The SEC on September 28, 2016, published Release No. 34-78962, Amendment to Securities Transaction Settlement Cycle, to propose shortening the settlement cycle to two days from three days following a securities trade.
Comments are due 60 days following publication in the Federal Register, which normally occurs within a few weeks of a rule’s posting on the SEC’s website.
Shortening the settlement cycle to two days, or T+2, will reduce various risks related to unsettled trades, promote greater efficiency in clearing and settling trades, and reduce the overall risk in the financial markets, the SEC said. The current T+3 settlement period was put in place in 1993 to reduce the settlement period from five days.
If the proposed rule is finalized, Rule 15c6-1 of the Securities Exchange Act of 1934 will be amended to reflect the two-day settlement cycle.
In particular, the proposed rules would prohibit a broker-dealer from buying or selling a security that provides for payment of funds and delivery of securities later than two business days after the trade date, unless the parties at the time of the transaction agreed to otherwise.
The SEC said shortening the time between trade execution and trade settlement decreases the total number of unsettled trades as well as the total market value of all unsettled trades. This in turn should “correspond to a reduction in market participants’ exposure to credit, market, liquidity and systemic risk arising from those unsettled transactions,” the SEC said in Release No. 34-78962. “The reduction of these risks should, in turn, improve the stability of the U.S. markets, and ultimately enhance investor protection.”
The SEC said there is already industry-wide effort underway to move to the two-day trading settlement cycle.
The SEC estimated in Release No. 34-78962 that it expects the securities industry to incur initial costs between $2.1 billion to $4.2 billion to update systems and processes for the two-day settlement cycle. SEC Chair Mary Jo White said she wants to examine the costs and benefits of cutting the settlement cycle further to a day after the trade or the day of the trade.
Settlement occurs when the buying broker delivers cash to the seller, and the selling broker hands over the securities to the buyer. Until a trade settles, there is a risk to the market that the seller of the security could default on delivering it, or the buyer could default on the payment. Such defaults can be a problem for the rest of the market because they can hurt investor confidence, and if unchecked can spark a broader sell-off. To offset the risk, brokers have to pledge collateral with a clearinghouse, and a shorter settlement cycle may lower the amount of collateral brokers have to commit.
A two-day settlement cycle already exists in national markets in the European Union, Australia, and New Zealand, the SEC said. In addition, Canada and Japan are considering reducing their settlement period to two days.
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