In 2017, the Securities and Exchange Commission (SEC), made a change for security settlements. The SEC adopted an amendment to the settlement cycle rule, Rule 15c6-1(a) under the Securities Exchange Act of 1934, to shorten the standard settlement cycle for most broker-dealer transactions from three business days after the trade date (T+3) to two business days after the trade date (T+2) standard. On September 5, 2017, that change became effective.
Recently, the DTCC (Depository Trust Clearing Corporation) along with ICI (Investment Company Institute), Deloitte and SIFMA (Securities Industry and Financial Markets Association) published a 44-page whitepaper on Accelerating the US Securities Settlement Cycle to T+1. On February 9, 2022, the SEC proposed a package of rules that includes shortening the settlement cycle to one business day after the trade date (T+1). As of February 24, 2022, DTCC has announced that the SEC unanimously voted in favor of the change and has officially set the date for implementation of March 31, 2024.
These changes are “designed to protect investors, reduce risk, and increase operational efficiency.”1 How you ask? We are living in a very digital world; money moves electronically and trades are placed electronically rather than calling them in. Long before we had computers, every trade and transaction was a manual process, so it made sense to have a settlement three days after the trade date. But as we became more of a digital world, it no longer made sense in practice to have the settlement cycle be so long. These two factors alone mitigate risk, because the more you have people touching a transaction, the more likely it will be exposed to errors and risk.
As for operational efficiency, there are several reasons why this is a good policy change. Most transactions, especially for exchange-traded funds (ETFs) are done as in-kind. Having a T+1 settlement allows the fund to receive shares more quickly and distribute creation units to the Authorized Participants (APs) in a shorter time period. This, in turn, allows them to distribute shares onto the exchange for purchase in the secondary market.
Internal compliance departments at broker/dealer (B/D) desks are required to get T+1 (short settlement) approval, and given that cash redeem orders often come in 15 minutes before market close, it makes it difficult for the issuer to ask for T+1 settlement on Mark on Close (MOC) orders given the B/D’s requirement to get approval internally.
In addition, when an ETF is fixed income or commodities based, most orders to create are done in cash. The T+1 settlement on cash create order makes it more efficient for the fund to purchase the bonds or futures the day of the order (since the AP has to post the funds the same day) due to market fluctuation. But for a cash redeem order of a fixed income or commodities-based ETF, it actually makes more sense for the fund to have a T+2 settlement.
As for ETFs that have international securities, a T+1 settlement may not be efficient at all. Most ETFs that deal with markets outside of the United States have a T-1 order window, meaning APs place the order today (T-1) after the market close, for tomorrow’s trade date(T). The T-1 order typically requires collateral capital to be posted so that the portfolio manager can do trades overnight in the affected markets for any cash order and/or cash-in-lieu securities. A T+1 settlement would be almost impossible to make happen for both parties—the fund and the AP—involved in this scenario.
The biggest disadvantage today for a T+1 settlement being the standard is that market “participants must align and agree to shorten the settlement cycle by implementing the necessary operational and business changes.”2 DTCC itself can handle T+1 and even same day (T+0) settlements already, but the industry as a whole will need to align itself around the shortened settlement cycle. It remains to be seen if T+0 will become standard as an industry whole. For now, the consensus is that T+1 is a good change and will be embraced by the whole of the market for its risk reduction, quicker deployment of capital and operational efficiency.
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- Securities and Exchange Commission, Release No. 34-94212, File No. S7-07-22, February 9, 2022, https://www.sec.gov/rules/proposed/2022/34-94212.pdf , page 1.
- DTCC Press Release, February 24, 2021, https://www.dtcc.com/news/2021/february/24/dtcc-proposes-approach-to-shortening-us-settlement-cycle-to-t1-within-two-years
Written by Nichole M. Kramer
Vice President, SS&C ALPS