate this number of
advisers to be approximately 50% of small and medium sized
registered investment advisers that have institutional clients, or
approximately 220 small and medium size advisers. See infra Table 1
(Summary of burden estimates for the proposed amendment to Rule 204-
2) note 4. The estimated 2 hours per adviser would be an initial
burden to update procedures and instruct personnel to retain these
records in the advisers' electronic recordkeeping systems, including
any confirmations that they may receive in paper format and do not
currently retain. We believe that these advisers already have
recordkeeping systems to accommodate these records, which would
include, at a minimum, spreadsheet formats and email retention
systems. As with our estimates relating to the previous amendments
to Advisers Act Rule 204-2, the Commission expects that performance
of these functions would most likely be allocated between compliance
clerks and general clerks, with compliance clerks performing 17% of
the function and general clerks performing 83% of the function. We
assume 20 minutes of a compliance clerk (at $76 per hour) and 100
minutes of a general clerk (at $68 per hour). (1/3 x 76 + 5/3 x 68)
x 220 = $30,507.
\401\ We estimate that currently registered large advisers that
do not currently maintain electronic records, would be part of the
estimated 1% of advisers that would incur 2 hours each to comply
with the proposed amendment as described above. For new large
advisers, we estimate that there would be no incremental cost
associated with this proposed amendment, as we believe these
advisers would implement electronic systems as part of their initial
compliance with Rule 204-2, and that these electronic systems would
have an ability to capture a date and time stamp.
\402\ We estimate 1% of 11,283 or 113 advisers do not sent
allocations or affirmations electronically. We assume, for each
adviser, 20 minutes for a compliance clerk (at $76 per hour) and 100
minutes of a general clerk (at $68 per hour). (1/3 x 76 + 5/3 x 68)
x 113 = $15,669.
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In addition, we estimate that 70% of institutional trades are
affirmed by custodians, and therefore advisers may not retain or have
access to the affirmations these custodians sent to brokers or dealers.
Because we do not know the number of advisers that correlate to these
trades, we estimate for purposes of this collection of information that
70% of advisers with institutional clients make institutional trades
that are affirmed by custodians. Therefore, we estimate that these
advisers would incur initial one-time costs of approximately $1,095,000
to direct their institutional clients' custodians to copy the adviser
on any affirmations sent through email, or for the adviser to use its
systems to issue affirmations, which we amortize over three years for
an estimated annual cost of approximately $365,500.\403\
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\403\ We estimate 70% of 11,283 or 7,898 advisers affirm trades
through custodians. We assume, for each advisor, 20 minutes for a
compliance clerk (at $76 per hour) and 100 minutes of a general
clerk (at $68 per hour). (1/3 x 76 + 5/3 x 68) x 7,898 = $1,095,189.
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Proposed Rule 17Ad-27 would require a CMSP to establish, implement,
maintain, and enforce written policies and procedures. Based on the
similar policies and procedures requirements and the corresponding
burden estimates previously made by the Commission for Rules 17Ad-
22(d)(8) and 17Ad-22(e)(2),\404\ the Commission preliminarily estimates
that respondent CMSPs would incur an aggregate one-time cost of
approximately $27,000.\405\
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\404\ See Clearing Agency Standards, Exchange Act Release No.
68080 (Oct. 22, 2012), 77 FR 66219, 66260 (Nov. 2, 2012) (``Clearing
Agency Standards Adopting Release''); Standards for Covered Clearing
Agencies, Exchange Act Release No. 78961 (Sept. 28, 2016), 81 FR
70786, 70891-92 (Oct. 13, 2016) (``CCA Standards Adopting
Release'').
\405\ There are currently three CMSPs and the Commission
anticipates that one additional entity may seek to become a CMSP in
the next three years. The aggregate cost was estimated as follows:
(Assistant General Counsel at $602/hour x 8 hours = $4,816) +
(Compliance Attorney at $334/hour x 6 hours = $2,004) = $6,820 x 4
CMSPs equals $27,280.
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The proposed rule would also require ongoing documentation
activities with respect to the annual report required to be submitted
to the Commission. Based on the similar reporting requirements and the
corresponding burden estimates
[[Page 10491]]
previously made by the Commission for Rule 17Ad-22(e)(23),\406\ the
Commission preliminarily estimates that the ongoing activities required
by proposed Rule 17Ad-27 would impose an aggregate annual cost of this
ongoing burden of approximately $44,000.\407\
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\406\ See CCA Standards Adopting Release, supra note 404, at
70899.
\407\ This figure was calculated as follows: [(Compliance
Attorney at $397/hour x 24 hours = $9,528) + (Computer Operations
Manager at $480/hour x 10 hours = $4,800) = $14,328 x 4 CMSPs =
$57,312]. In addition, we estimate that the Inline XBRL requirement
would require respondent CMSPs to spend $900 each year to license
and renew Inline XBRL compliance software and/or services, and incur
1 internal burden hour to apply and review Inline XBRL tags for the
three disclosure requirements on the report, resulting in a total
annual aggregate cost of $5,188 [(Compliance Attorney at $397/hour x
1 hour = $397) + $900 in external costs = $1,297 x 4 CMSPs =
$5,188]. In addition, respondent CMSPs that do not already have
access to EDGAR would be required to file a Form ID so as to obtain
the access codes that are required to file or submit a document on
EDGAR. We anticipate that each respondent would require 0.15 hours
to complete the Form ID, and for purposes of the PRA, that 100% of
the burden of preparation for Form ID will be carried by each
respondent internally. Because two respondent CMSPs already have
access to EDGAR, we anticipate that proposed amendments would result
in a one-time nominal increase of 0.30 burden hours for Form ID,
which would not meaningfully add to, and would effectively be
encompassed by, the existing burden estimates associated with these
reports.
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(4) Indirect Costs
In estimating these implementation costs, the Commission notes that
market participants who bear the direct costs of the actions they
undertake to comply with the amendment to Rule 15c6-1 may pass these
costs on to their customers. For example, retail and institutional
investors might not directly bear the cost of all of the necessary
upgrades for a T+1 settlement cycle, but might indirectly bear these
costs as their broker-dealers might increase their fees to amortize the
costs of updates among their customers. The Commission is unable to
quantify the overall magnitude of the indirect costs that retail and
institutional investors may bear, because such costs would depend on
the market power of each broker-dealer, and each broker-dealer's
willingness to pass on the costs of migration to a T+1 standard
settlement cycle to its customers. However, the Commission
preliminarily believes that in situations where broker-dealers have
little or no competition, broker-dealers may pass on as much as 100% of
their initial costs to their customers. As discussed above, this could
be as high as the full amount of the estimated $5.44 million for
broker-dealers that serve institutional investors, and $9.91 million
for broker-dealers that serve retail investors. However, in situations
where broker-dealers face heavy competition for customers, they may
bear the full costs of the initial investment, and avoid passing on any
portion of these costs to their customers.
As noted in Part V.B.4, the ability of market participants to pass
implementation costs on to customers likely depends on their relative
bargaining power. For example, CCPs, like many other utilities, exhibit
many of the characteristics of natural monopolies and, as a result, may
have market power, particularly relative to broker-dealers who submit
trades for clearing. This means that CCPs may be able to share
implementation costs they directly face related to shortening the
settlement cycle with broker-dealers through higher clearing fees.
Conversely, to the extent that institutional investors have market
power relative to broker-dealers, broker-dealers may not be in a
position to impose indirect costs on them.
