SEC shortens the securities settlement cycle to T+1, with Canada to follow

Securities regulators in both Canada and the U.S. have proposed new rules to shorten the settlement cycle for most routine securities transactions from two days (T+2) to one day (T+1). The move to a shorter settlement cycle is expected to come into effect in 2024 in both countries. The applicable U.S. rules have been adopted in final form, while the Canadian rules have been published for comment by industry participants but have not yet become final.

The move to a shortened trade settlement cycle is designed to mitigate the exposure of trade counterparties to liquidity, market and credit risk during the period between trade execution and settlement. Recent market events, including COVID-19 and the “meme stock” frenzy of 2021, have underscored those concerns. Abbreviating the time between execution and settlement should reduce the overall number of unsettled trades at any given time and reduce market exposure in that interim period. It also gives sellers of securities quicker access to cash proceeds from the sale. The rule changes have important implications for market participants, including broker-dealers and clearing agencies.

These changes to the settlement cycle are potentially a precursor to a T+0 regime (i.e., instantaneous settlement) in the future, which the SEC is continuing to consider.

The U.S.

The U.S. rules were finalized on February 15, 2023, but the compliance date is not until May 28, 2024. The new rules amend Rule 15c6-1 under the Securities Exchange Act of 1934 (Exchange Act) to shorten the standard settlement cycle for broker-dealer transactions to T+1. The rules also shorten the separate settlement cycle for firm commitment offerings to T+2, as discussed further below. Certain securities are exempt from the T+1 rule, consistent with the existing T+2 rule: these include government securities, commercial paper, certain foreign securities that do not have facilities for transfer or delivery in the U.S. (e.g., those underlying American Depository Receipts (ADRs)), certain insurance products, certain limited partnership interests that are not listed or quoted, as well as security-based swaps. T+1 will, however, apply to ADRs and U.S. listed ETFs with baskets including foreign securities and ADRs. The new rules also retain the so-called override provision in the existing rule that preserves the ability of the transaction parties to contractually agree, at the time of the trade, to a longer settlement period.

One noteworthy element of the new U.S. rules is that they shorten the standard settlement cycle to T+2 for firm commitment underwritten offerings registered under the Securities Act of 1933 (Securities Act), including initial public offerings (IPOs), that are priced after 4:30 p.m. ET, from the current T+4 regime. As initially proposed, the rules would have shortened the cycle to T+1, but commentators successfully lobbied for a slightly longer period to address failed settlement concerns for issues related to transfer agents, legend removal, non-U.S. parties and local law compliance. The change from T+4 to T+2, however, may not necessarily represent a significant change in market practice given that most U.S. IPOs and other U.S.-only SEC-registered offerings currently settle on a T+2 or T+3 basis. As with transactions in the secondary market, parties to a firm commitment offering will be permitted to agree to a longer settlement period.

It is not expected that the new regime will have a significant impact on prospectus delivery procedures given the “access equals delivery” effect of Securities Act Rule 172 and the 48-hour sales confirmation requirement in Exchange Act Rule 15c2-8. Rule 172 generally allows the formal prospectus delivery obligation to be fulfilled by filing the prospectus with the SEC. Rule 15c2-8 permits broker-dealers to send sales confirmations within 48 hours of the transaction, which is within the newly-adopted T+2 settlement cycle for underwritten offerings; accordingly, the SEC left this rule unchanged.

As part of the changes, the SEC is adopting new requirements that are designed to facilitate implementation of the T+1 settlement cycle. Currently, investment managers effecting trades for several client accounts at the same time need to provide account allocation instructions to the broker or custodian prior to settlement. In addition, certain institutional trades require exchanges of confirmations and affirmations to achieve settlement. To facilitate T+1, the SEC adopted new Exchange Act Rule 15c6-2, which requires broker-dealers to establish procedures and policies or enter into written agreements, in each case, to ensure completion of allocations, affirmations and confirmations in a timely way not later than end of day on the trade date.

The new T+1 settlement regime also compresses the time periods of a variety of rules and market practices that are associated with the standard settlement cycle. These include delivery of Rule 10b-10 trade confirmations by broker-dealers to customers as well as the time within which margin is required to be obtained for transactions subject to Regulation T, which deals with the extension of credit by broker-dealers.

Canada

The U.S. trade settlement cycle moved to a T+2 settlement cycle on September 5, 2017, and, for cross-border consistency, the Canadian market adopted T+2 on the same date. Canadian regulators published proposed rule amendments in December 2022 to support the adoption of T+1 and continued alignment with the U.S. settlement cycle. The transition to T+1 is expected to occur at the same time in 2024 that the United States moves to T+1.

As the Canadian Securities Administrators (CSA) and others have observed, moving to T+1 will require significant operational changes, and financial market participants will need to prepare to successfully implement the migration to T+1. However, moving to a shorter settlement cycle in Canada is expected to yield the same advantages as in the U.S. market, and concurrent adoption of T+1 with the United States is important given the interconnectedness of Canadian and U.S. markets. The Canadian Capital Markets Association (CCMA) is leading Canadian coordination efforts, working with industry participants in Canada and the U.S. to facilitate a successful transition.

As noted above, the new U.S. rules will still permit parties to a trade to expressly agree to a longer settlement period. Since the Canadian rules do not apply to trades in previously unissued securities and/or contain similar exemptions, we expect that Canada-only public offerings and cross-border U.S.-Canada public offerings may continue to settle on T+4 or T+5, consistent with current practice. This longer settlement period reflects the fact that, under Canadian law, investors have two business days from receiving a final prospectus to withdraw from the transaction. Accordingly, transactions generally do not close until after the expiry of the withdrawal period. Although electronic delivery is currently available to satisfy delivery requirements, Canada, unlike the United States, has yet not adopted access equals delivery.

On April 7, 2022, the CSA published for comment proposed amendments to several national instruments and policies to adopt an access equals delivery model (AED Model), which would allow reporting issuers (other than investment funds) to satisfy the requirement to deliver certain prospectuses, annual and interim financial statements and related MD&A by (i) publicly filing the document on SEDAR and (ii) issuing and filing a news release announcing that the document is publicly available on SEDAR and that a paper or electronic copy can be obtained upon request. Comments on the proposed amendments were due on July 6, 2022. Work to implement an AED Model is ongoing, but the CSA has not yet indicated when the proposed amendments will be finalized. The adoption of the AED Model has been identified as a priority and will be a welcome development as the industry prepares to transition to T+1.