T+1: It’s Not an Assignment, It’s an Opportunity

As of May 28, 2024, both buy-side and sell-side transactions — from placing a trade to payment and delivery of securities — must be completed within one business day.

This shift is the result of SEC rule changes made on February 15, 2023, amendments to Rules 15c6-1, 204-2, and 17AD-27 and the adoption of Rule 15c6-2. These regulations affect U.S. equities, corporate and municipal bonds, mutual funds, ETFs, UITs, ADRs, and instruments comprised of these components, among others. In addition to contracting the settlement cycle, the rule changes include modifications to how broker-dealers process institutional trades and impose record-keeping requirements on investment advisors for allocations, confirmations, and affirmations of specific securities transactions.

Meeting the new standards

Institutions throughout the financial services industry and across the entire trade lifecycle, ranging from asset managers and broker-dealers to transfer agents, exchanges, vendors, and clearing firms are examining their capacity to meet the new standards. Canada is also adopting a T+1 standard. It begins May 27, 2024, one day before the U.S. start day, which is delayed by the Memorial Day holiday. Mexico is also following suit with a T+1 compliance date beginning May 27. In EMEA, both the UK and EU are currently considering a move to T+1.

Settlements are complex for many reasons. Broadly, the passage of the time between the offer to buy or sell and the completion of the trade exposes both parties to risk—the risk that the seller will not deliver the asset or that the buyer will not provide proper payment. This becomes even more complicated with high volume trading, global markets in varying currencies, evolving products, and execution across time zones.

Why the change?

In his February 23, 2023 announcement of the rule changes, SEC Chair Gary Gensler said, “Today’s adoption addresses one of the four areas the staff recommended the Commission address in response to the meme stock events of 2021. Taken together, these amendments will make our market plumbing more resilient, timely, orderly, and efficient.”¹

According to the Industry Steering Committee and the Industry Working Group of the U.S. financial markets, the 2017 transition from T+3 to T+2 cut post-trade processing time by nearly one-third, the transition from T+2 to T+1 is expected to reduce processing time by nearly another one-half.

From the regulating agency’s perspective, moving to T+1 offers many pluses. Among them are:

• Increased efficiency. The transition to T+1 requires companies to ensure their processes and operations are engineered to meet the new requirements. The resulting infrastructure modernization should result in greater overall efficiency of the securities markets.
• Mitigated risk. Risk, specifically systemic, counterparty, and operational, will be particularly alleviated during times of high volume and market volatility.
• Enhanced use of capital. T+1 reduces firms’ market and counterparty exposure, allowing broker-dealers to direct their available capital for other purposes. For investment firms, T+1 syncs the settlement of U.S. mutual fund shares with portfolio securities, which also benefits their capital management.
• Improved financial stability. Amelioration of all of the above, plus the heightened ability of financial firms to manage a 24-hour turnaround, should strengthen the security of markets overall.

How we got here

Technology has vastly transformed the pace, products, capabilities, and capacity of the financial markets, including settlement period processes, upending what was originally paper-based, in-person agreements to electronic transactions.

Trading origins

When the New York Stock & Exchange Board, the forerunner of the New York Stock Exchange was formally organized in 1817, brokers gathered twice a day to trade from a list of 30 stocks and bonds. The settlement period was determined by the length of time it took to physically deliver the stock certificate and funds, which could take not only days but weeks.

Improvements in market communications in the nineteenth and early twentieth century enabled greater volumes in trading as well as faster settlement periods. Transatlantic cables; the stock ticker; telephones on the trading floor; pneumatic tubes for delivering messages; automation to connect various trading processes all accelerated buying and selling. Computerization, electronic trading, and continuing technological developments radically changed how trading occurs as well as the risk involved.

Moving to a reduced settlement period

In 1975, Congress passed the Securities Acts Amendments, which, among other things, empowered the SEC to develop a nationwide system for the clearing and settlement of securities. In 1993, the SEC reduced the five-day settlement period to three days. Rule 15C6-1 was the first to mandate a particular settlement period. The prior T+5 practice was largely custom and practice and had drifted over the decades. The decision to regulate the time period was designed to decrease risk and provide security in the markets and was partially spurred in response to the financial system risks exposed during the 1987 financial crisis as well as the 1990 bankruptcy of broker-dealer Drexel Burnham, whose holdings in mortgage-backed securities influenced how it handled its corporate securities^2. This three-day time period was further reduced in March 2017 to the current T+2.

An opportunity to evaluate service infrastructure

Meeting the new SEC standards offers industry participants the opportunity to review their entire business model: how they trade, settle, and reconcile, and how they can become more efficient. Companies may need to modify their operating policies and procedures as well as controls. What were manual processes may need to be automated, simultaneously increasing productivity and decreasing operational risk.

While larger investment firms, having invested in changes during T+2, may find the transition to T+1 more routine, smaller and mid-size firms may be scrambling. Here are some challenges that companies may discover:

• FX settlement, when more than one currency is involved, must now be resolved within 24 hours.
• Accelerated margin calls.
• Tangled coordination with non-U.S. markets. When the U.S. migrated to T+2, most international markets were already there. That is not true for T+1, although Canada and Mexico will be moving to T+1 the day before.

To meet the latest rule changes, necessary upgrades may include [recommendations from Accelerating the U.S. Securities Cycle to T+1³]:

• Adopting end-to-end straight-through-processing
• Enabling match-to-instruct capabilities for trade affirmations and confirmations
• Synchronizing processes, particularly as they affect counterparties
• Implementing digital tools that enable archiving of trade records
• Moving away from middle- and back-office processing to a purely technological solution for trade execution to settlement

RELATED READING: Implications of T+1: Assessing Your Firm’s Readiness

Develop a future-forward model

As is becoming evident to many asset managers, upgrades to legacy systems or manual processes may not even be possible on a patchwork basis. The key to T+1 is reliable data throughout the trade lifecycle, which is complicated by processing silos. Companies may also discover that moving to cloud-based technology is finally necessary to achieve required speed and volume management. Doing so will generate efficiencies in other areas, including reporting and reconciliation.

Key elements of a future-forward model

To respond to the accelerated T+1 settlement timeframe, firms will need to swiftly capture, clean, logically organize, and distribute their foundational data. The essential elements of a future-forward model include tools that enables firms to:

• Capture and store data from any internal or third-party system, market data vendor, or counterparty
• Organize and validate datasets to create a single source of truth across their entire organization
• Simplify operations platforms and streamline workflows
• Access an assortment of tools to support a broad array of asset classes across regions and currencies

While these and other technological improvements may require significant investment, their long-term benefits, including cost reductions resulting from new efficiencies, are clear. Additionally, modifications that create a more resilient ecosystem will be beneficial in the event of further regulatory changes or unexpected market conditions.

Want to learn more about how to leverage the T+1 opportunity for your firm? This article provides a deep dive on how firms can work as a team to optimize their resources for a smooth transition.

Sources:

1 SEC Press Release: SEC Finalizes Rules to Reduce Risks in Clearance and Settlement, Feb. 15. 2023

2 FINRA. SEC Adopts Rule 15C6-A; Establishes Three-Business-Day Settlement for Securities Transactions, November 1, 1993,

3 Accelerating the U.S. Securities Settlement Cycle to T+1, DTCC, December 1, 2021