(5) Industry-Wide Costs
To estimate the aggregate, industry-wide cost of a transition to a
T+1 standard settlement cycle, the Commission takes its own per-entity
estimates and multiplies them by our estimate of the respective number
of entities. The Commission preliminarily estimates that there are
1,229 buy-side firms, 156 self-clearing broker-dealers, and 49
custodian banks.\408\ Additionally, while there are three Matching/ETC
Providers, the Commission believes that only one of these is currently
providing services in the U.S. We estimate there are 1,282 broker-
dealers that would incur investor education costs. One way to establish
a total industry initial compliance cost estimate would be to multiply
each estimated per-entity cost by the respective number of entities and
sum these values, which would result in an estimate of $4.97
billion.\409\ The Commission, however, preliminarily believes that this
estimate is likely to overstate the true initial cost of transition to
a T+1 settlement cycle for a number of reasons. First, our per-entity
estimates do not account for the heterogeneity in market participant
size, which may have a significant impact on the costs that market
participants face. While the BCG Study included both estimates of the
number of entities in different size categories as well as estimates of
costs that an entity in each size category is likely to incur, it did
not provide sufficient underlying information to allow the Commission
to estimate the relationship between participant size and compliance
cost and thus we cannot produce comparable estimates. The Commission
solicits comment on the extent to which market participants believe
that the compliance costs for proposed Rule 15c6-1(a) would scale with
market participant size.
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\408\ The estimate for the number of buy-side firms is based on
the Commission's 13(f) holdings information filers with over $1
billion in assets under management, as of December 31, 2020. The
estimate for the number of broker-dealers is based on FINRA FOCUS
Reports of firms reporting as self-clearing. See supra note 312 and
accompanying text. The estimate for the number of custodian banks is
based on the number of ``settling banks'' listed in DTC's Member
Directories, available at http://www.dtcc.com/client-center/dtc-directories.
\409\ Calculated as 156 broker-dealers (self-clearing) x
$9,914,000 + 1,282 broker-dealers (self-clearing and introducing) x
$30,000 + 49 custodian banks x $1,337,000 + 1,229 buy-side firms x
$2,673,000 + 1 Matching/ETC Providers x $12,575,000 + 2 FMUs x
$12,575,000 + (IA costs of 30,500 + 16,000 + 1,095,000) + (CMSP
initial costs of $26,000) = $ 4,974,556,500.
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Second, investments by third-party service providers may mean that
many of the estimated compliance costs for market participants are
duplicated. The BCG Study suggests that ``leverage'' from service
providers may yield a savings of $194 million, reducing aggregate costs
by approximately 29%.\410\ The Commission seeks further comment on the
extent to which the efficiencies generated by the investments of
service providers might reduce the compliance costs of market
participants. Taking into account potential cost reductions due to
repurposing existing systems and using service providers as described
above, the Commission preliminarily believes that $3.5 billion
represents a reasonable range for the total industry initial compliance
costs.\411\
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\410\ See BCG Study, supra note 22, at 79.
\411\ The lower bound of this range is calculated as ($4.97
billion x (1-0.29)) = $3.5 billion.
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In addition to these initial costs, a transition to a shorter
settlement cycle may also result in certain ongoing industry-wide
costs. Though the Commission preliminarily believes that a move to a
shorter settlement cycle would generally bring with it a reduced
reliance on manual processing, a shorter settlement cycle may also
exacerbate remaining operational risk. This is because a shorter
settlement cycle would provide market participants with less time to
resolve errors. For example, if there is an entry error in the trade
match details sent by either counterparty for a trade, both
counterparties would have one extra day to resolve the error under the
baseline than in a T+1 environment. For these errors, a shorter
settlement cycle
[[Page 10492]]
may increase the probability that the error ultimately results in a
settlement fail. However, the Commission preliminarily believes that a
large variety of operational errors are possible in the clearance and
settlement process and some of these errors are likely to be
infrequent, the Commission is unable to quantify the impact that a
shorter settlement cycle may have on the ongoing industry-wide costs
stemming from a potential increase in operational risk.
D. Reasonable Alternatives
1. Amend 15c6-1(c) to T+2
The Commission is proposing to delete Rule 15c6-1(c) that
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.\412\
The Commission has considered amending Rule 15c6-1(c) to shorten the
settlement cycle for firm commitment offerings to T+2.
---------------------------------------------------------------------------
\412\ See supra Part III.A.3.
---------------------------------------------------------------------------
The T+1 Report stated that paragraph (c) is rarely used in the
current T+2 settlement environment.\413\ The Commission adopted
paragraph (c) of Rule 15c6-1 in 1995, two years after Rule 15c6-1 was
originally adopted.\414\ 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.\415\ 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).\416\
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\413\ T+1 Report, supra note 18, at 33-35.
\414\ 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'').
\415\ 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.
\416\ Id.
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As discussed further in Part III.E.4, 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 do not require time to print and deliver prospectus--a point
originally cited by many commenters in support of adopting paragraph
(c).\417\
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\417\ Id. at 32.
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Although rarely used in the current T+2 settlement environment, the
IWG expects a T+1 standard settlement cycle would increase reliance on
paragraph (c).\418\ 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.\419\
The T+1 Report cites issues with respect to documentation and other
operational elements of equity offerings that may delay settlement to
T+2 in a T+1 environment. As the Commission is not currently aware of
any specific documentation associated with firm commitment offerings
that cannot be completed by T+1, the Commission preliminarily believes
that the need to complete possibly complex transaction documentation
prior to settlement does not justify proposing a T+2 standard
settlement cycle for equity offerings.
---------------------------------------------------------------------------
\418\ T+1 Report, supra note 18, at 33-35.
\419\ Id. at 33.
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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. 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. 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).
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 preliminarily 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 complex
documentation with respect to the transaction.
2. Propose 17Ad-27 To Require Certain Outcomes
The Commission is proposing Rule 17Ad-27 to require a CMSP
establish, implement, maintain and enforce policies and procedures to
facilitate straight-through processing for transactions involving
broker-dealers and their customers.\420\ Proposed Rule 17Ad-27 also
would require a CMSP to submit every twelve months to the Commission a
report that describes the following: (i) The CMSP's current policies
and procedures for facilitating straight-through processing; (ii) its
progress in facilitating straight-through processing during the twelve
month period covered by the report; and (iii) the steps the CMSP
intends to take to facilitate and promote straight-through processing
during the twelve month period that follows the period covered by the
report.
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\420\ See supra Part III.D (discussing the proposed rule); see
also supra Part III.D.1 (discussing straight-through processing).
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The Commission has taken a ``policies and procedures'' approach in
developing the proposed rule because it preliminarily believes such an
approach will remain effective over time as CMSPs consider and offer
new technologies and operations to improve the settlement of
institutional trades. The Commission also believes that improving the
CMSPs' systems to facilitate straight-through processing can help
market participants consider additional ways to make their own systems
more efficient. In addition, a ``policies and procedures'' approach can
help ensure that a CMSP considers in a holistic fashion how the
obligations it applies to its users will advance the implementation of
methodologies, operational capabilities, systems, or services that
support straight-through processing.
The Commission has considered as an alternative to the policies and
procedures approach in proposed Rule 17Ad-27, proposing a rule to
require CMSPs to achieve certain outcomes that
[[Page 10493]]
would facilitate straight-through processing. For example, the
Commission could propose to require that a CMSP do the following: (i)
Enable the users of its service to complete the matching, confirmation,
or affirmation of the securities transaction as soon as technologically
and operationally practicable and no later than the end of the day on
which the transaction was effected by the parties to the transaction;
or (ii) forward or otherwise submit the transaction for settlement as
soon as technologically and operationally practicable, as if using
fully automated systems.
The Commission believes that these requirements would achieve
certain discrete objectives with respect to straight-through processing
and would promote prompt and accurate clearance and settlement. The
Commission believes, however, that the proposed approach requires
policies and procedures that include a holistic review and framework
for considering how systems and processes facilitate straight-through
processing and that can adapt over time to changes in technology and
operations, both among and beyond the CMSP's systems.
