Amendment to Securities Transaction Settlement Cycle, 69240-69280 [2016-23890]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 81, Number 193 (Wednesday, October 5, 2016)]
[Proposed Rules]
[Pages 69240-69280]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-23890]



[[Page 69239]]

Vol. 81

Wednesday,

No. 193

October 5, 2016

Part III





Securities and Exchange Commission





-----------------------------------------------------------------------





17 CFR Part 240





Amendment to Securities Transaction Settlement Cycle; Proposed Rule

Federal Register / Vol. 81 , No. 193 / Wednesday, October 5, 2016 / 
Proposed Rules

[[Page 69240]]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-78962; File No. S7-22-16]
RIN 3235-AL86


Amendment to Securities Transaction Settlement Cycle

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

-----------------------------------------------------------------------

SUMMARY: The Securities and Exchange Commission (``Commission'') 
proposes to amend Rule 15c6-1(a) under the Securities Exchange Act of 
1934 (``Exchange Act'') 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''). The proposed amendment is designed to reduce a number of 
risks, including credit risk, market risk, and liquidity risk and, as a 
result, reduce systemic risk for U.S. market participants.

DATES: Submit comments on or before December 5, 2016.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (https://www.sec.gov/rules/proposed.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number [-] on the subject line; or
     Use the Federal eRulemaking Portal (https://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments to Brent J. Fields, Secretary, 
Securities and Exchange Commission, 100 F Street NE., Washington, DC 
20549-1090. All submissions should refer to File Number [-].
    To help us process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (https://www.sec.gov/rules/proposed.shtml).
    Comments are available for Web site viewing and printing in the 
Commission's Public Reference Room, 100 F Street NE., Washington, DC 
20549 on official business days between the hours of 10:00 a.m. and 
3:00 p.m. All comments received will be posted without change; the 
Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly.
    Studies, memoranda or other substantive items may be added by the 
Commission or staff to the comment file during this rulemaking. A 
notification of the inclusion in the comment file of any such materials 
will be made available on the Commission's Web site. To ensure direct 
electronic receipt of such notifications, sign up through the ``Stay 
Connected'' option at www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: Jeffrey Mooney, Assistant Director, 
Susan Petersen, Special Counsel, Andrew Shanbrom, Special Counsel, 
Office of Clearance and Settlement; Justin Pica, Senior Policy Advisor, 
Office of Market Supervision; Natasha Vij Greiner, Assistant Chief 
Counsel, Jonathan Shapiro, Special Counsel, Office of Chief Counsel; at 
202-551-5550, Division of Trading and Markets, Securities and Exchange 
Commission, 100 F Street NE., Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION: The Commission is proposing an amendment to 
Rule 15c6-1 of the Exchange Act under the Commission's rulemaking 
authority set forth in Sections 15(c)(6), 17A and 23(a) of the Exchange 
Act (15 U.S.C. 78o(c)(6), 78q-1, and 78w(a) respectively).

Table of Contents:

I. Introduction
II. Background
    A. Overview of the Clearance and Settlement of Securities 
Transactions
    1. Statutory Framework
    2. Participating Entities
    a. FMUs--CCPs and CSDs
    (1) CCPs
    (2) CSDs
    b. Matching/ETC Providers--Exempt Clearing Agencies
    c. Market Participants--Investors, Broker-Dealers, and 
Custodians
    3. Overview of Trade Settlement Processes
    a. Retail Investor Trade Settlement Process
    b. Institutional Investor Trade Settlement Process
    4. Impact of the Settlement Cycle
    5. Post-Rule 15c6-1 Adoption
    a. SIA T+1 Initiative
    b. Securities Transaction Concept Release
    c. Current Efforts To Shorten the Settlement Cycle in the U.S
    (1) BCG Study
    (2) Industry Steering Committee and Industry Planning
    (3) Investor Advisory Committee Recommendations
    B. Transition to T+2 in Non-U.S. Securities Markets
III. Discussion
    A. Proposal
    1. Current Rule 15c6-1
    2. Proposed Amendment to Rule 15c6-1 To Shorten the Standard 
Settlement Cycle to T+2
    3. Reasons to Transition From T+3 to T+2
    4. Consideration of Settlement Cycle Shorter Than T+2
    B. Impact on Other Commission Rules
    1. General
    2. Regulation SHO
    3. Financial Responsibility Rules Under the Exchange Act
    4. Exchange Act Rule 10b-10
IV. Compliance Date
V. Request for Comment
VI. Economic Analysis
    A. Background
    B. Baseline
    1. Clearing Agencies
    2. Market Participants--Investors, Broker-Dealers, and 
Custodians
    3. Investment Companies
    4. The Current Market for Clearance and Settlement Services
    C. Analysis of Benefits, Costs, and Impact on Efficiency, 
Competition, and Capital Formation
    1. Benefits
    2. Costs
    3. Economic Implications Through Other Commission Rules
    4. Effect on Efficiency, Competition, and Capital Formation
    5. Quantification of Direct and Indirect Effects of a T+2 
Settlement Cycle
    a. Industry Estimates of Costs and Benefits
    b. Commission Estimates of Costs
    (1) FMUs--CCPs and CSDs
    (2) Matching/ETC Providers--Exempt Clearing Agencies
    (3) Market Participants--Investors, Broker-Dealers, and 
Custodians
    (4) Indirect Costs
    (5) Industry-Wide Costs
    D. Alternatives
    1. Shift to a T+1 Standard Settlement Cycle
    2. Straight-Through Processing Requirement
    E. Request for Comment
VII. Small Business Regulatory Enforcement Fairness Act
VIII. Initial Regulatory Flexibility Analysis
    A. Reasons for, and Objectives of, the Proposed Action
    B. Legal Basis
    C. Small Entities Subject to the Rule and Rule Amendment
    D. Projected Reporting, Recordkeeping and Other Compliance 
Requirements
    E. Duplicative, Overlapping or Conflicting Federal Rules
    F. Significant Alternatives
    G. Request for Comment
IX. Statutory Authority and Text of the Proposed Amendment to Rule 
15C6-1

I. Introduction

    The Commission originally adopted Exchange Act Rule 15c6-1 in 1993 
to establish T+3 as the standard settlement cycle for broker-dealer 
transactions, and in so doing, effectively shortened the settlement 
cycle for most securities transactions (with certain exceptions), which 
at the time was generally five business days after the trade date

[[Page 69241]]

(``T+5'').\1\ The Commission cited a number of reasons for 
standardizing and shortening the settlement cycle, which included, 
among others, reducing credit and market risk exposure related to 
unsettled trades, reducing liquidity risk among derivatives and cash 
markets, encouraging greater efficiency in the clearance and settlement 
process, and reducing systemic risk for the U.S. markets.\2\
---------------------------------------------------------------------------

    \1\ Securities Transactions Settlement, Exchange Act Release No. 
33023 (Oct. 6, 1993), 58 FR 52891, 52893 (Oct. 13, 1993) (``T+3 
Adopting Release''). Rule 15c6-1 of the Exchange Act prohibits 
broker-dealers from effecting or entering into a contract for the 
purchase or sale of a security (other than an exempted security, 
government security, municipal security, commercial paper, bankers' 
acceptances, or commercial bills) that provides for payment of funds 
and delivery of securities later than the third business day after 
the date of the contract unless otherwise expressly agreed to by the 
parties at the time of the transaction. 17 CFR 240.15c6-1.
    \2\ T+3 Adopting Release, 58 FR at 52893.
---------------------------------------------------------------------------

    The Commission now proposes to amend Exchange Act Rule 15c6-1(a) to 
further shorten the standard settlement cycle from T+3 to T+2. As 
discussed in greater detail below, the Commission preliminarily 
believes that there are a number of reasons supporting shortening the 
standard settlement cycle to T+2 at this time. As an initial matter, 
the Commission believes that shortening the standard settlement cycle 
will result in a further reduction of credit, market, and liquidity 
risk,\3\ and as a result a reduction in systemic risk for U.S. market 
participants.
---------------------------------------------------------------------------

    \3\ Credit risk refers to the risk that the credit quality of 
one party to a transaction will deteriorate to the extent that it is 
unable to fulfill its obligations to its counterparty on settlement 
date. Market risk refers to the risk that the value of securities 
bought and sold will change between trade execution and settlement 
such that the completion of the trade would result in a financial 
loss. Securities Transactions Settlement, Exchange Act Release No. 
31904 (Feb. 23, 1993), 58 FR 11806, 11809 nn.26-27 (Mar. 1, 1993) 
(``T+3 Proposing Release''). Liquidity risk describes the risk that 
an entity will be unable to meet financial obligations on time due 
to an inability to deliver funds or securities in the form required 
though it may possess sufficient financial resources in other forms. 
See Standards for Covered Clearing Agencies, Exchange Act Release 
No. 71699 (Mar. 12, 2014), 79 FR 29508, 29531 (May 22, 2014) (``CCA 
Proposal'').
---------------------------------------------------------------------------

    Since the Commission adopted Rule 15c6-1 in 1993, the financial 
markets have expanded and evolved significantly.\4\ During this period, 
the Commission has continued to focus on further mitigating and 
managing risks in the clearance and settlement process, and how those 
risks relate to managing systemic risk.\5\ The Commission also notes 
that shortening the standard settlement cycle at this time is 
consistent with the broader focus by the Commission on enhancing the 
resilience and efficiency of the national clearance and settlement 
system and the role that certain systemically important financial 
market utilities (``FMUs''),\6\ particularly central counterparties 
(``CCPs''), play in concentrating and managing risk.\7\ In light of 
this ongoing focus on further mitigating and managing risks in the 
clearance and settlement process, the Commission preliminarily believes 
that a transition to a T+2 settlement cycle would yield important 
benefits for market participants and the national clearance and 
settlement system.
---------------------------------------------------------------------------

