Executive Summary
On February 15, 2023, the U.S. Securities and Exchange Commission (“SEC”) adopted rule changes to shorten the standard settlement cycle for most broker-dealer transactions in securities from two business days after the trade date (T+2) to one (T+1).
The adopting release followed a proposal released in February 2022, in response to which AIMA submitted a comment letter to raise functional and economic concerns about the resulting misalignment with international markets that will remain at T+2. AIMA also raised these concerns through a number of industry group advocacy efforts and in additional discussions with members of the SEC. Although these concerns were acknowledged in the adopting release, they remain at issue.
The newly adopted rules, some of which will affect all U.S. market participants, include:
- Shortening the standard settlement cycle for most securities transactions to T+1;
- Shortening the standard settlement cycle for firm commitment offerings priced after 4:30 p.m. from the current T+4 to T+2;
- New requirements for broker-dealers and registered investment advisers related to same-day affirmations; and
- New requirements to facilitate straight-through processing applicable to clearing agencies that are central matching service providers (CMSPs).
For investment advisers registered with the SEC, the SEC amended the investment adviser recordkeeping rule (Rule 204-2 under the Investment Advisers Act of 1940) to require registered investment advisers to make and keep records of confirmations they receive and of allocations and affirmations they send or receive for any transaction that is subject to the requirements of new Rule 15c6-2(a). These additional recordkeeping requirements are relatively straightforward and were finalized largely as proposed.
The final rules were published in the Federal Register on March 6, with an effective date of May 5, 2023. The compliance (go-live) date is May 28, 2024. A detailed summary of the requirements and potential challenges is available to members is available here and additional resources will be added as they become available.
Should you have any questions related to the summary or to the move to T+1, please contact Suzan Rose ([email protected]).
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Suzan Rose
Senior Adviser, Government and Regulatory Affairs, AIMA
Notable Impacts for Fund Managers
The transition to T+1 settlement is scheduled to occur on the Compliance Date of Tuesday, May 28, 2024. Canada plans to transition to T+1 settlement on the same date. Other jurisdictions are evaluating and considering a move to T+1, but there are no commitments as yet. As such, many key markets around the world can be expected to remain at T+2 settlement at the time of the U.S. T+1 transition, temporarily or indefinitely. This situation, where there is a misalignment in securities settlement periods between the U.S. and other markets, raises a host of concerns for fund managers.
As AIMA has repeatedly identified to the SEC in discussions, formal letter submissions, and as a party to industry letters and studies, the resulting cross-border market misalignment poses difficulty and increased costs for managers who are domiciled in or will continue to trade with T+2-remaining markets. Misalignment issues range from time zone differences that reduce the window to address settlement issues, to the need to raise capital from T+2 positions to fund T+1 settlement. Foreign exchange (“F/X”) conversion also is a significant concern, as it generally requires two days, which would not be accommodated with T+1 settlement.
Aside from liquidity and collateral concerns, smaller managers impacted by the misalignment may be disproportionately harmed by operational requirements. They may not be able to shoulder the costs of additional staffing and resources to support off-hours processing that would be required to meet accelerated deadlines from their forward time zones. Trade errors and breaks may not be addressed in sufficient time to meet accelerated deadlines, resulting in settlement fails.
While acknowledged in the SEC’s Adopting Release, misalignment-related difficulties and costs were viewed by the SEC as acceptable burdens for the sake of efficiencies anticipated from accelerating U.S. settlement. No exceptions or accommodations have been made for those negatively impacted by the U.S. move to T+1.
Affected members should refer to the full summary for suggested action points.
Timeline
AIMA has categorized these requirements as Medium Priority/Medium Impact and they are therefore represented in mid-dark blue in the AIMA Regulatory Horizon Scan gantt chart.
Compliance Date | May 28, 2024 |
Effective Date | May 5, 2023 |
AIMA summary of final rule published | April 11, 2023 |
Final rule published | February 15, 2023 |
AIMA response to proposal filed | April 11, 2022 |
AIMA request for extension submitted | March 3, 2022 |
AIMA summary for members published | February 15, 2022 |
Proposal published by SEC | February 9, 2022 |
Update on US Move to T+1 Settlement: SEC Issues Risk Alert Reminding Industry of Responsibilities
We are now two months from the May 28 live date for the US securities settlement move to T+1, accelerating from the current T+2 cycle that has been in place since 2017. Yesterday, the SEC’s EXAMS division published a Risk Alert which serves as a reminder of the forthcoming changes and the related responsibilities of the various participants in the securities settlement cycle. It also referred to ongoing reviews it has been conducting to gauge and confirm readiness for the move to T+1. A copy of the risk alert can be found here.
Although Canada and Mexico plan to join the US in this accelerated settlement move on May 28, other key trading regions will not. The European Union and the UK continue to analyze and contemplate their own respective moves to T+1 in the future, and both recently published analysis and considerations on the subject. However, both also have indicated that they intend to watch the US transition closely for learnings and will not accelerate settlement in the near term.