E. Request for Comment
The Commission solicits comment on the potential economic impact of
the proposed amendment to Rule 15c6-1(a), the proposed deletion of Rule
15c6-1(c), proposed new Rule 15c6-2, the proposed amendment to Rule
204-2, and proposed new Rule 17Ad-27. In addition, the Commission
solicits comment on related issues that may inform the Commission's
views regarding the economic impact of the proposed amendment to Rule
15c6-1(a), the proposed deletion of Rule 15c6-1(c), proposed new Rule
15c6-2, the proposed amendment to Rule 204-2, and proposed new Rule
17Ad-27 as well as alternatives to the proposed amendments, deletion,
and new rules. The Commission in particular seeks comment on the
following:
144. The Commission invites commenters to provide additional data
on the time it takes to complete each step within the current clearance
and settlement process. What are current constraints or impediments for
each step within the clearance and settlement process that would limit
the ability to shorten the settlement cycle from T+2 to T+1? Do these
constraints or impediments vary by market participant type?
145. The Commission invites commenters to provide additional data
on the expected collateral efficiency gains from a T+1 standard
settlement cycle. How would clearing fund deposits change as a result
of the proposed amendment? To what extent does this change fully
represent the change to the level of risk associated with the
settlement cycle for securities transactions?
146. The Commission invites commenters to discuss the impact of a
T+1 settlement cycle on broker-dealers and their customers, including
custodians who may hold securities on behalf of said customers. What
types of adaptations would be necessary to comply with a T+1 settlement
cycle, and what are their relative costs and benefits?
147. The Commission invites commenters to provide data regarding
the extent to which a broker-dealer engages in ``internalization'' of a
transaction on behalf of a customer. How prevalent are internalization
practices? How does the volume of internalization compare to the volume
of transactions that are submitted for clearing? \421\
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\421\ See Part II.B.2 (further discussing internalization by
broker-dealers).
---------------------------------------------------------------------------
148. The Commission invites commenters to discuss the potential
impact of a T+1 standard settlement cycle with respect to cross-border
and cross-asset class transactions. Would a T+1 standard settlement
cycle make any cross-border or cross-asset transactions more or less
costly?
149. The Commission invites commenters to discuss the anticipated
market changes, if any, if the proposed amendment to Rule 15c6-1(a)
were not adopted. Which activities necessary for compliance with a T+1
standard settlement cycle would occur in the absence of the proposed
rule amendment and how quickly would they occur?
150. In addition to the prospective impact on costs/burdens, the
Commission solicits comments related to the credit, market, liquidity,
legal, and operational risks (increase or decrease) associated with
shortening the standard settlement cycle to T+1, and in particular,
quantification of such risks.
151. Are there types of customers other than institutional
customers that would be affected by proposed Rule 15c6-2? If so, please
describe what types of customers. Would the rules impose an
unanticipated burden on these customers? Please explain.
152. What are the benefits and costs of requiring broker dealers to
enter into written agreements with customers engaging in the trade date
allocation, confirmation and affirmation process where such agreements
require the process to be completed by the end of the day on trade
date?
153. What are the relative burdens of proposed Rule 15c6-2 on the
different market participants involved in the allocation, confirmation,
and affirmation process, particularly smaller market participants?
VI. Paperwork Reduction Act
Two of the rule proposals, proposed Rule 17Ad-27 and the proposed
amendment to Rule 204-2(a), contain ``collection of information''
requirements within the meaning of the Paperwork Reduction Act of 1995
(``PRA'').\422\ The Commission is submitting the proposed collections
of information to the Office of Management and Budget (``OMB'') for
review in accordance with the PRA. For the proposed amendment to Rule
204-2(a), the title of the information collection is ``Rule 204-2 under
the Investment Advisers Act of 1940'' (OMB control number 3235-0278).
For proposed Rule 17Ad-27, the title of the information collection is
``Clearing Agency Standards for Operation and Governance'' (OMB Control
No. 3235-0695). An agency may not conduct or sponsor, and a person is
not required to respond to, a collection of information unless it
displays a currently valid OMB control number.
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\422\ See 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
A. Proposed Amendment to Rule 204-2
Under Section 204 of the Advisers Act, investment advisers
registered or required to register with the Commission under Section
203 of the Advisers Act must make and keep for prescribed periods such
records (as defined in Section 3(a)(37) of the Exchange Act), furnish
copies thereof, and make and disseminate such reports as the
Commission, by rule, may prescribe as necessary or appropriate in the
public interest or for the protection of investors. Rule 204-2 sets
forth the requirements for maintaining and preserving specified books
and records. This collection of information is found at 17 CFR 275.
204-2 and is mandatory. The Commission staff uses the collection of
information in its regulatory and examination program. Responses to the
requirements of the proposed amendment to Rule 204-2 that are provided
to the Commission in the context of its regulatory and examination
program would be kept confidential subject to the provisions of
applicable law.\423\
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\423\ See Section 210(b) of the Advisers Act, 15 U.S.C. 80b-
10(b).
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[[Page 10494]]
The proposed amendment to Rule 204-2 would require advisers to
maintain records of certain documents described in proposed Rule 15c6-2
if the adviser is a party to a contract under that rule. Rule 15c6-2
specifically identifies ``allocations, confirmations or affirmations''
as documents that must be completed no later than the end of the day on
trade date. The respondents to this collection of information are
approximately 13,804 advisers registered with the Commission.\424\ The
Commission further estimates that 2,521 of these registered advisers
would not be required to make and keep the proposed required records
because they do not have any institutional advisory clients.\425\
Therefore, the remaining 11,283 of these advisers, or 81.74% of the
total registered advisers that are subject to Rule 204-2, would enter a
contract with a broker or dealer under proposed Rule 15c6-2 and
therefore be subject to the related proposed recordkeeping amendment.
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\424\ Based on data from Form ADV as of December, 2020.
\425\ Based on data from Form ADV as of December, 2020, this
figure represents registered investment advisers that: (i) Report no
clients that are registered investment companies in response to Item
5.D, (ii) do not report any institutional separately managed
accounts in Item 5.D., or separately managed account exposures in
Section 5.K.(1) of Schedule D, and (iii) do not advise any reported
hedge funds as per Section 7.B.(1) of Schedule D.
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As discussed above, based on staff experience, the Commission
believes that many advisers already have recordkeeping processes in
place to retain records of confirmations received, and allocations and
affirmations sent to brokers or dealers.\426\ The Commission believes
that while these are customary and usual business practices for many
advisers, some small and mid-size advisers do not currently retain
these records. Further, the Commission believes that the vast majority
of these books and records are kept in electronic fashion in a trade
order management or other recordkeeping system, through system logs of
file transfers, email archiving or as part of DTC's Institutional Trade
Processing services, but that some advisers maintain paper records
(e.g., confirmations) and/or communicate allocations by telephone. In
addition, as noted in Section III.C, above, we believe that up to 70%
of institutional trades are affirmed by custodians, and therefore
advisers may not retain or have access to the affirmations these
custodians sent to brokers or dealers.\427\ Also as noted above, based
on staff experience, the Commission believes that many advisers send
allocations and affirmations electronically to brokers or dealers, and
therefore these records are already date and time stamped in many
instances. Nevertheless, the proposed amendments would explicitly add a
new requirement to date and time stamp allocations and affirmations
(but not confirmations), and thus increase this collection of
information burden. The Commission estimates that the associated
increase in burden would be included in our estimate described in the
chart below for advisers that we believe do not electronically send
allocations and affirmations to their brokers or dealers.
---------------------------------------------------------------------------
\426\ See supra Section III.C.
\427\ See DTCC ITP Forum Remarks, supra note 58.
---------------------------------------------------------------------------
We describe the estimated burdens associated with the proposed
recordkeeping amendment below. These estimated changes from the
currently approved burden are due to the estimated increase in the
internal hour and internal time cost burden that would be due to the
proposed amendment, and the increase in the number of registered
investment advisers (an increase of 80 advisers).
Table 1--Summary of Burden Estimates for the Proposed Amendment to Rule 204-2
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual
Advisers Initial internal hour Annual internal hour Wage rate \2\ Internal time cost external cost
burden burden \1\ per year burden \3\
--------------------------------------------------------------------------------------------------------------------------------------------------------
220 small and mid-size advisers 2 hours per adviser \5\... 2 hours, amortized $69.36 per hour........... 0.667 hour x $69.36 $0
that have institutional clients, over a 3 year per hour = $43.60
that we believe do not currently period, for an per adviser per
maintain the proposed records \4\. annual ongoing year. $69.36 x
internal burden of 146.74 aggregate
0.667 hours per year hours = $10,159.16
(220 advisers x aggregate cost per
0.667 hours each = year.