    \4\ See generally Concept Release on Equity Market Structure, 
Exchange Act Release No. 61358 (Jan. 14, 2010), 75 FR 3594 (Jan. 21, 
2010).
    \5\ See generally Clearing Agency Standards, Exchange Act 
Release No. 68080 (Oct. 22, 2012), 77 FR 66220, 66221-22 (Nov. 2, 
2012) (``Clearing Agency Standards Adopting Release''); CCA 
Proposal, 79 FR 29508.
    \6\ Section 803(6)(A) of the Payment, Clearing, and Settlement 
Supervision Act of 2010 (``Clearing Supervision Act'') enacted by 
Title VIII of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act of 2010 (``Dodd-Frank Act''), 12 U.S.C. 5301, et 
seq., defines ``financial market utility'' or ``FMU'' as any person 
that manages or operates a multilateral system for the purpose of 
transferring, clearing, or settling payments, securities, or other 
financial transactions among financial institutions or between 
financial institutions and the person. 12 U.S.C. 5462(6)(A). Section 
803(6)(B)(i) of the Clearing Supervision Act generally excludes 
certain persons from the definition of FMU including designated 
contract markets, registered futures associations, swap or security-
based swap data repositories, swap execution facilities, national 
securities exchanges, and alternative trading systems. 12 U.S.C. 
5462(6)(B)(i). The term FMU includes not only U.S. registered 
clearing agencies but also other types of entities that are not U.S. 
registered clearing agencies.
    \7\ See Clearing Agency Standards Adopting Release, 77 FR at 
66221-22.
---------------------------------------------------------------------------

    The Commission preliminarily has considered the costs and benefits 
attendant to shortening the standard settlement cycle to T+2 and 
believes that the proposed amendment to Rule 15c6-1(a) will yield 
benefits that justify the associated costs. The Commission also 
preliminarily believes that the case for further shortening the 
standard settlement cycle at this time is supported by certain progress 
and efficiencies already achieved by market participants since the 
Commission's adoption of Rule 15c6-1 in 1993, including significant 
technological developments. The Commission, however, is sensitive to 
the effects this proposal could have on a wide range of market 
participants. Accordingly, in addition to specific requests for 
comment, the Commission seeks generally input on the economic effects 
associated with shortening the standard settlement cycle to T+2, 
including any costs, benefits or burdens, and any effects on 
efficiency, competition and capital formation.

II. Background

    Rule 15c6-1(a) of the Exchange Act prohibits broker-dealers from 
effecting or entering into a contract for the purchase or sale of a 
security (other than certain exempted securities) \8\ that provides for 
payment of funds and delivery of securities later than the third 
business day after the date of the contract unless otherwise expressly 
agreed to by the parties at the time of the transaction.\9\ Subject to 
the exceptions enumerated in the rule, the prohibition in paragraph (a) 
of Rule 15c6-1 applies to all securities. The definition of the term 
``security'' in Section 3(a)(10) of the Exchange Act covers, among 
others, equities, corporate bonds, unit investment trusts (``UITs''), 
mutual funds, exchange-traded funds (``ETFs''), American depositary 
receipts (``ADRs''), security-based swaps, and options.\10\ Many of

[[Page 69242]]

these securities (e.g., options, and certain mutual funds) generally 
settle on a settlement cycle less than T+3 and therefore will not be 
impacted by the Commission's current proposal to shorten the standard 
settlement cycle to T+2. Accordingly, the discussion in this release is 
primarily focused on securities that currently settle on a T+3 standard 
settlement cycle.\11\ However, the Commission seeks comment on whether 
and the extent to which other securities, as defined in Section 
3(a)(10) of the Exchange Act, will be affected by the amendment to Rule 
15c6-1(a), as proposed.
---------------------------------------------------------------------------

    \8\ Rule 15c6-1(a) does not apply to a contract for an exempted 
security, government security, municipal security, commercial paper, 
bankers' acceptances, or commercial bills. 17 CFR 240.15c6-1(a). The 
rule also provides an additional exemption for: (i) Transactions in 
limited partnership interests that are not listed on an exchange or 
for which quotations are not disseminated through an automated 
quotation system of a registered securities association; (ii) 
contracts for the purchase and sale of securities that the 
Commission may from time to time, taking into account then existing 
market practices, exempt by order; and (iii) contracts for the sale 
of cash securities that priced after 4:30 p.m. (Eastern Standard 
Time) that are sold by an issuer to an underwriter pursuant to a 
firm commitment offering registered under the Securities Act of 1933 
(``Securities Act'') or the sale to an initial purchaser by a 
broker-dealer participating in such offering. 17 CFR 240.15c6-1(b) 
and (c).
    Additionally, as discussed further in the T+3 Adopting Release, 
the Commission determined not to include transactions in municipal 
securities within the scope of Rule 15c6-1, with the expectation 
that the Municipal Securities Rulemaking Board (``MSRB'') would take 
the lead in implementing three-day settlement of municipal 
securities by the implementation date of the new rule. The 
Commission requested a report from the MSRB within six months of the 
Commission's adoption of Rule 15c6-1 outlining the schedule in which 
the MSRB intended to implement T+3 in the municipal securities 
market. T+3 Adopting Release, 58 FR at 52899. MSRB rules that 
established T+3 as the standard settlement cycle for transactions in 
municipal securities became operative on June 7, 1995, the same date 
as Exchange Act Rule 15c6-1. See Order Approving MSRB Proposed Rule 
Change Establishing Three Business Day Settlement Time Frame, 
Exchange Act Release No. 35427 (Feb. 28, 1995), 60 FR 12798 (Mar. 8, 
1995).
    \9\ Although current Rule 15c6-1 establishes a settlement 
timeframe of no more than three business days after the trade date, 
certain types of transactions routinely settle on a settlement cycle 
shorter than T+3, which is permissible under the rule. See, e.g., 
note 11 infra.
    \10\ 15 U.S.C. 78c(a)(10). Title VII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act, Public Law 111-203, 124 
Stat. 1376 (2010), amended, among other things, the definition of 
``security'' under the Exchange Act to encompass security-based 
swaps. In July 2011, the Commission granted temporary exemptive 
relief from compliance with certain provisions of the Exchange Act 
(including Rule 15c6-1) in connection with the revision of the 
Exchange Act definition of ``security'' to encompass security-based 
swaps. See Order Granting Temporary Exemptions Under the Securities 
Exchange Act of 1934 In Connection With the Pending Revision of the 
Definition of ``Security'' To Encompass Security-Based Swaps, 
Exchange Act Release No. 64795 (July 1, 2011), 76 FR 39927 (July 7, 
2011). Certain of the exemptions (including the exemption for Rule 
15c6-1) are set to expire on February 5, 2017. See Order Extending 
Temporary Exemptions Under the Securities Exchange Act of 1934 In 
Connection With the Revision of the Definition of ``Security'' To 
Encompass Security-Based Swaps, Exchange Act Release No. 71485 (Feb. 
5, 2014), 79 FR 7731 (Feb. 10, 2014).
    \11\ In today's environment, ETFs and certain closed-end funds 
clear and settle on a T+3 basis. Open-end funds (i.e., mutual funds) 
generally settle on a T+1 basis, except for certain retail funds 
which typically settle on T+3. Thus, the proposed amendment to Rule 
15c6-1(a) would require ETFs, closed-end funds, and mutual funds 
settling on a T+3 basis to revise their settlement timeframes. See 
infra notes 213 and 214, regarding ETF secondary market trading, 
including creation or redemption transactions for authorized 
participants.
---------------------------------------------------------------------------

A. Overview of the Clearance and Settlement of Securities Transactions

    ``Clearance and settlement'' refers generally to the activities 
that occur following the execution of a trade. These post-trade 
processes are critical to ensuring that a buyer receives securities and 
a seller receives proceeds in accordance with the agreed-upon terms by 
the settlement date. The discussion that follows provides a basic 
description of the clearance and settlement of securities transactions, 
and is organized in the following manner: (1) An overview of the 
statutory framework and goals driving the national clearance and 
settlement system; (2) an introduction to securities clearing agencies 
and other key market participants in the clearance and settlement 
process; (3) an overview of the trade settlement process for the U.S. 
securities markets; (4) a discussion of how the length of the 
settlement cycle may impact the presence of credit, market, liquidity 
and systemic risk in the clearance and settlement process; and (5) an 
overview of ongoing efforts by market participants to shorten the 
standard settlement cycle.
1. Statutory Framework
    The national clearance and settlement system in place today is 
largely a product of the difficulties experienced in the U.S. 
securities markets in the late 1960s and early 1970s. As trading 
volumes increased during that time period, the manual process 
associated with transferring certificated securities among market 
participants in a relatively uncoordinated fashion created what came to 
be known as the ``Paperwork Crisis.'' The Paperwork Crisis nearly 
brought the securities industry to a standstill and directly or 
indirectly caused the failure of a large number of broker-dealers.\12\ 
The breakdown in the handling of paper associated with the clearance 
and settlement of securities transactions threatened to curtail the 
flow of debt and equity instruments available for public investment and 
jeopardized the continued operation of the securities markets.\13\
---------------------------------------------------------------------------

    \12\ See U.S. Securities and Exchange Commission, Study of 
Unsafe and Unsound Practices of Brokers and Dealers, H.R. Doc. No. 
92-231 (1971); see also Securities Transactions Settlement, Exchange 
Act Release No. 49405 (Mar. 11, 2004), 69 FR 12922 (Mar. 18, 2004); 
see also S. Rep. No. 94-75, at 4-5 (1975), reprinted in 1975 
U.S.C.C.A.N. 179, 183.
    \13\ Id.
---------------------------------------------------------------------------

