SEC approves rule to shorten settlement periods

The SEC commissioners unanimously approved a recommendation on Wednesday to reduce the time investors have to settle securities transactions with broker-dealers from three days to two.  

Under the proposed rule, broker-dealers would be prohibited from entering into a contract that allows for an exchange of funds for securities to occur later than two business days after the trade date, colloquially known as “T+2”.

Mark Flannery, director of the SEC’s Division of Economic and Risk Analysis, said the move to two-day settlements would reduce risks and costs while increasing efficiency in the clearance and settlement system thanks to a variety of factors.

{mosads}“First, reducing the length of time a transaction remains unsettled will reduce the amount of credit, market and liquidity risk faced by the counterparties to that transaction, including the central counterparties,” he said. “Second, the shorter settlement cycle will mean, for a fixed volume of transactions, fewer transactions remain unsettled at any given time, reducing the aggregate level of settlement related risks faced by the market.

“As the level of financial risk related to clearance and settlement decreases, we believe that the costs of managing and mitigating those risks will decrease as well,” Flannery said. 

A “no-brainer.” 

Commissioner Michael Piwowar said in a prepared statement that he emphatically supported the proposal, which he referred to as a “no-brainer.”

“Indeed, I have been quite vocal about the fact that I would have preferred for us to consider this rulemaking long ago,” he stated. “Years from now, investors will be puzzled about how a T+3 settlement cycle existed for so long.”

Piwowar also speculated about the costs and benefits of shortening the settlement period even further.

“I preliminarily understand that a T+1 settlement cycle would produce distinct challenges and generate costs magnitudes above a T+2 settlement cycle, but I encourage commenters to tell us whether that is true and also identify the costs and benefits of each alternative relative to one another,” he said. 

Industry initiative.

On March 7, the U.S. T+2 Industry Steering Committee, organized by the Depository Trust and Clearing Corporation and co-chaired by the Securities Industry and Financial Markets Association and the Investment Company Institute (ICI), set a target date for T+2 industry compliance of Sept. 7, 2017.

Marty Burns, chief industry operations officer at ICI, said in a statement the commission’s ruling will help the industry meet the target date.

“Today’s action represents a critical milestone that will keep the T+2 project moving along toward implementation next year,” he said. 

The commission will send the approved proposal out for public comment for 60 days. The SEC will then review comments and determine whether to adopt T+2 as a final rule. 

Clearing standards.

The commission unanimously approved two recommendations that apply to clearing agencies. The first urged adoption of final requirements that will heighten the standards for registered clearing agencies designated systemically important by the Financial Stability Oversight Council and other agencies with complex risk profiles.

The second called for the commission to issue a proposal to broaden the definition of covered clearing agencies to include any registered clearing agency providing services of a central counterparty, central securities depository or securities settlement system. 

According to Chairwoman Mary Jo White’s statement, the enhanced standards for clearing agencies would focus on, “among other things, the management of financial, liquidity, credit, operational, and general business risks.”

Costs and benefits.

Weighing the pros and cons of the rule, Flannery said enhanced standards could result in increased costs, which would may be passed down to investors. In addition, rising costs may force certain participants out of the market, reducing liquidity.

Conversely, the heightened standards could reduce transaction costs associated with counterparty default risk.

Commissioner Kara Stein voted in favor of the measure, though she stated she felt the standards were too vague, which could entice important critical clearing agencies to circumvent the rules.

“I will vote for this rule today only because it marginally decreases the risk of systemically important clearing agencies,” she said.

The second recommendation, which calls for a commission proposal to broaden the definition of clearing agencies, would help enhance the effectiveness of the standards rule, according to Steve Luparello, director of the SEC’s Division of Trading and Markets.

“This would be an incremental change, but one that we believe is important to ensure that all clearing agencies registered with the commission performing these critical functions are subject to new enhanced requirements being proposed today,” he said in a written statement. 

The enhanced standards final rule will become effective 60 days after publication in the Federal Register. Clearing agencies will have 120 days to comply following the effective date. The broadened definition proposal will be sent out for public comment and then reviewed by the SEC after 60 days. 

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