146.74 aggregate
annual hours).
--------------------------------------------------------------------------------------------------------------------------------------------------------
113 advisers that have 2 hours per adviser \7\... 2 hours, amortized $69.36 per hour........... 0.667 hour x $69.36 0
institutional clients that staff over a 3 year per hour = $43.60
estimates do not send allocations period, for an per adviser per
or affirmations electronically to annual ongoing year. $69.36 per
brokers or dealers (e.g., they internal burden of hour x 75.37
communicate them by telephone) 0.667 hours per year aggregate hours =
\6\. (113 advisers x $5,227.67 aggregate
0.667 hours each = cost per year.
75.37 aggregate
annual hours).
--------------------------------------------------------------------------------------------------------------------------------------------------------
7,898 advisers with institutional 2 hours per adviser \9\... 2 hours, amortized $69.36 per hour........... 0.667 hour x $69.36 0
clients that the staff estimates over a 3 year per hour = $43.60
make institutional trades that period, for an per adviser per
are affirmed by custodians, and annual ongoing year. $69.36 per
therefore do not maintain the internal burden of hour x 5,267.97
proposed affirmations \8\. 0.667 hours per year aggregate hours =
(7,898 advisers x $365,386.40
0.667 hours each = Aggregate cost per
5,267.97 aggregate year.
hours).
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total estimated burden per adviser per year resulting from the 5,490.08 aggregate $380,791.95 per year (5,490.08 aggregate hours 0
proposed amendment. hours per year,\10\ per year x $69.36 per hour)
or 0.4 blended hours
per year per adviser
\11\.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Currently approved aggregate burden........................... 2,764,563 aggregate $175,980,426 0
hours per year.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Estimated revised aggregate burden............................ 2,786,199 hours \12\. $193,250,787.60 \13\ 0
--------------------------------------------------------------------------------------------------------------------------------------------------------
Notes:
\1\ We believe that the estimated internal hour burdens associated with the proposed amendment would be one-time initial burdens, and we amortize these
burdens over three years.
[[Page 10495]]
\2\ As with our estimates relating to the previous amendments to Advisers Act Rule 204-2, the Commission expects that performance of these functions
would most likely be allocated between compliance clerks and general clerks, with compliance clerks performing 17% of the function and general clerks
performing 83% of the function. Data from SIFMA's Office Salaries in the Securities Industry 2013, modified by Commission staff to account for an 1800-
hour work-year and inflation, and multiplied by 2.93 to account for bonuses, firm size, employee benefits and overhead, suggest that costs for these
position are $76 and $68, respectively. A blended hourly rate is therefore: (.17 x $76) + (.83 x $68) = $69.36 per hour.
\3\ Under the currently approved PRA for Rule 204-2, there is no cost burden other than the cost of the hour burden described herein, and we believe
that the proposed amendment would not result in any cost burden other than the cost of the hour burden.
\4\ Based on staff experience, we estimate that approximately 50% of small and mid-sized registered investment advisers that have institutional clients,
do not currently maintain the proposed records. Based on Form ADV data as of December 2020, we estimate that there are 199 and 241 mid-sized and small
entity RIAs, respectively, that would be required to retain the proposed new records, for a total of 440 advisers (these are advisers that report the
following on Form ADV Part 1A as of December 2020: (i) Having any clients that are registered investment companies in response to Item 5.D, (ii)
having any institutional separately managed accounts in Item 5.D., or separately managed account exposures in Section 5.K.(1) of Schedule D, or (iii)
advising any reported hedge funds as per Section 7.B.(1) of Schedule D). The categories of mid-size and small entity advisers are based on responses
to the following Items of Form ADV Part 1A: Item 2.a.(2) (mid-size RIA) and Items 5.F. and 12 (small entity). 50% of 440 advisers = 220 advisers.
\5\ We estimate an initial burden of 2 hours per adviser, to update procedures and instruct personnel to retain the proposed required records in the
advisers' electronic recordkeeping systems, including any confirmations that they may receive in paper format and do not currently retain. We believe
that these advisers already have recordkeeping systems to accommodate these records, which would include, at a minimum, spreadsheet formats and email
retention systems which have an ability to capture a date and time stamp. For those advisers maintaining date and time stamped electronic records
already, we estimate no incremental compliance costs.
\6\ We believe that only a small number of advisers, or 1% of advisers that have institutional clients, do not send allocations or affirmations
electronically to brokers or dealers (e.g., they communicate them by telephone). 1% of 11,283 RIAs with institutional clients = 112.83 advisers
(rounded to 113). For new large advisers, we estimate that there would be no incremental cost associated with this proposed amendment, as we believe
these advisers would implement electronic systems as part of their initial compliance with Rule 204-2, and that these electronic systems would have an
ability to capture a date and time stamp.
\7\ We estimate that these advisers would incur an initial burden of 2 hours of updating their procedures and training their personnel to send these
communications through their existing electronic systems (such as, at a minimum, their current spreadsheet formats and current email and electronic
retention system to maintain electronic records with date and time stamps). Because these email and electronic retention systems would provide date
and time stamps, we estimate there would be no incremental compliance costs in connection with the proposed date and time stamp requirement.
\8\ As noted above, we estimate that 70% of institutional trades are affirmed by custodians, and therefore advisers may not retain or have access to the
affirmations these custodians sent to brokers or dealers. We believe that some of these advisers themselves, however, sometimes send affirmations to
brokers or dealers. Because we do not know the number of advisers that correlate to these trades, we estimate for purposes of this collection of
information that 70% of advisers with institutional clients make institutional trades that are affirmed by custodians. This estimate equals 7,898.1
advisers, rounded to 7,898 advisers (70% of 11,283 RIAs with institutional clients = approximately 7,898 advisers).
\9\ We estimate that the proposed amendments to rule 204-2 would result in an initial increase in the collection of information burden estimate by 2
hours for these advisers, to direct their institutional clients' custodians to electronically copy the adviser on any affirmations sent through email
or for the adviser to use its systems to issue affirmations.
\10\ 146.74 hours + 75.37 hours + 5,267.97 hours = 5,490.08 hours.
\11\ 5,490.08 aggregate hours per year/13,804 total RIAs that are subject to Rule 204-2 = a blended average of 0.4 hours per adviser per year.
\12\ The currently approved collection of information burden is 2,764,563 aggregate hours for 13,724 advisers, or 201.44 hours per adviser. The proposed
new collection of information burden would add approximately 0.4 blended hours per adviser per year, for a total estimate of 201.84 blended hours per
adviser per year, or 2,786,199 aggregate hours under amended Rule 204-2 for all registered advisers subject to the rule (201.84 blended hours per
adviser x 13,804 RIAs subject to Rule 204-2 = 2,786,199 aggregate burden hours for RIAs).
\13\ (201.84 estimated revised burden hours per adviser x $69.36 per hour) x 13,804 RIAs = $193,250,787.60 revised aggregate annual cost of the hour
burden for Rule 204-2.
B. Proposed Rule 17Ad-27
The purpose of the collections under proposed Rule 17Ad-27 is to
ensure that CMSPs facilitate the ongoing development of operational and
technological improvements associated with the straight-through
processing of institutional trades, which may in turn facilitate
further shortening of the settlement cycle in the future. The
collections are mandatory. To the extent that the Commission receives
confidential information pursuant to this collection of information,
such information would be kept confidential subject to the provisions
of applicable law.\428\
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\428\ See, e.g., 5 U.S.C. 552 et seq. Exemption 4 of the Freedom
of Information Act provides an exemption for trade secrets and
commercial or financial information obtained from a person and
privileged or confidential. See 5 U.S.C. 552(b)(4). Exemption 8 of
the Freedom of Information Act provides an exemption for matters
that are contained in or related to examination, operating, or
condition reports prepared by, on behalf of, or for the use of an
agency responsible for the regulation or supervision of financial
institutions. See 5 U.S.C. 552(b)(8).