    In light of the experiences of the Paperwork Crisis, and with the 
objectives of improving the operation of the U.S. clearance and 
settlement system and protecting investors,\14\ Congress amended the 
Exchange Act in 1975 to, among other things, (i) direct the Commission 
to facilitate the establishment of a national system for the prompt and 
accurate clearance and settlement of transactions in securities, and 
(ii) provide the Commission with the authority to regulate those 
entities critical to the clearance and settlement process.\15\ At the 
same time, Congress empowered the Commission with direct rulemaking 
authority over broker or dealer activity in making settlements, 
payments, transfers, and deliveries of securities.\16\ Taken together, 
these provisions provide the Commission with the authority to regulate 
entities that are critical to the national clearance and settlement 
system.\17\
---------------------------------------------------------------------------

    \14\ See 15 U.S.C. 78q-1(a)(1)(A)-(D), which lays out the 
Congressional findings for Section 17A of the Exchange Act. In 
particular, Congress found that inefficient clearance and settlement 
procedures imposed unnecessary costs on investors and those acting 
on their behalf and that new data processing and communications 
techniques create the opportunity for more efficient, effective, and 
safe procedures for clearance and settlement.
    \15\ 15 U.S.C. 78q-1(a)(2)(A); see also S. Rep. No. 94-75, supra 
note 12, at 53. Congress provided the Commission with the authority 
and responsibility to regulate, coordinate, and direct the 
operations of all persons involved in processing securities 
transactions, toward the goal of a national system for the prompt 
and accurate clearance and settlement of securities transactions. 
Id. at 55.
    \16\ S. Rep. No. 94-75, at 111. Specifically, Section 15(c)(6) 
of the Exchange Act prohibits broker-dealers from engaging in or 
inducing securities transactions in contravention of such rules and 
regulations as the Commission shall prescribe as necessary or 
appropriate in the public interest and for the protection of 
investors or to perfect or remove impediments to a national system 
for the prompt and accurate clearance and settlement of securities 
transactions, with respect to the time and method of, and the form 
and format of documents used in connection with, making settlements 
of and payments for transactions in securities, making transfers and 
deliveries of securities, and closing accounts. 15 U.S.C. 78o(c)(6).
    \17\ See 15 U.S.C. 78q-1(b)-(c); 15 U.S.C. 78o(c).
---------------------------------------------------------------------------

    Congress reaffirmed its view of the importance of a strong 
clearance and settlement system in 2010 with the enactment of the 
Clearing Supervision Act.\18\ Specifically, Congress found that the 
``proper functioning of the financial markets is dependent upon safe 
and efficient arrangements for the clearing and settlement of payments, 
securities, and other financial transactions.'' \19\ Under the Clearing 
Supervision Act, registered clearing agencies providing CCP and central 
securities depository (``CSD'') services are FMUs.\20\ FMUs centralize 
clearance and settlement activities and enable market participants to 
reduce costs, increase operational efficiency, and manage risks more 
effectively. While an FMU can provide many risk management benefits to 
participants, the concentration of clearance and settlement activity at 
an FMU has the potential to disrupt the securities markets if the FMU 
does not effectively manage the risks in its clearance and settlement 
activities.\21\ To address those risks, the Commission has used its 
authority under the Exchange Act, as supplemented by the authority set 
forth under the Clearing Supervision Act, to help ensure that the FMUs 
under its supervision are subject to robust regulatory 
requirements.\22\
---------------------------------------------------------------------------

    \18\ See 12 U.S.C. 5301, et seq.
    \19\ 12 U.S.C. 5461(a)(1).
    \20\ See supra note 6.
    \21\ See CCA Proposal, 79 FR at 29587; see also Risk Management 
Supervision of Designated Clearing Agencies, Joint Report to Senate 
Committees on Banking, Housing, and Urban Affairs and Agriculture, 
Nutrition, and Forestry, and the House Committees on Financial 
Services and Agriculture, from the Board of Governors of the Federal 
Reserve System, Securities and Exchange Commission, and Commodity 
Futures Trading Commission (July 2011), https://www.federalreserve.gov/publications/other-reports/files/risk-management-supervision-report-201107.pdf.
    \22\ See, e.g., Clearing Agency Standards Adopting Release, 
supra note 5. In addition, on July 18, 2012, the Financial Stability 
Oversight Council designated as systemically important the following 
then-registered clearing agencies: Chicago Mercantile Exchange, Inc. 
(``CME''); The Depository Trust Company (``DTC''); Fixed Income 
Clearing Corporation (``FICC''); ICE Clear Credit LLC (``ICC''); 
National Securities Clearing Corporation (``NSCC''); The Options 
Clearing Corporation (``OCC''). See Press Release, U.S. Department 
of the Treasury, Financial Stability Oversight Council Makes First 
Designations in Effort to Protect Against Future Financial Crises 
(July 18, 2012), https://www.treasury.gov/press-center/press-releases/Pages/tg1645.aspx. As such, these clearing agencies are 
also subject to the Clearing Supervision Act. In addition to its 
authority to regulate clearing agencies, pursuant to Section 17A of 
the Exchange Act, the Commission is also the supervisory agency, as 
that term is defined in Section 803(8) of the Clearing Supervision 
Act, for DTC, FICC, NSCC, and OCC. The CFTC is the supervisory 
agency for CME and ICE, and the Federal Reserve Bank of New York 
oversees DTC's banking and trust company activities. The Commission 
jointly regulates ICC and OCC with the CFTC.

---------------------------------------------------------------------------

[[Page 69243]]

2. Participating Entities
a. FMUs--CCPs and CSDs
    Clearance and settlement activities in securities markets are 
supported by an infrastructure that is comprised of entities that 
perform a variety of different functions. These functions for the U.S. 
securities markets are performed in most instances by FMUs that are 
registered clearing agency \23\ subsidiaries of The Depository Trust & 
Clearing Corporation (``DTCC''): NSCC and DTC.
---------------------------------------------------------------------------

    \23\ Section 17A(b) of the Exchange Act requires any clearing 
agency performing the functions of a clearing agency with respect to 
any security (other than an exempted security) to be registered with 
the Commission, unless the Commission has exempted such entity from 
the registration requirements. 15 U.S.C. 78q-1(b)(1). The term 
``clearing agency'' is defined broadly to include any person who: 
(1) Acts as an intermediary in making payments or deliveries or both 
in connection with transactions in securities; (2) provides 
facilities for comparison of data respecting the terms of settlement 
of securities transactions, to reduce the number of settlements of 
securities transactions, or for the allocation of securities 
settlement responsibilities; (3) acts as a custodian of securities 
in connection with a system for the central handling of securities 
whereby all securities of a particular class or series of any issuer 
deposited within the system are treated as fungible and may be 
transferred, loaned, or pledged by bookkeeping entry, without 
physical delivery of securities certificates (such as a securities 
depository); or (4) otherwise permits or facilitates the settlement 
of securities transactions or the hypothecation or lending of 
securities without physical delivery of securities certificates 
(such as a securities depository). A clearing agency may provide, 
among other things, CCP services and CSD services. See 15 U.S.C. 
78c(a)(23).
---------------------------------------------------------------------------

(1) CCPs
    A CCP, following trade execution, interposes itself between the 
counterparties to a trade, becoming the buyer to each seller and seller 
to each buyer to ensure the performance of open contracts. One critical 
function of a CCP is to eliminate bilateral credit risk between 
individual buyers and sellers.
    NSCC is the CCP \24\ for trades between broker-dealers involving 
equity securities, corporate and municipal debt, and UITs in the 
U.S.\25\ NSCC facilitates the management of risk among broker-dealers 
using a number of tools, which include: (1) Novating and guaranteeing 
trades to assume the credit risk of the original counterparties; (2) 
collecting clearing fund contributions from members to help ensure that 
NSCC has sufficient financial resources in the event that one of the 
counterparties defaults on its obligations; and (3) netting to reduce 
NSCC's overall exposure to its counterparties.
---------------------------------------------------------------------------

    \24\ In addition to providing CCP services, NSCC provides a 
number of other non-CCP services to market participants, including, 
for example, services that support mutual funds, alternative 
investments and insurance products.
    \25\ Certain SRO rules (e.g., Financial Industry Regulatory 
Authority (``FINRA'') Rule 6350B(b) and FINRA Rule 6274(b)) 
authorize broker-dealer members to settle transactions outside of 
the facilities of a registered clearing agency, or ``ex-clearing,'' 
if both parties agree.
---------------------------------------------------------------------------

    In novation, when a CCP member presents a contract to the CCP for 
clearing, the original contract between the buyer and seller is 
discharged and two new contracts are created, one between the CCP and 
the buyer and the other between the CCP and the seller. The CCP thereby 
assumes the original parties' contractual obligations to each other. 
NSCC attaches its trade guaranty \26\ to novated transactions at 
midnight on T+1.\27\ Through novation and the trade guaranty, the two 
original trading counterparties to the transaction replace their 
bilateral credit, market and liquidity risk exposure to each other with 
risk exposure to NSCC.
---------------------------------------------------------------------------

    \26\ Pursuant to Rule 11 and Addendum K to NSCC's Rules and 
Procedures, NSCC guarantees the completion of CNS settling trades 
(``NSCC trade guaranty'') that have reached the later of midnight of 
T+1 or midnight of the day they are reported to NSCC's members. NSCC 
also guarantees the completion of shortened process trades, such as 
same-day and next-day settling trades, upon comparison or trade 
recording processing. See NSCC Rules and Procedures, Rule 11, 
Section 1(c) and Addendum K (as of July 14, 2016) (``NSCC Rules and 
Procedures''), www.dtcc.com/legal/rule-and-procedures.
    \27\ NSCC has stated that it is currently in the process of 
seeking regulatory approval to move its trade guaranty forward to 
the point of trade validation (for locked-in trades) and comparison 
(for trades compared through NSCC). This initiative is referred to 
as the ``Accelerated Trade Guaranty'' or ``ATG.'' See NSCC, 
Disclosures under the Principles for Financial Market 
Infrastructures, at 17 n.11 (Dec. 2015) (``NSCC PFMI Disclosure 
Framework''), https://www.dtcc.com/legal/policy-and-compliance.
---------------------------------------------------------------------------

