The U.S. Securities and Exchange Commission (SEC) has adopted a new rule in response to the market volatility experienced during the stock frenzy of 2021. Effective May 28, 2024, this new rule will enforce a shorter settlement cycle for all U.S. transactions routed through the Depository Trust Company (DTC), reducing it from T+2 to T+1.
From May 2024 onward, T+1 settlement becomes a legal requirement for all DTC-settled transactions. Firms need to prepare well in advance for compliance, yet many haven't started. A survey earlier this year by the DTCC and other agencies revealed that "41% of industry participants have yet to start considering T+1, climbing to 61% on the buy side."
Following are some key implications of the new rule, its impact on the securities industry, and the necessary actions firms must take to remain compliant.
Over the past 20 years, technological advancements have brought securities trading online. Before electronic trading, physical stock certificates were delivered through carrier mail, settling on a T+5 basis. Once trading went electronic, the settlement cycle moved from T+3 to T+2, and soon, to T+1.
Market volatility experienced in 2020, 2021, and early 2022 put the potential move to T+1 back in focus. A report by the Industry Steering Committee (ISC) in December 2021 highlighted the advantages, stating that a T+1 cycle would enhance market efficiency, reduce risk, optimize capital usage, and promote financial stability.
On February 15, 2023, the SEC amended Exchange Act Rule 15c6-1, mandating a shift of all security trades settled through the DTC to a T+1 cycle, effective May 28, 2024.
The rule change will have far-reaching implications, affecting a wide spectrum of securities, including most equities, corporate bonds, ADRs, unit investment trusts, mutual funds, exchange-traded funds, options on equities, private-label mortgage-backed securities, and exchange-listed limited partnership interests. View a complete list here.
Under the current T+2 cycle, trades need to be matched by 11:30 am Eastern Time (ET). With the new rule, trades must be matched by 9 pm ET on the transaction date to be part of the DTC's "Night Cycle." For inclusion in the current settlement date processing, trades can be accepted until 1:30 pm ET.
This shift necessitates a significant adjustment for firms’ middle and back-office teams, requiring adjustments in workflows and operations to meet the revised timeline. For instance, Asia currently has one day to reconcile, but after the new rule comes into effect, that window will be reduced to as little as two hours, depending on the market.
While there won't be regulatory penalties for failing to affirm trades on T and not settling on T+1, missing the cut-off triggers manual processes for broker-dealers and custodians, reducing efficiency and increasing costs per transaction. Firms are advised to allocate trades promptly, ideally by the end of the transaction date at the latest. Best practice suggests completing allocations by 7 pm ET on the transaction date to ensure readiness for the 9 pm trade matching cut-off. This proactive approach will facilitate smooth and compliant operations within the new T+1 settlement framework.
With the looming deadline only five months away, firms must immediately begin preparing for the implementation of this rule. Four proactive steps can be taken now to ensure readiness for May 28, 2024.
The move to T+1 settlement marks a significant milestone for the securities industry. With the SEC's adoption of this rule, firms must proactively prepare to ensure compliance with these monumental changes.
Petra Funds Group’s Fund Administration team has decades of experience administering private fund trade settlements across a wide array of security types. This expertise enables them to provide practical insight and guidance on establishing trade settlement best practices. Learn more about Petra’s fund administration offering here.