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Respondents under this rule are the three CMSPs to which the
Commission has granted an exemption from registration as a clearing
agency. The Commission anticipates that one additional entity may seek
to become a CMSP in the next three years, and so for purposes of this
proposal the Commission has assumed four respondents.
Proposed Rule 17Ad-27 would require a CMSP to establish, implement,
maintain, and enforce written policies and procedures. Based on the
similar policies and procedures requirements and the corresponding
burden estimates previously made by the Commission for Rules 17Ad-
22(d)(8) and 17Ad-22(e)(2),\429\ the Commission estimates that
respondent CMSPs would incur an aggregate one-time burden of
approximately 56 hours to create new policies and procedures,\430\ and
that the aggregate cost of this one time burden would be $27,280.\431\
---------------------------------------------------------------------------
\429\ See Clearing Agency Standards Adopting Release, supra note
404; CCA Standards Adopting Release, supra note 404.
\430\ This figure was calculated as follows: (Assistant General
Counsel for 8 hours + Compliance Attorney for 6 hours) = 14 hours x
4 respondent CMSPs = 56 hours.
\431\ This figure was calculated as follows: (Assistant General
Counsel at $602/hour x 8 hours = $4,816) + (Compliance Attorney at
$334/hour x 6 hours = $2,004) = $6,820 x 4 CMSPs equals $27,280.
---------------------------------------------------------------------------
Proposed Rule 17Ad-27 would impose ongoing burdens on a respondent
CMSP as follows: (i) Ongoing monitoring and compliance activities with
respect to the written policies and procedures required by the proposed
rule; and (ii) ongoing documentation activities with respect to the
required annual report. Based on the similar reporting requirements and
the corresponding burden estimates previously made by the Commission
for Rule 17Ad-22(e)(23),\432\ the Commission estimates that the ongoing
activities required by proposed Rule 17Ad-27 would impose an aggregate
annual burden on respondent CMSPs of 140 hours,\433\ and an aggregate
cost of $58,900.\434\ The total industry cost is estimated to be
$84,592.\435\
---------------------------------------------------------------------------
\432\ See CCA Standards Adopting Release, supra note 404, at
70899.
\433\ This figure was calculated as follows: (Compliance
Attorney for 25 hours + Computer Operations Manager for 10 hours) =
34 hours x 4 respondent CMSPs = 136 hours. As discussed previously,
supra note 407, the Commission estimates that the Inline XBRL
requirement would require respondent CMSPs to incur one additional
ongoing burden hour to apply and review Inline XBRL tags, as
follows: (Compliance Attorney for 1 hour) x 4 CMSPs = 4 hours. Taken
together, the total ongoing burden is 140 hours (136 hours + 4 hours
= 140 hours).
\434\ This figure was calculated as follows: [(Compliance
Attorney at $397/hour x 24 hours = $9,528) + (Computer Operations
Manager at $480/hour x 10 hours = $4,800)] = $14,328 x 4 CMSPs =
$57,312. The Commission also estimates the costs associated with the
one burden hour associated with applying and review Inline XBRL tags
as follows: (Compliance Attorney at $397/hour x 1 hour = $397) x 4
CMSPs = $1,588. Taken together, the total amount is $58,900 ($57,312
+ $1,588 = $58,900).
\435\ This figure was calculated as follows: $27,280 (industry
one-time burden) + $58,900 (industry ongoing burden) = $84,592.
[[Page 10496]]
Table 2--Summary of Burden Estimates for Proposed Rule 17Ad-27
--------------------------------------------------------------------------------------------------------------------------------------------------------
Initial
Type of Number of burden per Ongoing burden Total annual Total industry
Name of information collection burden respondents entity per entity burden per burden (hours)
(hours) (hours) entity (hours)
--------------------------------------------------------------------------------------------------------------------------------------------------------
17Ad-27................................................. Recordkeeping 4 56 35 91 364
--------------------------------------------------------------------------------------------------------------------------------------------------------
C. Request for Comment
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits
comments to:
154. Evaluate whether the proposed collections of information are
necessary for the proper performance of the Commission's functions,
including whether the information shall have practical utility;
155. Evaluate the accuracy of the Commission's estimates of the
burdens of the proposed collections of information;
156. Determine whether there are ways to enhance the quality,
utility, and clarity of the information to be collected;
157. Evaluate whether there are ways to minimize the burden of
collection of information on those who are to respond, including
through the use of automated collection techniques or other forms of
information technology; and
158. Evaluate whether the proposed rules and rule amendments would
have any effects on any other collection of information not previously
identified in this section.
Persons submitting comments on the collection of information
requirements should direct them to the Office of Management and Budget,
Attention: Desk Officer for the Securities and Exchange Commission,
Office of Information and Regulatory Affairs, Washington, DC 20503, and
should also send a copy of their comments to Secretary, Securities and
Exchange Commission, 100 F Street NE, Washington, DC 20549-1090, with
reference to File Number S7-[ ]-22. Requests for materials submitted to
OMB by the Commission with regard to this collection of information
should be in writing, with reference to File Number S7-[ ]-22 and be
submitted to the Securities and Exchange Commission, Office of FOIA/PA
Services, 100 F Street NE, Washington, DC 20549-2736. As OMB is
required to make a decision concerning the collection of information
between 30 and 60 days after publication, a comment to OMB is best
assured of having its full effect if OMB receives it within 30 days of
publication.
VII. Small Business Regulatory Enforcement Fairness Act
Under the Small Business Regulatory Enforcement Fairness Act of
1996,\436\ a rule is ``major'' if it has resulted, or is likely to
result in: An annual effect on the economy of $100 million or more; a
major increase in costs or prices for consumers or individual
industries; or significant adverse effects on competition, investment,
or innovation. The Commission requests comment on whether the proposed
rules and rule amendments would be a ``major'' rule for purposes of the
Small Business Regulatory Enforcement Fairness Act. In addition, the
Commission solicits comment and empirical data on: The potential effect
on the U.S. economy on annual basis; any potential increase in costs or
prices for consumers or individual industries; and any potential effect
on competition, investment, or innovation.
---------------------------------------------------------------------------
\436\ Public Law 104-121, Title II, 110 Stat. 857 (1996).
---------------------------------------------------------------------------
VIII. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires the Commission,
in promulgating rules, to consider the impact of those rules on small
entities.\437\ Section 603(a) of the Administrative Procedure Act,\438\
as amended by the RFA, generally requires the Commission to undertake a
regulatory flexibility analysis of all proposed rules to determine the
impact of such rulemaking on ``small entities.'' \439\ Section 605(b)
of the RFA states that this requirement shall not apply to any proposed
rule which, if adopted, would not have a significant economic impact on
a substantial number of small entities.\440\ The Commission has
prepared the following initial regulatory flexibility analysis in
accordance with Section 603(a) of the RFA.
---------------------------------------------------------------------------
\437\ See 5 U.S.C. 601 et seq.
\438\ 5 U.S.C. 603(a).
\439\ Section 601(b) of the RFA permits agencies to formulate
their own definitions of ``small entities.'' See 5 U.S.C. 601(b).
The Commission has adopted definitions for the term ``small entity''
for the purposes of rulemaking in accordance with the RFA. These
definitions, as relevant to this rulemaking, are set forth in 17 CFR
240.0-10.
\440\ See 5 U.S.C. 605(b).
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A. Proposed Rules and Amendments for Rules 15c6-1, 15c6-2, and 204-2
1. Reasons for, and Objectives of, the Proposed Actions
The Commission is proposing to amend Exchange Act Rule 15c6-1 to
shorten the standard settlement cycle for securities transactions
(other than those excluded by the rule) from T+2 to T+1. The Commission
believes that the proposed amendments to Rule 15c6-1 to shorten the
standard settlement cycle from two days to one day would offer market
participants benefits by reducing exposure to credit, market, and
liquidity risk, as well as related reductions to overall systemic risk.