    NSCC collects clearing fund deposits from its members to maintain 
sufficient financial resources in the event a member or members default 
on their obligations to NSCC.\28\ NSCC's rules also allow NSCC to 
adjust and collect additional clearing fund deposits as needed to cover 
the risks present while a member's trades are unsettled. Each member's 
required clearing fund deposit is calculated at least once daily 
pursuant to a formula set forth in NSCC's rules,\29\ and is designed to 
provide sufficient funds to cover NSCC's exposure to the member.\30\
---------------------------------------------------------------------------

    \28\ NSCC's clearing fund is comprised of cash, securities, and 
letters of credit posted by NSCC members to provide NSCC the 
necessary resources to cover member defaults. The amount and timing 
of contributions to the clearing fund are determined pursuant to 
NSCC's rules. See NSCC Rules and Procedures, Rules 1 and 4.
    \29\ See NSCC Rules and Procedures, Rule 4 and Procedure XV.
    \30\ Commission Rules 17Ad-22(b)(1) through (4) require a 
registered clearing agency that performs CCP services to establish, 
implement, and maintain policies and procedures reasonably designed 
to do the following: (1) Measure its credit exposures at least once 
a day, and use margin requirements to limit its exposures to 
potential losses from defaults by its participants; (2) use risk-
based models and parameters to set margin requirements and to review 
such requirements at least monthly; (3) maintain sufficient 
financial resources to withstand a default by the two participant 
families, if clearing security-based swaps, or one participant 
family otherwise, to which it has the largest exposure; and (4) 
provide for an annual model validation process. 17 CFR 240.17Ad 
22(b)(1)-(4).
---------------------------------------------------------------------------

    Figure 1 below shows NSCC's clearing fund deposits by quarter. As 
illustrated in Figure 1, the total amount that NSCC collects to 
mitigate the risks associated with member defaults has varied from 
roughly $3 to $6.5 billion for the years 2010 through 2015.\31\ The 
majority of these deposits are held in cash, while a much smaller 
portion is held in highly liquid securities such as U.S. treasury 
securities.
---------------------------------------------------------------------------

    \31\ See NSCC Quarterly Financial Statements, https://www.dtcc.com/legal/financial-statements?subsidiary=NSCC&pgs=1.

---------------------------------------------------------------------------

[[Page 69244]]

[GRAPHIC] [TIFF OMITTED] TP05OC16.000

    As mentioned above, NSCC also reduces its risk exposure as a CCP 
through netting. Netting reduces risk in the settlement process by 
reducing the overall amount of obligations that must be settled. The 
reduction in the overall amount of unsettled obligations translates 
into relatively fewer and smaller settlement payments, thereby reducing 
the cost to trade. Netting also lessens the risk by reducing the number 
of outstanding unsettled transactions linking market participants, 
thereby reducing the likelihood that a settlement failure by one market 
participant will trigger a chain reaction of additional defaults by 
other market participants. Through the use of NSCC's netting and 
accounting system, the Continuous Net Settlement System (``CNS''), NSCC 
nets trades and payments among its participants, reducing the value of 
securities and payments that need to be exchanged by an average of 97% 
each day.\32\ NSCC accepts trades into CNS \33\ for clearing from the 
nation's major exchanges and other trading venues and uses CNS to net 
each NSCC member's trades in each security traded that day to a single 
receive or deliver position for the securities.\34\ Throughout the day, 
cash debit and credit data generated by NSCC's members' activities are 
recorded, and at the end of the processing day, the debits and credits 
are netted to produce one aggregate cash debit or credit for each 
member.\35\
---------------------------------------------------------------------------

    \32\ See NSCC PFMI Disclosure Framework, supra note 27, at 8.
    \33\ NSCC accepts CNS-eligible securities. To be CNS-eligible, a 
security must be eligible for book-entry transfer on the books of 
DTC, and must be capable of being processed in the CNS system. For 
example, securities may be ineligible for CNS processing due to 
certain transfer restrictions (e.g., 144A securities) or due to the 
pendency of certain corporate actions. See Rule 1 of NSCC's rules 
for the definition of CNS-eligible securities, and Rule 3 of NSCC's 
rules for a list of CNS-eligible securities. NSCC Rules and 
Procedures, Rules 1 and 3.
    \34\ In CNS, compared and recorded transactions in CNS-eligible 
securities that are scheduled to settle on a common settlement date 
are netted by specific security issue into one net long (i.e., buy) 
or net short (i.e., sell) position. CNS then nets those positions 
further with positions of the same specific security issue that 
remain open after their originally scheduled settlement date, which 
are generally referred to as ``Fail Positions.'' The result of the 
netting process is a single deliver or receive obligation for each 
NSCC member for each specific security issue in which the member has 
activity on a given day. See NSCC Rules and Procedures, Rule 11 and 
Procedure VII and X.
    \35\ See NSCC PFMI Disclosure Framework, supra note 27, at 9.
---------------------------------------------------------------------------

    When one of the counterparties does not fulfill its settlement 
obligations by delivering the required securities, a ``failure to 
deliver'' occurs in CNS. Failures to deliver may be caused by the NSCC 
member's failure to receive securities from a customer or counterparty 
to a previous transaction.\36\ For illustration purposes, Figure 2 
shows a recent seven-year period of time, in this case, October 23, 
2008, through October 23, 2015, with the outstanding failures to 
deliver as a percentage of the overall shares outstanding for the 
securities which NSCC clears.\37\
---------------------------------------------------------------------------

    \36\ For more information on NSCC ``failures to deliver,'' see 
generally Office of Investor Education and Advocacy, U.S. Securities 
and Exchange Commission, Key Points About Regulation SHO (Apr. 8, 
2015), https://www.sec.gov/investor/pubs/regsho.htm.
    \37\ NSCC failure-to-deliver data is publicly available on the 
Commission's Web site at https://www.sec.gov/foia/docs/failsdata.htm.

---------------------------------------------------------------------------

[[Page 69245]]

[GRAPHIC] [TIFF OMITTED] TP05OC16.001

    While NSCC provides final settlement instructions to its members 
each day, the payment for and transfer of securities ownership occurs 
at DTC. At the conclusion of each trading day, CNS short positions 
(i.e., obligations to deliver) at NSCC are compared against the long 
positions held in the NSCC members' DTC accounts to determine security 
availability.\38\ If securities are available, they are transferred 
from the NSCC member's account at DTC to NSCC's account at DTC, to 
cover the NSCC member's CNS short positions. CNS long positions (i.e., 
the right to receive securities owed to the participant) are 
transferred from the NSCC account at DTC to the accounts of NSCC 
members at DTC. On settlement date, NSCC submits instructions to DTC to 
deliver (i.e., transfer) securities positions for each security netted 
though CNS for each NSCC member holding a long position in such 
securities. Cash obligations are settled through DTC by one net payment 
for each NSCC member at the end of the settlement day.
---------------------------------------------------------------------------

    \38\ See NSCC PFMI Disclosure Framework, supra note 27, at 106.
---------------------------------------------------------------------------

(2) CSDs
    A CSD is an entity that holds securities for its participants 
either in certificated or uncertificated (dematerialized) form so that 
ownership can be easily transferred through a book entry (rather than 
the transfer of physical certificates) and provides central safekeeping 
and other asset services. Additionally, a CSD may operate a securities 
settlement system, which is a set of arrangements that enables 
transfers of securities, either for payment or free of payment, and 
facilitates the payment process associated with such transfers. DTC 
serves as the CSD and settlement system for most equity securities and 
a significant number of debt securities held by U.S. market 
participants.
    In its capacity as a CSD, DTC provides custody and book-entry 
transfer services for the vast majority of securities transactions in 
the U.S. market involving equities, corporate and municipal debt, money 
market instruments, ADRs, and ETFs. In accordance with its rules, DTC 
accepts deposits of securities from its participants \39\ (i.e., mostly 
broker-dealers and banks), credits those securities to the depositing 
participants' accounts, and effects book-entry transfer of those 
securities. The securities deposited with DTC are registered in DTC's 
nominee name and are held in fungible bulk for the benefit of its 
participants and their customers. Each participant having an interest 
in the securities of a given issuer credited to its account has a pro 
rata interest in the securities of that issuer held by DTC. By 
immobilizing securities (e.g., holding and transferring ownership of 
securities positions in book-entry form, with DTC's nominee reflected 
as the registered owner on the issuer's records) and centralizing and 
automating securities settlements, DTC substantially reduces the number 
of physical securities certificates transferred in the U.S. markets, 
which significantly improves operational efficiencies and

[[Page 69246]]

reduces risk and costs associated with the processing of physical 
securities certificates. These benefits not only provide efficiencies 
to DTC and its participants, but to the investing public as well.
---------------------------------------------------------------------------

    \39\ NSCC's rules provide for several categories of membership 
with different levels of access to NSCC's services. This release 
uses the term ``member'' when referring to an NSCC member that has 
full access to NSCC's CCP services. See NSCC Rules and Procedures, 
Rule 1, for the definition of the various membership categories. 
DTC's rules also provide for different categories of membership, 
including ``participants.'' This release uses the term 
``participant'' when referring to a participant of DTC. See Rules, 
By-Laws, and Organizational Certificate of DTC Rule 1 for the 
definition of various categories of membership.
---------------------------------------------------------------------------