The majority of the effort in the move to T+1 is required of fund manager trading counterparties and service providers. Broker-dealers, matching service providers, prime brokers, custodians and the like have had to make substantial changes to their processes and systems to account for accelerated settlement. These changes have been largely completed, though some work continues in response to testing feedback and refinements.
For fund managers, T+1 preparation has been more a matter of ensuring that their timing and operational procedures for trade processing match that of the new accelerated deadlines, which extend further into the evening on trade date (T0) or into the night/next morning for those in forward time zones. Fund managers also must be clear on which securities are subject to T+1 settlement, as there are exceptions. The SEC’s Trading and Market’s division released an FAQ yesterday that addresses this and other questions; it can be accessed here.
For SEC-registered investment advisers, there are additional books and records obligations to comply with. However, these books and records are likely to already be captured by fund managers’ systems and if not, fund managers can rely on third parties to fulfill these obligations (subject to certain conditions).
All fund managers are facing basic functional issues such as staffing to cover later hours, which are overnight hours in time zone disadvantaged regions with one business day now removed from the process. However, more significant concerns arise for fund managers who trade or operate in markets that will remain at T+2, facing misalignment issues due to settlement timing differences. Liquidity concerns and other practical considerations result from the T+1 acceleration; fund managers will need to carefully consider their funding needs region to region, including the potential opportunity cost of liquidating a position early in a T+2 market in order to fund a T+1 trade. Furthermore, fund managers also are likely to face challenges with f/x conversion, given that it takes approximately two days and will not accelerate to match the T+1 cycle. AIMA has highlighted these and other issues in regulatory comment letters, member updates, and in numerous conversations with T+1 transition stakeholders.
Fund managers are among the most innovative, adaptable participants in financial markets. No doubt, some of the noted issues will be resolved through that innovation, others by adapting their businesses. We will continue to update you on any notable developments; please contact Suzan Rose with any questions.
The Final Countdown to T+1 in the US: Ready or Not, Here it Comes
On May 28, the US securities market will settle on a T+1 basis, removing a day from the settlement cycle it has been on since 2017 when it advanced from T+3 to join many other global markets. However, many of those global markets it moved to align with back then will remain on T+2 for the time being, choosing instead to wait and watch before making their move.
In theory, accelerating settlement is an idea that is easy to embrace. After all, who doesn’t want their assets sooner? As the SEC has repeatedly asserted, a shorter settlement cycle can help liquidity and the overall efficiency of the market. It can reduce risk, which can in turn translate into less need for collateral. There is little doubt it can do these things, but preparation is critical and coordination is key. Certainly, preparations have been made and the changes have been known to all stakeholders for quite some time. The final rule was released in February 2023, and a coalition of market leaders has provided guidance and ample testing resources throughout.
However, coordination outside of the US - where markets and certain processes will not accelerate to T+1 - remains a significant deficiency, and realistic solutions to resulting issues that do not drive up costs or drive off participation are in short supply. With only weeks to go, we are about to witness theory face off with practice, and no one can accurately predict the outcome yet.
Leading with Two Left Feet: Lack of Global Coordination Spawns Misalignment
Since the SEC first tabled the potential for accelerating US securities settlement back in 2021, AIMA has strongly cautioned the potential for issues with international market misalignment and foreign exchange (“f/x”) conversion. The settlement cycle for f/x transactions typically takes two days – a day longer than provided by T+1.
In terms of misalignment, the impact is more greatly felt as forward time zone differences increase. It’s simple math: If your business day is five hours ahead and trades must be allocated and affirmed on trade date (T) to move smoothly through the settlement cycle, you are going to be working well into the night. If you are 12 or more hours ahead, you will need to pull an all-nighter to be within the trade allocation and affirmation window, which closes at 9:00pm ET. As the Depository Trust Clearing Corporation (“DTCC”) states, the key to T+1’s success is for 90% of trades to be affirmed by 9:00pm ET on trade date. Clearly, time zone differences are not your friend.
To be clear, trades can be settled without meeting that critical 9:00pm ET deadline, but it is far from ideal. The accelerated flow is designed for all settlement functions to occur on a sequentially accelerated schedule. Everything from batch processing, stock loan recall, margin calculations, corporate action processing, wires and cash management, and other settlement and clearing functions happen after affirmation. You could attempt to begin - and end - the process on T+1, same day, but you also could have your trade fail. It will be a risk-aware decision for those who cannot meet the 9:00pm ET cutoff.
F/x settlement risk is a trickier issue, and one that had not factored into the prior move from T+3 to T+2 because the typical two-day conversion process fell within the settlement timeline. The timing for currency conversion is not changing, but the securities settlement speed is. Therein lies the problem, and a big one at that. The move to T+1 did not involve coordination or collaboration with the many global banking entities that together enable f/x conversion, with CLS Group’s Continuous Linked Settlement internation payment application in the forefront to coordinate settlement of foreign exchange markets. CLS cannot force this underlying banking consortium to accelerate and it would be a massive global undertaking in any case. CLS is enabling an extended 6:00pm ET cutoff for its settlement netting, but that is unlikely to move the needle for non-US fund managers. As well, the cost of f/x transactions tends to spike at the US close, so once again time is not on their side.