The Commission is also proposing new Exchange Act 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. The Commission believes that new Rule 15c6-2 would help
facilitate settlement of these institutional trades in a T+1 or shorter
standard settlement cycle by promoting the timely transmission of trade
data necessary to achieve settlement. Furthermore, the Commission
believes that proposed Rule 15c6-2 would foster continued improvements
in institutional trade processing, which should in turn also further
improve accuracy and efficiency, reduce fails, and in turn,
collectively reduce operational risk.
The Commission is proposing a related amendment to investment
adviser recordkeeping rule under the Advisers Act designed to ensure
that advisers that are parties to contracts under proposed Rule 15c6-2
retain records of confirmations received, and of the allocations and
affirmations sent to a broker or dealer, with a date and time stamp
that indicates when the allocation or affirmation was sent to the
broker or dealer.
2. Legal Basis
The Commission proposes amendments to Rule 15c6-1 and new Rule
15c6-2 pursuant to authority set forth in the Exchange Act,
particularly
[[Page 10497]]
Sections 15(c)(6),\441\ 17A,\442\ and 23(a).\443\ The Commission
proposes an amendment to Rule 204-2 pursuant to authority set forth in
Sections 204 and 211 of the Advisers Act.\444\
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\441\ 15 U.S.C. 78o(c)(6).
\442\ 15 U.S.C. 78q-1.
\443\ 15 U.S.C. 78w(a).
\444\ 15 U.S.C. 80b-4 and 80b-11.
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3. Small Entities Subject to the Proposed Rule and Proposed Rule
Amendments
Paragraph (c) of Exchange Act Rule 0-10 provides that, for purposes
of Commission rulemaking in accordance with the provisions of the RFA,
when used with reference to a broker or dealer, the Commission has
defined the term ``small entity'' to mean a broker or dealer: (1) With
total capital (net worth plus subordinated liabilities) of less than
$500,000 on the date in the prior fiscal year as of which its audited
financial statements were prepared pursuant to Rule 17a-5(d) under the
Exchange Act,\445\ or if not required to file such statements, a
broker-dealer with total capital (net worth plus subordinated
liabilities) of less than $500,000 on the last business day of the
preceding fiscal year (or in the time that it has been in business, if
shorter); and (2) is not affiliated with any person (other than a
natural person) that is not a small business or small
organization.\446\
---------------------------------------------------------------------------
\445\ 17 CFR 240.17a-5(c).
\446\ 17 CFR 240.0-10(d).
---------------------------------------------------------------------------
Under Commission rules, for the purposes of the Advisers Act and
the Regulatory Flexibility Act, an investment adviser generally is a
small entity if it: (i) Has assets under management having a total
value of less than $25 million; (ii) did not have total assets of $5
million or more on the last day of the most recent fiscal year; and
(iii) does not control, is not controlled by, and is not under common
control with another investment adviser that has assets under
management of $25 million or more, or any person (other than a natural
person) that had total assets of $5 million or more on the last day of
its most recent fiscal year.\447\
---------------------------------------------------------------------------
\447\ See 17 CFR 275.0-7.
---------------------------------------------------------------------------
The proposed amendments to Rule 15c6-1 would prohibit broker-
dealers, including those that are small entities, from effecting or
entering into a contract for the purchase or sale of a security (other
than an exempted security, government security, municipal security,
commercial paper, bankers' acceptances, or commercial bills) that
provides for payment of funds and delivery of securities no 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.
Proposed Rule 15c6-2 would prohibit broker-dealers, where the broker-
dealer has agreed with its 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 (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 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). Based on FOCUS
Report data, the Commission estimates that, as of June 30, 2021,
approximately 1,439 of broker-dealers might be deemed small entities
for purposes of this analysis.
The proposed amendment to Rule 204-2 would require that advisers
that are parties to contracts under proposed Rule 15c6-2 retain records
of confirmations received, and of the allocations and affirmations sent
to a broker or dealer, with a date and time stamp for each allocation
(as applicable) and each affirmation that indicates when the allocation
or affirmation was sent to the broker or dealer. As discussed in Part
VI above, the Commission estimates that based on IARD data as of
December 30, 2020, approximately 11,283 investment advisers would be
subject to the proposed amendment to rule 204-2 under the Advisers Act.
Our proposed amendment would not affect most investment advisers that
are small entities (``small advisers'') because they are generally
registered with one or more state securities authorities and not with
the Commission. Under Section 203A of the Advisers Act, most small
advisers are prohibited from registering with the Commission and are
regulated by state regulators.\448\ Based on IARD data, the Commission
estimates that as of December 2020, approximately 431 advisers
registered with the Commission are small entities under the Regulatory
Flexibility Act.\449\ Of these, the Commission anticipates that 199, or
46% of small advisers registered with the Commission, would be subject
to the proposed amendment under the Advisers Act.\450\
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\448\ 15 U.S.C. 80b-3a.
\449\ Based on responses from registered investment adviser to
Items 5.F. and 12 of Form ADV.
\450\ Based on data from Form ADV as of December 2020, this
figure represents registered investment advisers that: (i) Report
clients that are registered investment companies in response to Item
5.D, (ii) report any institutional separately managed accounts in
Item 5.D., or have particular separately managed account exposures
in Section 5.K.(1) of Schedule D, or (iii) advise reported hedge
funds as per Section 7.B.(1) of Schedule D.
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4. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
The proposed amendments to Rule 15c6-1 would not impose any new
reporting or recordkeeping requirements on broker-dealers that are
small entities. However, the proposed amendments to Rule 15c6-1 may
impact certain broker-dealers, including those that are small entities,
to the extent that broker-dealers may need to make changes to their
business operations and incur certain costs in order to operate in a
T+1 environment.
For example, conversion to a T+1 standard settlement cycle may
require broker-dealers, including those that are small entities, to
make changes to their business practices, as well as to their computer
systems, and/or to deploy new technology solutions. Implementation of
these changes may require broker-dealers to incur new or increased
costs, which may vary based on the business model of individual broker-
dealers as well as other factors.
Additionally, conversion to a T+1 standard settlement cycle may
also result in an increase in costs to certain broker-dealers who
finance the purchase of customer securities until the broker-dealer
receives payment from its customers. To pay for securities purchases,
many customers liquidate other securities or money fund balances held
for them by their broker-dealers in consolidated accounts such as cash
management accounts. However, some broker-dealers may elect to finance
the purchase of customer securities until the broker-dealer receives
payment from its customers for those customers that do not choose to
liquidate other securities or have a sufficient money fund balance
prior to trade execution to pay for securities purchases. Broker-
dealers that elect to finance the purchase of customer securities may
incur an increase in costs in a T+1 environment resulting from
settlement occurring one day earlier unless the broker-dealer can
expedite customer payments.
Proposed Rule 15c6-2 would not impose any new reporting or
recordkeeping requirements on broker-dealers that are small entities.
However,
[[Page 10498]]
the proposed rule may impact certain broker-dealers, including those
that are small entities, to the extent that broker-dealers may need to
make changes to their business operations and incur certain costs in
order to achieve trade date completion of institutional trade
allocations, confirmations, and affirmations. For example, completion
of allocations, confirmations, and affirmations on trade date may
require broker-dealers, including those that are small entities, to
make changes to their business practices, as well as to their computer
systems, and/or to deploy new technology solutions. Implementation of
these changes may require broker-dealers to incur new or increased
costs, which may vary based on the business model of individual broker-
dealers as well as other factors.