    In addition to a securities account at DTC, each DTC participant 
has a settlement account at a clearing bank to record any net funds 
obligation for end-of-day settlement, whether payment will be due to or 
from the participant. During the day, debits and credits are entered 
into the participant's settlement account. The debits and credits arise 
from DVP transfers and from other events or transactions involving the 
transfer of funds, such as principal and interest payments distributed 
to a participant or intraday settlement progress payments by a 
participant to DTC.\40\ Debits and credits in the participant's 
settlement account are netted intraday to calculate, at any time, a net 
debit balance or net credit balance, resulting in an end-of-day 
settlement obligation or right to receive payment. DTC nets debit and 
credit balances for participants who are also members of NSCC to reduce 
funds transfers for settlement, and acts as settlement agent for NSCC 
in this process. Settlement payments between DTC and DTC's 
participants' settlement banks are made through the National Settlement 
System of the Federal Reserve System.\41\
---------------------------------------------------------------------------

    \40\ As noted above, a CSD operates a securities settlement 
system that provides for transfers of securities either free of 
payment or for payment. When a transfer occurs for payment, 
typically securities settlement systems provide ``delivery versus 
payment'' or ``DVP,'' whereby the delivery of the security occurs 
only if payment occurs. The concept of DVP is sometimes referred to 
as ``DVP/RVP.'' The term ``receive versus payment'' or ``RVP'' is 
from the perspective of the seller.
    \41\ See NSCC PFMI Disclosure Framework, supra note 27, at 9-10.
---------------------------------------------------------------------------

b. Matching/ETC Providers--Exempt Clearing Agencies
    Matching/ETC Providers electronically facilitate communication 
among a broker-dealer, an institutional investor, and the institutional 
investor's custodian to reach agreement on the details of a securities 
trade.\42\ These entities emerged as a result of efforts by market 
participants to develop a more efficient and automated matching process 
that continues to be viewed as a necessary step in achieving straight-
through processing (``STP'') \43\ for the settlement of institutional 
trades.\44\ Currently, there are three entities that have obtained 
exemptions from registration as a clearing agency from the Commission 
to operate as Matching/ETC Providers.\45\ The current Matching/ETC 
Providers use two methods, ``Matching'' and ``ETC,'' to facilitate 
agreement on the trade details among the parties. When the parties 
reach agreement, it is generally referred to as an ``affirmed 
confirmation.''
---------------------------------------------------------------------------

    \42\ Electronic trade confirmation (``ETC'') was originally 
developed by DTC in the early 1970s as an alternative to the use of 
phone, fax or other manual processes. To facilitate greater use of 
ETC by market participants to process institutional trades, the 
Commission approved rule changes filed by several SROs that required 
the use of ETC for trades involving institutional investors. See 
Exchange Act Release No. 19227 (Nov. 9, 1982), 47 FR 51658, 51664 
(Nov. 18, 1982) (order approving confirmation rules for exchanges 
and securities association).
    \43\ The Securities Industry Association (which in 2006 merged 
with The Bond Markets Association to form the Securities Industry 
Financial Markets Association) has described STP ``as the seamless 
integration of systems and processes to automate the trade process 
from end-to-end--trade execution, confirmation, and settlement--
without manual intervention or the re-keying of data.'' Securities 
Industry Association, Glossary of Terms, reprinted in part in Kyle L 
Brandon, Prime Brokerage: Of Prime Importance to the Securities 
Industry (SIA Res. Rep., Vol. VI, No. 4, New York, N.Y.), Apr. 28, 
2005, at 25-26, https://www.sifma.org/WorkArea/linkit.aspx?LinkIdentifier=id&ItemID=21718&libID=5884.
    \44\ Securities Industry Association, Institutional Transaction 
Processing Model, at 3 (May 2002) (``ITPC 2002 White Paper''). The 
Securities Industry Association's Institutional Transaction 
Processing Committee (``ITPC'') published its first white paper in 
December 1999 with a subsequent version released in February 2001. 
The ITPC 2002 White Paper was published in May 2002.
    \45\ The Commission issued an interpretive release in 1998 
concluding that matching constitutes comparison of data respecting 
the terms of settlement of securities transactions, and therefore an 
entity that provides matching services as an intermediary between a 
broker-dealer and an institutional customer is a clearing agency 
within the meaning of Section 3(a)(23) of the Exchange Act and is, 
therefore, subject to the registration requirements of Section 17A. 
See Confirmation and Affirmation of Securities Trades, Exchange Act 
Release No. 39829 (Apr. 6, 1998), 63 FR 17943, 17946 (Apr. 13, 
1998); Clearing Agency Standards, Exchange Act Release No. 68080 
(Oct. 22, 2012), 77 FR 66220, 66228 & n.94 (Nov. 2, 2012) (noting 
the 1998 interpretive release); see also 15 U.S.C. 78c(a)(23) 
(defining the term ``clearing agency''). The Commission has provided 
exemptions from registering as a clearing agency to certain entities 
that operate matching and ETC services. See Order Granting Exemption 
from Registration as a Clearing Agency for Global Joint Venture 
Matching Services-U.S., LLC, Exchange Act Release No. 44188 (Apr. 
17, 2001), 66 FR 20494, 20501 (Apr. 23, 2001); Order Approving 
Applications for an Exemption from Registration as a Clearing Agency 
for Bloomberg STP LLC and SS&C Techs., Inc., Exchange Act Release 
No. 76514 (Nov. 24, 2015), 80 FR 75388, 75413 (Dec. 1, 2015).
---------------------------------------------------------------------------

    ETC is a process where the Matching/ETC Provider simply provides 
the communication facilities to enable a broker-dealer and its 
institutional investor to send messages back and forth that ultimately 
results in the agreement of the trade details or affirmed confirmation, 
which is in turn sent to DTC to effect settlement of the trade.\46\ 
Specifically, the Matching/ETC Provider will send the affirmed 
confirmations to DTC where the DTC participants who will be delivering 
securities will authorize the trades for automated settlement.\47\
---------------------------------------------------------------------------

    \46\ ITPC 2002 White Paper, supra note 44.
    \47\ See Order Approving Proposed Rule Change by The Depository 
Trust Company To Allow the Inventory Management System To Accept 
Real-Time and Late Affirmed Trades from Omgeo, Exchange Act Release 
No. 54701 (Nov. 3, 2006), 71 FR 65854 (Nov. 9, 2006).
---------------------------------------------------------------------------

    In contrast, ``Matching'' is a process by which the Matching/ETC 
Provider compares and reconciles the broker-dealer's trade details with 
the institutional investor's allocation instructions to determine 
whether the two descriptions of the trade agree. If the trade details 
and institutional investor's allocation instructions match, an affirmed 
confirmation is generated, which also is used to effect settlement of 
the trade. As with ETC, transmission of the affirmed confirmations by 
the Matching/ETC Provider to DTC facilitates automated trade 
settlement.\48\
---------------------------------------------------------------------------

    \48\ Id.
---------------------------------------------------------------------------

    ETC is considered less efficient than Matching because it is an 
iterative process where each participant has to wait for a trigger 
before executing the next step in the process and has to manually re-
key trade data into several systems, resulting in delay and redundant 
flows of non-essential data.\49\ Moreover, during this process broker-
dealers and their institutional investors often rely on internal 
systems that lack either automation, common message standards, or both, 
resulting in a lack of synchronized automated data that can cause 
errors and discrepancies. Matching, in contrast to ETC, is not an 
iterative process. Rather, matching eliminates the separate step of 
producing a confirmation for the institutional investor to review and 
affirm. Currently, Matching/ETC Providers assist many, but not all, 
market participants in affirming institutional trade details as soon as 
possible after trade execution, thereby helping to ensure that a trade 
will clear and settle by the end of the settlement cycle.\50\
---------------------------------------------------------------------------

    \49\ ITPC 2002 White Paper, supra note 44, at 3.
    \50\ See infra Part III.A.3. for affirmation rates for certain 
Matching/ETC Providers.
---------------------------------------------------------------------------

c. Market Participants--Investors, Broker-Dealers, and Custodians
    A variety of market participants depend on the clearance and 
settlement services facilitated by the FMUs and Matching/ETC Providers, 
including but not limited to institutional and retail investors, 
broker-dealers, and custodians (e.g., banks). Furthermore, the relevant 
clearance and settlement

[[Page 69247]]

steps that need to be accomplished by the FMUs, Matching/ETC Providers, 
and financial service firms within the settlement cycle vary depending 
on whether an investor is an institutional investor or a retail 
investor.
    Institutional investors are entities such as mutual funds, pension 
funds, hedge funds, bank trust departments, and insurance companies. 
Transactions involving institutional investors are often more complex 
than those for and with retail investors due to the volume and size of 
the transactions, the entities involved in facilitating the execution 
and settlement of the trade, including Matching/ETC Providers and 
custodians, and the need to manage certain regulatory or business 
obligations.\51\ Trades involving retail investors are typically 
smaller in size than institutional trades, and the settlement of retail 
investor trades generally occurs directly with the investor's or their 
intermediary's broker-dealer and does not involve a separate custodian 
bank.
---------------------------------------------------------------------------

    \51\ The distinction between ``retail investor'' and 
``institutional investor'' is made only for the purpose of 
illustrating the manner in which these types of entities generally 
clear and settle their securities transactions. For purposes of this 
release, the term ``retail investor'' includes any entity that 
settles their securities transactions in a manner described in Part 
II.A.3.a. Similarly, the term ``institutional investor'' is used to 
describe any entity that is permitted and chooses to settle their 
securities transactions in the manner described in Part II.A.3.b.
---------------------------------------------------------------------------