Hard Choices
These misalignment and f/x conversion issues cannot be easily reconciled, and indeed the only alternatives suggested are costly – with the costs ultimately being borne by fund investors.
First and foremost – and contrary to the implied belief of some – a fund manager does not have a limitless pot of cash at their disposal. Their duty is to invest, and indeed there are hardline restrictions in some global jurisdictions (such as those for UCITS) that strictly limit the amount of assets that can be held in cash. Yet, the primary recommendation of the SEC is to pre-fund trades in order to ensure T+1 settlement. With what money?
It comes down to hard choices. A fund manager could liquidate their T+2 positions early to raise cash to enable settlement of those in scope for T+1, but this approach comes with a real opportunity cost. A manager also would need to estimate how much USD is needed to fund its T+1 trading, then get those f/x transactions underway early enough in time to settle. Perhaps it can do this without liquidating T+2 positions; perhaps not. There may be parties within the settlement ecosystem willing to bridge the USD for the manager until their f/x transactions settle, but this lending certainly would not be free of charge nor necessarily available to all. They could redeem US money market positions, which may have an unintended negative impact to this market segment that the SEC likely did not envision.
Comparatively speaking, the issue for time zone-disadvantaged fund managers working into, or through, the night to attend to settlement matters is easier to address, with the age-old solution of throwing more bodies at the problem. Those bodies may be new hires, staggered hours among existing staff, or outsourced services that have unsurprisingly surfaced to assist for a fee. All of this comes at a cost, though whose cost is less clear, particularly in light of recent US regulatory changes and proposals.
Of course, fund managers facing these costly T+1 issues have another option: They can choose to trade less in the U.S. No doubt some have taken a closer look at their regional allocations in light of the impending T+1 live date. Whether they will pare back their US exposure, temporarily or permanently, remains to be seen. The first few weeks and months will be telling as their choices yield results.
AIMA repeatedly has raised these concerns since 2021 when accelerated settlement was tabled for discussion, including in detailed discussions with SEC staff and in its comment letters. While acknowledged in the SEC’s Adopting Release, misalignment-related difficulties and costs were viewed by the SEC as “acceptable burdens” for the sake of efficiencies anticipated from accelerating U.S. settlement. No exceptions or accommodations have been made for those negatively impacted by the U.S. move to T+1 – leaving them with hard choices to make.
Could Crypto Help Solve a TradFi Problem?
Oh, the irony. As AIMA has continually sought solutions to the f/x conversion problem that do not ratchet up trading costs, one potential option became apparent this past winter: Payment stablecoins. Payment stablecoins are arguably the most un-crypto digital asset of them all, and something many governments around the world see as a proverbial toe into the digital assets waters.
Having discussed the potential for a timelier alternative to conventional f/x conversion with stakeholders in the crypto space, it is clear that certain payment stablecoins such as USDC may have sufficient liquidity to take at least some of this painful edge off of f/x conversion timing for those willing to use them - and able to work with service providers who are as well. The mint-and-burn process for payment stablecoins can take mere minutes and be available around the clock globally, versus current inflexible, lengthy processing times in the TradFi world.
Numerous whitepapers – some that well predate the US T+1 move – identify the need for a “technological solution” in order to accelerate and ultimately achieve the dream of continuous settlement. Some of this research contemplates digital assets, albeit in various forms. While tokenization of securities often is put forth by the crypto world as a solution to trading issues, that concept is fraught with regulatory controversy for now. For the time being, the mundane option of payment stablecoins may be one that works, at least in part. Given the SEC’s skeptical view of digital assets, this certainly seems to be an unintended consequence of the move to T+1.
Ok… But You Go First
Following the announcement of the US’ transition to T+1, other T+2 markets began considering a move to T+1 settlement. Although continental neighbors Canada and Mexico decided to move to T+1 as well, others are taking a wait-and see approach.
For the most part, the question of moving to T+1 is not “if” but “when”. Indeed, considerations and planning are fairly advanced in the UK and EU, with detailed assessments underway to analyze the appropriateness and costs and benefits of shortening the settlement cycle and detailed outlines of how to move to a shorter settlement cycle. It is heartening to know that they also are keenly following the impact of international developments on settlement cycles on the EU’s capital markets. Hopefully the list of lessons learned from T+1 will be mild enough to not dissuade plans to accelerate settlement: Misalignment issues, save for f/x conversion, will resolve as global markets realign.
On Your Marks, Get Set…
There are only a scant few weeks left until we see how everything pans out with respect to T+1. Fund managers have proven time and again to be incredibly adaptive and agile. We expect they may take a variety of approaches in addressing the issues enumerated in this summary, perhaps switching tack until they settle on what works best for them and their investors.
The US market is a giant in the world of securities trading and one that fund managers are unlikely to forego despite increased costs and effort. However, these T+1 issues are compounded by numerous recent regulatory changes and proposals that collectively diminish the appeal of US market involvement. Whatever happens from May 28 forward, trading in the US just got more expensive for many, and that’s just one more reason for them to deploy capital elsewhere. We continue to hope they won’t.
For questions on the above summary or T+1, please contact Suzan Rose.