The proposed amendment to Rule 204-2 imposes certain reporting and
compliance requirements on certain investment advisers, including those
that are small entities. It would require them to retain records of
each confirmation received, and any allocation and each affirmation
sent given to a broker or dealer, 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. The reasons
for and objectives of, the proposed amendment to the books and records
rule are discussed in more detail in Part III.C. These requirements as
well as the costs and burdens on investment advisers, including those
that are small entities, are discussed in Parts V and VI and below. As
discussed above, there are approximately 431 small advisers, and
approximately 199 small advisers would be subject to amendments to the
books and records rule. As discussed in Part VI.A, the proposed
amendments to Rule 204-2 under the Advisers Act would increase the
annual burden by approximately 0.4 blended hours per adviser per year,
or an increased burden of 172.4 blended hours in the aggregate for
small advisers.\451\ The Commission therefore believes the annual
monetized aggregate cost to small advisers associated with our proposed
amendments would be approximately $11,957.66.\452\
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\451\ 0.4 hour x 431 small advisers = 172.4 blended hours in the
aggregate for small advisers.
\452\ 172.4 blended hours x $69.36 per hour = $11,957.66. See
Part VI.A for a discussion of the monetized cost of the hour burden
per adviser.
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5. Duplicative, Overlapping, or Conflicting Federal Rules
The Commission believes that no federal rules duplicate, overlap or
conflict with the proposed amendments to Rule 15c6-1, proposed Rule
15c6-2, or the proposed amendment to Rule 204-2.
6. Significant Alternatives
The RFA requires that the Commission include in its regulatory
flexibility analysis a description of any significant alternatives to
the proposed rule which would accomplish the stated objectives of
applicable statutes and which would minimize any significant economic
impact of the proposed rule on small entities.\453\ Pursuant to Section
3(a) of the RFA, the Commission's initial regulatory flexibility
analysis must consider certain types of alternatives, including: (a)
The establishment of differing compliance or reporting requirements or
timetables that take into account the resources available to small
entities; (b) the clarification, consolidation, or simplification of
the compliance and reporting requirements under the rule for small
entities; (c) the use of performance rather than design standards; and
(d) an exemption from coverage of the rule, or any part of thereof, for
such small entities.\454\
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\453\ 5 U.S.C. 603(c).
\454\ Id.
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The Commission considered alternatives to the proposed amendments
to Rule 15c6-1 that would accomplish the stated objectives of the
amendment without disproportionately burdening broker-dealers that are
small entities, including: Differing compliance requirements or
timetables; clarifying, consolidating or simplifying the compliance
requirements; using performance rather than design standards; or
providing an exemption for certain or all broker-dealers that are small
entities. The purpose of Rule 15c6-1 is to establish a standard
settlement cycle for broker-dealer transactions. Alternatives, such as
different compliance requirements or timetables, or exemptions, for
Rule 15c6-1, or any part thereof, for small entities would prevent the
establishment of a standard settlement cycle and create substantial
confusion over when transactions will settle. Allowing small entities
to settle at a time later than T+1 could create a two-tiered market in
which order flow for small entities would not coincide with that of
other firms operating on a T+1 settlement cycle. Additionally, the
Commission believes that establishing a single timetable (i.e.,
compliance date) for all broker-dealers, including small entities, to
comply with the amendment is necessary to ensure that the transition to
a T+1 standard settlement cycle takes place in an orderly manner that
minimizes undue disruptions in the securities markets. In particular,
because broker-dealers do not always know the identity of their
counterparty when they enter a transaction, providing broker-dealers
that are small entities with an exemption from the standard settlement
cycle would likely create substantial confusion over when a transaction
will settle. With respect to using performance rather than design
standards, the Commission used performance standards to the extent
appropriate under the statute. For example, broker-dealers have the
flexibility to settle transactions under a standard settlement cycle
shorter than T+1. For firm commitment offerings, small entities do
retain the option under paragraph (d) to agree with their counterparty
in advance of the transaction to use a settlement cycle other than T+1.
In addition, under the proposed rule amendment, broker-dealers retain
flexibility to tailor their contracts, systems and processes to choose
how to comply with the rule most effectively. In Part V.C.5.b)(3), the
Commission preliminarily estimates the costs likely to be incurred by
broker-dealers to implement a T+1 standard settlement cycle.
The Commission also considered alternatives to proposed Rule 15c6-2
that would accomplish the stated objectives of the new rule without
disproportionately burdening broker-dealers that are small entities,
including: Differing compliance requirements or timetables; clarifying,
consolidating or simplifying the compliance requirements; using
performance rather than design standards; or providing an exemption for
certain or all broker-dealers that are small entities. The purpose of
proposed Rule 15c6-2 is to achieve trade date completion of
institutional trade allocations, confirmations, and affirmations to
facilitate a T+1 standard settlement cycle. Alternatives, such as
different compliance requirements or timetables, or exemptions, for
Rule 15c6-2, or any part thereof, for small entities would undermine
the purpose of establishing a standard settlement cycle. For example,
allowing small entities to complete the allocation, confirmation, and
affirmation processes at a time later than trade date could create a
two-tiered market that could work to the detriment of small entities
whose post-trade processing would not coincide with that of other firms
operating on a T+1 settlement cycle. Additionally, the Commission
believes
[[Page 10499]]
that establishing a single timetable (i.e., compliance date) for all
broker-dealers, including small entities, to comply with the new rule
is necessary to ensure that the transition to a T+1 standard settlement
cycle takes place in an orderly manner that minimizes undue disruptions
in the securities markets. With respect to using performance rather
than design standards, the Commission used performance standards to the
extent appropriate under the statute. Under the proposed rule, broker-
dealers have the flexibility to tailor their systems and processes, and
generally to choose how, to comply with the new rule.
The Commission considered alternatives to the proposed amendment to
Rule 204-2 that would accomplish the stated objectives of the amendment
without disproportionately burdening investment advisers that are small
entities, including: Differing compliance or reporting requirements or
timetables that take into account the resources available to small
entities; clarifying, consolidating or simplifying the compliance and
reporting requirements; using performance rather than design standards;
or providing an exemption from coverage of all or part of the proposed
rule for investment advisers that are small entities. Regarding the
first and fourth alternatives, the Commission believes that
establishing different compliance or reporting requirements or
timetables for small advisers, or exempting small advisers from the
proposed rule, or any part thereof, would be inappropriate under these
circumstances. Because the protections of the Advisers Act are intended
to apply equally to clients of both large and small firms, it would be
inconsistent with the purposes of the Advisers Act to specify
differences for small entities under the proposed amendment to Rule
204-2. While it is the staff's experience that some small and mid-size
advisers do not currently retain these records--whereas most larger
advisers already retain them--the Commission believes that the initial
burden on small advisers of retaining the proposed records would not be
large.\455\ As discussed above, the Commission believes these advisers
would need to update their policies and procedures and instruct
personnel to retain these records in their electronic recordkeeping
systems, including any confirmations that they may have retained in
paper format. However, because the Commission believes these advisers
already have recordkeeping systems to accommodate these records (which
would include, at a minimum, existing spreadsheet formats and email
retention systems), the Commission does not believe the two hour
additional burden of complying with this proposed amendment would
warrant establishing a different timetable for compliance for small
advisers. In addition, as discussed above, our staff would use the
information that advisers would maintain to help prepare for
examinations of investment advisers and verify that an adviser has
completed the steps necessary to complete settlement in a timely manner
in accordance with proposed rule 15c6-1(a). Establishing different
conditions for large and small advisers would negate these benefits.
Regarding the second alternative, we believe the current proposal is
clear and that further clarification, consolidation, or simplification
of the compliance requirements is not necessary. Our proposal states
the types of communications--confirmations, any allocations, and
affirmations--that advisers must retain in their records, and that
allocations (if applicable) and affirmations must be date and time
stamped. We believe that by proposing to clearly list these types of
communications as required records, advisers will not need to parse
whether, and if so which, current requirement under Rule 204-2 captures
these post-trade communications. Further, the proposed requirement to
date and time stamp the allocations (if applicable) and affirmations
sent to a broker or dealer is clear and consistent with many advisers'
current practices of date and time stamping these records, as discussed
in Part VI.A, above.\456\ Regarding the third alternative, the proposed
amendment to Rule 204-2 is narrowly tailored to correspond to the
proposed rules and rule amendments under the Exchange Act, and using
performance rather than design standards would be inconsistent with our
statutory mandate to protect investors, as advisers must maintain books
and records in a uniform and quantifiable manner that it is useful to
our regulatory and examination program.