    To clear and settle securities transactions directly through a 
registered clearing agency, the rules of the clearing agencies provide 
that a broker-dealer or other type of market participant must become a 
direct member of that clearing agency.\52\ Generally broker-dealers 
that are direct members of clearing agencies are referred to as 
``clearing broker-dealers.'' Clearing broker-dealers must comply with 
the rules of the clearing agency, including but not limited to rules 
relating to operational and financial requirements. Broker-dealers that 
submit transactions to a clearing agency through a clearing broker-
dealer are generally referred to as ``introducing broker-dealers.'' In 
general, broker-dealers executing trades on a registered securities 
exchange are required to clear those transactions through a registered 
clearing agency.\53\ Additionally, pursuant to certain self-regulatory 
organization (``SRO'') rules, broker-dealers that effect transactions 
in municipal and corporate debt securities are required to clear and 
settle those transactions through a registered clearing agency.\54\ 
Broker-dealers executing trades outside the auspices of a trading venue 
(e.g., on an internalized basis) may clear through a clearing agency, 
may choose to settle those trades through mechanisms internal to that 
broker-dealer, or may settle the trades bilaterally.\55\ Post-trade 
processing of securities transactions by broker-dealers generally 
occurs in the back office and entails the following functions: (1) 
Order management, which keeps track of the orders that are sent to the 
various markets and of the subsequent related executions that are 
received; (2) purchases and sales, which works closely with the 
appropriate clearing agency to ensure the transactions have been 
accurately cleared and settled and to reconcile the broker-dealer's 
position; (3) cashiering, which is responsible for receiving and 
delivering securities; and (4) asset servicing activities related to 
the processing of dividends, stock splits, and other corporate actions.
---------------------------------------------------------------------------

    \52\ Due to the financial and operational obligations of 
entities submitting trades to a clearing agency, all clearing 
agencies have established specific requirements for initial 
membership and ongoing participation in the clearing agency. See, 
e.g., NSCC Rules and Procedures, supra note 26, Rules 2A and 2B 
(discussing initial and ongoing requirements for membership).
    \53\ See, e.g., FINRA Rules 6350A(a) and 6350B(a) (requiring 
that FINRA members must clear and settle transactions in 
``designated securities'' (i.e., NMS stocks) through the facilities 
of a registered clearing agency that uses a continuous net 
settlement system). In addition, FINRA Rule 6274(a) requires that a 
member must clear and settle transactions ``effected on'' the 
Alternative Display Facility in ADF-eligible securities (i.e., NMS 
stocks) that are eligible for net settlement through the facilities 
of a registered clearing agency that uses a continuous net 
settlement system. Notwithstanding the requirements in Rules 
6350A(a), 6350B(a) and 6274(a), transactions in designated 
securities and transactions in ADF-eligible securities may be 
settled ``ex-clearing'' provided that both parties to the 
transaction agree to the same. See FINRA Rules 6350A(b), 6350B(b), 
6274(b).
    \54\ See MSRB Rule G-12(f); FINRA Rule 11900.
    \55\ See generally FINRA Rules 6350A, 6350B and 6274.
---------------------------------------------------------------------------

    Often, due to regulatory or business obligations, an institutional 
investor will not use its executing broker-dealer to custody the 
institutional investors' securities at DTC, but rather will use a 
custodian bank for the safekeeping and administration of both their 
securities and cash.\56\ The custodian may also provide other 
administrative services, such as: (1) Acting as an agent or fiduciary; 
(2) monitoring the purchase and sale of securities by the executing 
broker-dealers; and (3) collecting dividends and interest.
---------------------------------------------------------------------------

    \56\ Section 17(f) of the Investment Company Act of 1940 (the 
``Investment Company Act'') and the rules thereunder govern the 
safekeeping of a registered investment company's assets, and 
generally provide that a registered investment company must place 
and maintain its securities and similar instruments only with 
certain qualified custodians. Section 17(f)(1)(A) of the Investment 
Company Act permits certain banks to maintain custody of registered 
investment company assets subject to Commission rules. See 15 U.S.C. 
80a-17(f).
---------------------------------------------------------------------------

3. Overview of Trade Settlement Processes
    As described further below, the proposed amendment to paragraph (a) 
of Rule 15c6-1 would prohibit a broker or dealer from entering into a 
securities contract that settles later than the second business day 
after the date of the contract unless expressly agreed upon by both 
parties at the time of the transaction, subject to certain exceptions 
enumerated in the rule. To provide context for understanding the 
proposed amendment and the related economic analysis that follows, this 
section provides an overview of the current state of trade settlement 
processes under current Rule 15c6-1. Given the differences in the 
clearance and settlement processes for trades by retail and some 
institutional investors, the proposed amendment may have differing 
economic effects on different market participants involved in these 
transactions. Accordingly, the current clearance and settlement 
processes are discussed below separately.\57\
---------------------------------------------------------------------------

    \57\ Although trades in open-ended investment company securities 
(i.e., mutual funds) are subject to Rule 15c6-1, trades in these 
securities (other than ETFs and other types of exchange-traded 
products) are generally not executed in the secondary market, but 
rather between issuers and their broker-dealer distributors. As a 
non-CCP service, NSCC administers an electronic communication 
system, Fund/SERV, that centralizes and standardizes order entry, 
confirmation, registration and money settlement for mutual fund 
companies, broker-dealers, banks and trust companies, third party 
administrators and other intermediaries involved in the purchase and 
sale of mutual fund shares. Pursuant to NSCC rules, an NSCC member 
may roll up their daily cash obligation from Fund/SERV transactions 
into the member's daily net obligations at NSCC. NSCC Rules and 
Procedures, supra note 26, Rules 7, 12 and 52.
---------------------------------------------------------------------------

a. Retail Investor Trade Settlement Process
    Trade comparison, which consists of reporting, comparing, matching, 
and validating the buy and sell sides of a trade is the first step in 
the clearance and settlement of retail investor transactions. At the 
trading venue, such as an exchange or non-exchange trading venue (e.g., 
alternative trading system or electronic communication network), a buy 
order is electronically matched against a sell order. If the details of 
the trade submitted by the counterparties agree (e.g., the security 
price and quantity), the trade is considered ``locked in'' and then 
sent from the

[[Page 69248]]

trading venue to NSCC.\58\ The following is a high level description 
and illustration of what generally occurs each day following execution 
of a retail investor trade and submission of the trade to NSCC:
---------------------------------------------------------------------------

    \58\ Trade comparison can be completed at NSCC, through a 
trading venue, or through a Qualified Special Representative 
(``QSR'') (as defined in Rule 1 of NSCC's Rules and Procedures) on 
behalf of NSCC members, as permitted by clearing agency rules. 
Currently, over 99% of the trade data received by NSCC is received 
from a trading venue or QSR on a locked-in basis (i.e., already 
compared by the marketplace of execution). However, NSCC provides 
comparison services for transactions in fixed income securities 
(i.e., corporate and municipal bonds) and for over-the-counter 
transactions that are not otherwise generally matched through other 
facilities. NSCC performs its comparison process on the same 
timeline as locked-in trade submissions. See NSCC PFMI Disclosure 
Framework, supra note 27, at 7.
---------------------------------------------------------------------------

    Trade Date--NSCC validates trade data received from the trading 
venue and confirms receipt of the transaction details by electronically 
sending communication to NSCC members that are counterparties to the 
trade. This communication legally commits the members to complete the 
trade.\59\
---------------------------------------------------------------------------

    \59\ NSCC Rules and Procedures, supra note 26, Rule 5, Section 
1.
---------------------------------------------------------------------------

    T+1--At midnight on T+1, NSCC novates the trade, becoming the buyer 
to the selling broker-dealer, and the seller to the buying broker-
dealer and attaches a trade guaranty.\60\ (Step 1)
---------------------------------------------------------------------------

    \60\ NSCC accepts transactions for clearance on business days. 
Pursuant to Rule 1 of NSCC's Rules and Procedures, the term 
``business day'' means any day on which NSCC is open for business. 
However, on any business day that banks or transfer agencies in New 
York State are closed or a qualified securities depository is 
closed, no deliveries of securities and no payments of money shall 
be made through NSCC.
---------------------------------------------------------------------------

    T+2--NSCC issues a trade summary report to its members with a 
summary of all securities transactions and cash to be settled the 
following day, specifically indicating the net positions of securities 
and the net cash amount owed by the member or to be received by the 
member. NSCC also sends an electronic instruction to DTC detailing the 
net positions and cash that need to be settled for each member/
participant. (Step 2)
    T+3--DTC transfers the securities electronically between the buying 
and selling broker-dealer accounts at DTC. The participant broker-
dealers instruct their settlement banks to send money to, or receive 
money from, DTC to complete the transaction.\61\ (Step 3) Investors 
receive securities and cash from their respective broker-dealers. (Step 
4)
---------------------------------------------------------------------------

    \61\ Both NSCC and DTC jointly provide all members/participants 
and their settling banks with reports throughout the day indicating 
their net debit and net credit amounts for individual members/
participants as well as a net-net amount for each settling bank. 
Each NSCC member is required to select a settling bank to handle the 
electronic payment or receipt of payments through the Federal 
Reserve Bank's Fedwire system.
[GRAPHIC] [TIFF OMITTED] TP05OC16.002


[[Page 69249]]


b. Institutional Investor Trade Settlement Process
    Institutional trade processing typically starts when an 
institutional customer or its agent (sometimes referred to as the ``buy 
side'') places an order to buy or sell securities with its broker-
dealer. The broker-dealer will advise the institutional customer of the 
trade details, who in turn may advise its broker-dealer how the trade 
should be allocated among its various accounts.\62\ The process of 
verifying the allocation is completed through the confirmation/
affirmation procedures described in Part II.A.2.b., which discusses the 
automated post-trade pre-settlement processing of institutional 
investor trades.
---------------------------------------------------------------------------

    \62\ In instances where an institutional investor submits an 
order on behalf of other parties (e.g., an investment manager on 
behalf of several mutual funds), the institutional investor will 
instruct its broker-dealer as to how to allocate the transactions 
among the underlying entities. The broker-dealer will reply by 
sending details of, or confirming, each allocation and if correct, 
the institutional investor will affirm.
---------------------------------------------------------------------------

    Institutional investors may choose to trade through an executing 
broker-dealer that clears and settles its securities transactions 
though NSCC and DTC. However, depending on the size and complexity of 
the trade and the number of trading partners involved in the 
transaction, institutional investors may also choose to avail 
themselves of processes specifically designed to address the unique 
aspects of their trades. Specifically, these transactions can be 
processed on a trade-for-trade basis through a prime broker-dealer and 
settled on an RVP/DVP basis through DTC \63\ and the institutional 
customer's custodial bank.\64\
---------------------------------------------------------------------------

    \63\ DTC operates a DVP settlement system for settlement of 
securities on a gross basis and settlement of funds on a net basis. 
Deliveries of securities are subject to DTC's risk management 
controls, which are designed so that DTC may complete system-wide 
settlement notwithstanding the failure to settle of its largest 
participant or affiliated family of participants. See DTC, 
Disclosure under the PFMI Disclosure Framework, at 10 (Dec. 2015), 
https://www.dtcc.com/legal/policy-and-compliance.
    \64\ Through its ID Net Service, DTC allows its participant 
broker-dealers to net their institutional investor customer 
transactions with the broker-dealer's other transactions (including 
the broker's retail trades) to reduce the aggregate securities 
movement while still retaining the trade-for-trade settlement 
between the DTC participant and the custodian bank. This service 
also allows the banks to maintain their responsibility to pay for 
only those trades where all the shares are delivered, while at the 
same time providing brokers with the benefits of netting through 
NSCC's CNS system.
---------------------------------------------------------------------------

    The following is a high level description and illustration of what 
generally occurs each day following execution of an institutional 
investor trade and submission of the trade to DTC:
    Trade Date through T+2--The institutional investor sends to the 
Matching/ETC Provider, its broker-dealer, and its custodian the 
allocation information for the trade. (Step 1) The broker-dealer then 
submits to the Matching/ETC Provider trade data corresponding to each 
allocation, including settlement instructions and, as applicable, 
commissions, taxes, and fees. (Step 2)
    If the transaction is processed through a matching service, the 
Matching/ETC Provider compares the institutional investor's allocation 
information with the broker-dealer's trade data to determine whether 
the information contained in each field matches. If all required fields 
match, the Matching/ETC Provider generates a matched confirmation and 
sends it to the broker-dealer, the institutional investor, and other 
entities designated by the institutional investor (e.g., the 
institutional investor's custodian). (Step 3)
    If the institutional investor uses the ETC process, instead of 
comparing the institutional investor's allocation information with the 
broker's trade data, the Matching/ETC Provider would transmit the 
information to the broker-dealer and institutional investor so that 
each party could verify that the trade was executed and allocated 
correctly and produce an affirmed confirmation.
    T+2--After the Matching/ETC Provider creates the matched 
confirmation (whether by ETC or matching), the matching service submits 
it to DTC as an ``affirmed confirmation.'' After the affirmed 
confirmation has been submitted, DTC participants that are delivering 
securities then authorize the trades for automated settlement. DTC 
currently processes transactions in real-time from approximately 8:30 
p.m. on the night before settlement day (T+2) until 3:30 p.m. on 
settlement day (T+3) for DVP transactions and until 6:35 p.m. for free 
of payment transactions.
    T+3--DTC transfers the securities electronically between the buying 
and selling broker-dealer accounts at DTC. The participant broker-
dealers instruct their settlement banks to send money to, or receive 
money from, DTC to complete the transaction.

[[Page 69250]]

[GRAPHIC] [TIFF OMITTED] TP05OC16.003

4. Impact of the Settlement Cycle
    The length of the settlement cycle has varying degrees of impact 
across the range of market participants described above. That impact 
stems, in large part, from the type of risk exposure each entity brings 
to the clearance and settlement process and the nature of its processes 
and systems for operating within the existing framework.
    From the perspective of a CCP, such as NSCC, the length of the 
settlement cycle may affect the CCP's exposure to credit, market and 
liquidity risk that arises once a transaction has been novated and the 
CCP takes offsetting (and guaranteed) positions as a substituted 
counterparty for each of the parties to the original transaction.\65\ A 
CCP takes a number of measures to manage this credit risk to its 
members, including through financial resource contributions from 
members and netting down the total outstanding exposure it may have to 
a particular member. However, the extent to which a CCP must apply 
these risk mitigation tools depends in large part on the length of time 
it is exposed to the risk that one or more of its members may default 
on their settlement obligations, which in turn is driven by the length 
of the settlement cycle.
---------------------------------------------------------------------------

    \65\ See CCA Proposal, 79 FR at 29524, which provides an 
overview discussion of financial risks faced by clearing agencies.
---------------------------------------------------------------------------

    The settlement cycle similarly determines the period of time during 
which a CCP faces market risk following novation. Market risk, as a 
general matter, can arise for a CCP where a member has defaulted during 
the settlement cycle, and the CCP faces the risk that the defaulted 
member's positions and other resources the CCP holds (i.e., defaulted 
member collateral, such as clearing fund deposits) decline in market 
value as the CCP seeks to liquidate, transfer, or otherwise dispose of 
those assets to minimize losses.\66\ Finally, the settlement cycle can 
also impact the amount of liquidity risk a CCP may need to anticipate 
for purposes of settling an open transaction (the CCP often relies on 
incoming payments from some members to facilitate payments to other 
members) or otherwise deploying financial resources to cover losses 
that may result from a member's default.\67\ A DTCC paper published in 
2011 notes that shortening the settlement cycle may result in reduced 
liquidity obligations for NSCC.\68\ In addition, that study, which was 
conducted from October 19, 2010, through August 31, 2011, indicated 
certain procyclical benefits to a reduced settlement cycle in observing 
how NSCC clearing fund requirements

[[Page 69251]]

would decline if the settlement cycle was shortened.\69\ The results of 
the study are reflected in the tables below.
---------------------------------------------------------------------------

    \66\ See id.
    \67\ See id. Credit and liquidity risk may also be relevant to 
the functioning of a CSD, given that the CSD will rely on incoming 
payments or deliveries of securities from certain participants to 
make payments or deliveries to other participants. Where a CSD 
participant defaults, or where a CCP or a CSD participant faces 
liquidity pressure, the CSD itself may need to deploy financial 
resources to cover the shortfall. For example, the CSD may maintain 
a participant fund (similar in function to a clearing fund) or have 
available lines of credit to access in such instances.
    \68\ DTCC, Proposal to Launch a New Cost-Benefit Analysis on 
Shortening the Settlement Cycle, at 7 (Dec. 2011) (``DTCC Proposal 
to Launch a Cost-Benefit Analysis''), https://www.dtcc.com/en/news/2011/december/01/proposal-to-launch-a-new-cost-benefit-analysis-on-shortening-the-settlement-cycle.aspx.
    \69\ See id. at 8-9.

------------------------------------------------------------------------
                                                           Average daily
                                                           clearing fund
                    Settlement cycle                        requirement
                                                               ($MM)
------------------------------------------------------------------------
T+3.....................................................    4,012 (100%)
T+2.....................................................    3,421 (-15%)
T+1.....................................................    2,994 (-25%)
------------------------------------------------------------------------

    According to the study, clearing fund savings (for NSCC's members) 
resulting from shorter settlement cycles are more pronounced during 
periods of high volatility.\70\ By showing the same data for August 
2011, a period of high volatility, the study shows a greater decrease 
in NSCC's clearing fund requirements.\71\
---------------------------------------------------------------------------

    \70\ See id.
    \71\ See id.

------------------------------------------------------------------------
                                                           Average daily
                                                           clearing fund
                    Settlement cycle                        for August
                                                            2011 ($MM)
------------------------------------------------------------------------
T+3.....................................................    7,281 (100%)
T+2.....................................................    5,517 (-24%)
T+1.....................................................    4,619 (-37%)
------------------------------------------------------------------------

    NSCC also conducted a study from April 2011 to September 2011 that 
indicated that shortening the settlement cycle would reduce NSCC's 
liquidity obligations significantly. According to the study, in a T+2 
settlement cycle, NSCC's average liquidity obligations would decline by 
20%, thereby reducing members' required clearing fund deposits.\72\
---------------------------------------------------------------------------

    \72\ See id. at 7.
---------------------------------------------------------------------------

    For broker-dealers and investors, the impact of the length of the 
settlement cycle can be understood in most cases through the 
perspective of liquidity risk. Over the course of the settlement cycle, 
broker-dealers and investors will generally seek to manage two forms of 
liquidity risk--(i) sudden or unexpected liquidity demands that may 
arise due to the CCP's ongoing management of credit, market and 
liquidity risk exposure during the settlement cycle,\73\ and (ii) the 
need to timely obtain and deliver cash or securities to settle 
outstanding trades, as well as using cash or securities to engage in 
trading activity across other markets with mismatched settlement 
cycles, such as non-U.S. markets.
---------------------------------------------------------------------------

    \73\ In this respect, the liquidity risk can be linked to market 
risk faced by the CCP and its member arising from the open position 
between the CCP and the member, as well as any collateral posted by 
the member to the CCP to cover the CCP's credit risk exposure to the 
member. Where the market value of these open positions or the posted 
collateral fluctuates, the CCP may seek additional margin or other 
financial resources from the member. See CCA Proposal, 79 FR 29524.
---------------------------------------------------------------------------

    Broker-dealers that are CCP members (including broker-dealers that 
are NSCC members) have financial resource obligations which the CCP may 
collect for risk management purposes.\74\ These financial resource 
obligations may be at issue where a CCP member defaults and the CCP 
requires the defaulting member's resources or the other members' 
mutualized resources to address any credit, market and liquidity risk 
the CCP faces as it seeks to liquidate, transfer or otherwise dispose 
of the defaulted positions and related collateral of the defaulting 
member.\75\ These financial resource obligations may also be incurred 
within a settlement cycle where a CCP seeks additional resources to 
address potential risk that may increase due to changing or otherwise 
volatile market conditions that can also be procyclical.\76\ In such 
instances, the CCP member's obligation to make available financial 
resources to the CCP keys off of the period of time during which the 
CCP faces the member. Therefore, the length of the settlement cycle can 
impact the amount and types (e.g., stable, highly liquid assets) of 
financial resources a CCP may require of its members, which in turn 
creates liquidity risk exposure and capital costs for the member in 
terms of obtaining and delivering to the CCP the necessary financial 
resources in a timely manner.
---------------------------------------------------------------------------