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\455\ See supra Part III.C.
\456\ As noted above, however, we estimate that 50% of small and
mid-sized advisers that have institutional clients do not currently
maintain these records, and 1% of advisers that have institutional
clients, do not send allocations or affirmations electronically to
brokers or dealers.
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7. Request for Comment
The Commission encourages written comments on matters discussed in
the initial RFA. In particular, the Commission seeks comment on the
number of small entities that would be affected by the proposed
amendments to Rule 15c6-1, proposed Rule 15c6-2, and the proposed
amendment to Rule 204-2, and whether the effect(s) on small entities
would be economically significant. Commenters are asked to describe the
nature of any effect(s) the proposed amendments to Rule 15c6-1,
proposed Rule 15c6-2, and the proposed amendment to Rule 204-2 may have
on small entities, and to provide empirical data to support their
views.
B. Proposed Rule 17Ad-27
Proposed Rule 17Ad-27 would apply to clearing agencies that are
CMSPs. For the purposes of Commission rulemaking, a small entity
includes, when used with reference to a clearing agency, a clearing
agency that (i) compared, cleared, and settled less than $500 million
in securities transactions during the preceding fiscal year, (ii) had
less than $200 million of funds and securities in its custody or
control at all times during the preceding fiscal year (or at any time
that it has been in business, if shorter), and (iii) is not affiliated
with any person (other than a natural person) that is not a small
business or small organization.\457\
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\457\ See 17 CFR 240.0-10(d).
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Based on the Commission's existing information about the CMSPs that
would be subject to Rule 17Ad-27, the Commission believes that all such
CMSPs would not fall within the definition of a small entity described
above.\458\ While other CMSPs may emerge and seek to register as
clearing agencies or obtain exemptions from registration as a clearing
agency with the Commission, the Commission does not believe that any
such entities would be ``small entities'' as defined in 17 CFR 240.0-
10(d). Accordingly, the Commission believes that any such CMSP would
exceed the thresholds for ``small entities'' set forth in in 17 CFR
240.0-10.
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\458\ DTCC ITP Matching is a subsidiary of DTCC, and in 2020,
DTCC processed $2.329 quadrillion in financial transactions. DTCC,
2020 Annual Report. As of December 1, 2021, SS&C Technologies
Holdings, Inc. (NASDAQ: SSNC) had a market capitalization of $19.35
billion. Bloomberg STP LLC is a wholly-owned by Bloomberg L.P., a
global business and financial information and news company.
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For the reasons described above, the Commission preliminarily
believes that proposed Rule 17Ad-27 would not have a significant
economic impact on a substantial number of small entities and requests
comment on this analysis.
[[Page 10500]]
Statutory Authority and Text of the Proposed Rules and Rule Amendments
The Commission is proposing amendments to Rule 15c6-1, new Rule
15c6-2, and new Rule 17Ad-27 under the Commission's rulemaking
authority set forth in Sections 15(c)(6), 17A and 23(a) of the Exchange
Act [15 U.S.C. 78o(c)(6), 78q-1, and 78w(a) respectively]. The
Commission is proposing amendments to Rule 204-2 under the Advisers Act
under the authority set forth in Sections 204 and 211 of the Advisers
Act [15 U.S.C. 80b-4 and 80b-11].
List of Subjects in 17 CFR Parts 232, 240, and 275
Reporting and recordkeeping requirements, Securities.
Text of Amendment
For the reasons stated in the preamble, the Securities and Exchange
Commission proposes to amend 17 CFR parts 232, 240, and 275 as set
forth below:
PART 232-- REGULATION S-T--GENERAL RULES AND REGULATIONS FOR
ELECTRONIC FILINGS
0
1. The authority citation for part 232 continues to read as follows:
Authority: 15 U.S.C. 77c, 77f, 77g, 77h, 77j, 77s(a), 77z-3,
77sss(a), 78c(b), 78l, 78m, 78n, 78o(d), 78w(a), 78ll, 80a-6(c),
80a-8, 80a-29, 80a-30, 80a-37, 7201 et seq.; and 18 U.S.C. 1350,
unless otherwise noted.
* * * * *
0
2. Amend Sec. 232.101 by adding paragraph (xxii) to read as follows:
Sec. 232.101 Mandated electronic submissions and exceptions.
(a) * * *
(1) * * *
(xxii) Reports filed pursuant to Rule 17Ad-27 (Sec. 240.17Ad-27)
under the Exchange Act.
0
3. Add Sec. 232.409 to read as follows:
Sec. 232.409 Straight-through processing report interactive data.
The straight-through processing report required by Rule 17Ad-27
(Sec. 240.17Ad-27) under the Exchange Act must be submitted in Inline
XBRL in accordance with the EDGAR Filer Manual.
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
0
4. The authority citation for part 240 continues to read as follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f,
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4,
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20,
80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, and 7201 et. seq., and
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350;
Pub. L. 111-203, 939A, 124 Stat. 1376 (2010); and Pub. L. 112-106,
sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *
0
5. Amend Sec. 240.15c6-1 by reserving paragraph (c) and revising
paragraphs (a), (b), and (d) to read as follows:
Sec. 240.15c6-1 Settlement cycle.
(a) Except as provided in paragraphs (b) and (d) of this section, a
broker or dealer shall not effect or enter 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.
(b) Paragraph (a) of this section shall not apply to contracts:
(1) For 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;
(2) For the purchase or sale of securities that the Commission may
from time to time, taking into account then existing market practices,
exempt by order from the requirements of paragraph (a) of this section,
either unconditionally or on specified terms and conditions, if the
Commission determines that such exemption is consistent with the public
interest and the protection of investors.
(c) Reserved.
(d) For purposes of paragraph (a) of this section, the 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.
0
6. Add Sec. 240.15c6-2 to read as follows:
Sec. 240.15c6-2 Same-day allocation, confirmation, and affirmation.
For contracts where parties have agreed to engage in an allocation,
confirmation, or affirmation process, no broker or dealer shall effect
or enter 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 paragraph (a) of Sec. 240.15c6-1.
0
7. Add Sec. 240.17Ad-27 to read as follows:
Sec. 240.17Ad-27 Straight-through processing by central matching
service providers.
A clearing agency that provides a central matching service for
transactions involving broker-dealers and their customers must
establish, implement, maintain, and enforce policies and procedures
that facilitate straight-through processing. Such clearing agency also
must submit to the Commission every twelve months a report that
describes the following:
(a) Its current policies and procedures for facilitating straight-
through processing;
(b) Its progress in facilitating straight-through processing during
the twelve-month period covered by the report; and
(c) The steps it intends to take to facilitate straight-through
processing during the twelve-month period that follows the period
covered by the report.
The report must be filed electronically on EDGAR and must be
provided as interactive data as required by Sec. 232.409 of this
chapter (Rule 409 of Regulation S-T) in accordance with the EDGAR Filer
Manual.
PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940
0
8. The authority citation for part 275 continues to read as follows:
Authority: 15 U.S.C. 80b-2(a)(11)(G), 80b-2(a)(11)(H), 80b-
2(a)(17), 80b-3, 80b-4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless
otherwise noted.
* * * * *
Section 275.204-2 is also issued under 15 U.S.C 80b-6.
* * * * *
[[Page 10501]]
0
9. Amend Sec. 275.204-2 by revising paragraph (a)(7)(iii) to read as
follows:
Sec. 275.204-2 Books and records to be maintained by investment
advisers.
(a) * * *
(7) * * *
(iii) The placing or execution of any order to purchase or sell any
security; and if the adviser is a party to a contract under rule Sec.
240.15c6-2, 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.
* * * * *
By the Commission.
Dated: February 9, 2022.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2022-03143 Filed 2-23-22; 8:45 am]
BILLING CODE 8011-01-P