    \74\ See supra Part II.A.2.a.(1) for additional discussion 
regarding the use of financial resource requirements for risk 
management purposes. See also NSCC Rules and Procedures, supra note 
26, Rules 4 and 4(A).
    \75\ See CCA Proposal, 79 FR at 29524.
    \76\ See DTCC, DTCC Recommends Shortening the U.S. Trade 
Settlement Cycle (Apr. 2014), https://www.ust2.com/industry-action/.
---------------------------------------------------------------------------

    Further, for NSCC members/DTC participants, the length of the 
settlement cycle determines the deadline by which cash or securities 
must be delivered into the member/participant's DTC account for 
settlement purposes. Thus, a member/participant may face liquidity risk 
in obtaining (or recalling) from other markets with mismatched 
settlement cycles the necessary resources to deliver in time for 
settlement. Similarly, the length of the settlement cycle governs the 
time when the proceeds of a securities transaction may be made 
available to the member/participant. A mismatch in timing between the 
settlement cycle for the securities transaction and the settlement 
cycle for another market transaction, such as in the derivatives or a 
non-U.S. market with a different settlement cycle, can lead in turn to 
liquidity risk for the member in meeting all of its settlement 
obligations across markets.\77\
---------------------------------------------------------------------------

    \77\ For example and as noted earlier, the settlement cycle 
timeframe for open-end mutual funds that settle through NSCC is 
generally T+1. However, the settlement cycle timeframe for many 
underlying portfolio securities held by mutual funds is T+3. 
Settlement timeframes for securities with non-standard settlements 
held by these funds may be longer than T+3. This mismatch in timing 
presents potential liquidity risks for such funds as market 
participants with respect to the receipt of portfolio proceeds and 
in satisfying their investor redemption obligations. See Investment 
Company Act Release No. 31835 (Sept. 22, 2015), 80 FR 62273, 62282-
83 (Oct. 15, 2015); see also, e.g., PricewaterhouseCoopers LLP, 
Shortening the Settlement Cycle: The Move to T+2, at 13 n.18 (2015) 
(``ISC White Paper''), https://www.ust2.com/pdfs/ssc.pdf.
---------------------------------------------------------------------------

    Broker-dealers that are not members of a CCP may similarly face 
certain of the liquidity risks described above because the clearing 
broker-dealer may pass on related costs through margin charges, as well 
as other charges and fees (which may, in some cases, be incorporated in 
the clearing broker-dealer's management of its credit risk to the non-
clearing broker-dealer). These costs may also, in turn, be applied to 
or passed on to both institutional and retail investors by their 
executing or clearing broker-dealers.\78\ For example, an industry 
study noted that some NSCC members carry the exposure of their 
customers' open positions during the settlement cycle and that each 
day's reduction in the settlement cycle could lessen these open 
exposures by 25%.\79\ Therefore, the length of the settlement cycle can 
potentially affect the size and type of financial resource demands 
broker-dealers may pass on to investors.
---------------------------------------------------------------------------

    \78\ For further discussion on the downstream effects of 
liquidity risk costs, see infra Part VI.C.4.
    \79\ See DTCC Proposal to Launch a Cost-Benefit Analysis, supra 
note 68, at 7.
---------------------------------------------------------------------------

    The impact that the length of the settlement cycle may have on the 
credit, market and liquidity risk exposure faced by market participants 
can also lead to impacts on systemic risk. First, the length of the 
settlement cycle will determine the number of unsettled transactions 
present in the settlement system at any given point in time, and 
consequently the level of exposure to credit, market and liquidity 
risks faced by market participants. This attendant credit, market and 
liquidity risk, in turn, can affect the potential likelihood of a 
market participant defaulting. In the event of a default of a major 
market participant, the default may entail losses so large as to create 
widespread or systemic problems. Further, the default of one member may 
lead to the default of one or more other members, exacerbating any 
financial stress a CCP

[[Page 69252]]

or other market infrastructure may be experiencing because of the 
default.\80\
---------------------------------------------------------------------------

    \80\ See T+3 Adopting Release, 58 FR at 52894; see also Clearing 
Agency Standards Adopting Release, 77 FR at 66254 (discussing the 
need for default procedures to allow the clearing agency to take 
action resulting from one or more member defaults in order to 
contain resultant losses and liquidity pressures).
---------------------------------------------------------------------------

    As a more general matter, market participants rely on CCPs for 
prompt clearance and settlement of transactions and the receipt of 
proceeds from those transactions. Thus, a significant disruption in the 
clearance and settlement process and transmission of these proceeds 
could potentially harm other market participants, particularly in 
instances where market participants in centrally cleared and settled 
markets are linked through intermediation chains to each other and to 
participants in uncleared markets (as is the case in the U.S. clearance 
and settlement system). Shortening the settlement cycle is therefore 
one of the primary methods for reducing this risk.\81\
---------------------------------------------------------------------------

    \81\ See Christopher L. Culp, Risk Management by Securities 
Settlement Agents, 10 J. Applied Corp. Fin. 96 (Fall 1997), https://www.rmcsinc.com/articles/JACF103.pdf.
---------------------------------------------------------------------------

5. Post-Rule 15c6-1 Adoption
    Since the adoption of Rule 15c6-1, the Commission and various 
market participants have, as described in greater detail below, 
explored the possibility of shortening the standard settlement cycle 
further. Below is a description of these efforts.
a. SIA T+1 Initiative
    After the implementation of the T+3 settlement cycle, the 
Securities Industry Association (``SIA'') led an effort to shorten the 
settlement cycle to T+1 and implement STP.\82\ In 2000, the SIA 
published its T+1 Business Case Final Report (``SIA Business Case 
Report'') which concluded that the case for moving to a T+1 settlement 
cycle in the U.S. was ``strong'' based upon several factors.\83\ 
According to the SIA Business Case Report: (i) The move from T+3 to T+1 
would dramatically reduce the settlement risk exposure of the U.S. 
securities industry; \84\ (ii) the transition to a T+1 settlement cycle 
would enable the U.S. market to continue to maintain its global 
competitiveness by serving as the catalyst for enhancing the current 
post-trade processing and settlement process; \85\ and (iii) the move 
to T+1 would serve the interests of U.S. investors by synchronizing the 
clearance and settlement process across asset classes, thus enabling 
more fungible, flexible trading and investing.\86\
---------------------------------------------------------------------------

    \82\ The SIA (which has since merged with other industry groups 
to form the Securities Industry Financial Markets Association) was a 
trade association that represented U.S. broker-dealers.
    \83\ SIA, T+1 Business Case Final Report (July 2000) (``SIA 
Business Case Report''), https://www.sifma.org/issues/item.aspx?id=8589939820.
    \84\ Id. at 1, 7. The SIA Business Case Report did not 
explicitly define the term ``settlement risk.'' However, the report 
argued that a move to a T+1 settlement cycle would reduce credit 
risk exposure and operational risk exposure. See id. at 39-41.
    \85\ Id.
    \86\ Id.; see also infra Part VI.D.1. for a discussion of the 
alternative of shifting to a T+1 settlement cycle.
---------------------------------------------------------------------------

    The SIA Business Case Report also identified ten ``building 
blocks'' essential to realizing the goal of improving the speed, 
safety, and efficiency of the trade settlement process, and included a 
cost benefit analysis for transitioning to T+1.\87\ The implementation 
of these building blocks, the report noted, would ensure that the 
transition to a T+1 settlement cycle would be accomplished in an 
orderly and risk-effective manner.\88\
---------------------------------------------------------------------------

    \87\ See id. at 2-3. The 10 Building Blocks identified in the 
report are as follows: (1) Modify internal processes at broker-
dealers, asset managers, and custodians to ensure compliance with 
compressed settlement deadlines; (2) identify and comply with 
accelerated deadlines for submission of trades to the clearing and 
settlement systems; (3) amend NSCC's trade guaranty process so that 
guaranty is provided on trade date; (4) report trades to clearing 
corporations in locked-in format and revise clearing corporations' 
output; (5) rewrite CNS processes at NSCC to enhance speed and 
efficiency; (6) reduce reliance on checks and use alternative means 
of payment, such as automatic debits allowed by the National 
Automated Clearing House Association; (7) immobilize securities 
shares prior to conducting transactions; (8) revise the prospectus 
delivery rules and procedures for initial public offerings; (9) 
develop industry matching utilities and linkages for all asset 
classes; and (10) standardize reference data and move to 
standardized industry protocols for broker-dealers, asset managers, 
and custodians.
    \88\ Id. at 2.
---------------------------------------------------------------------------

    In July 2002, the SIA shifted the principal focus of its initiative 
from shortening the settlement cycle to achieving industry-wide STP and 
planned to reconsider the need to pursue a reduction in the settlement 
cycle in 2004.\89\ At that time, the SIA believed more work was needed 
on improving operational processing to achieve STP before a transition 
to T+1 could be considered.\90\ The SIA's reasoning for this shift in 
focus stemmed largely from an operational risk concern, observing that 
while a shorter settlement cycle would be expected to decrease the 
gross amount of unsettled trades subject to credit or market risk, it 
could increase operational risk at that time by reducing the time 
available to correct errors prior to settlement. The SIA therefore 
argued that the industry priority should be to ensure that a higher 
amount and rate of trades were affirmed/confirmed on an earlier basis 
via STP, which in turn would be useful for a later consideration of 
compressing the settlement cycle in an environment less prone to the 
likelihood of operational risk.\91\
---------------------------------------------------------------------------

    \89\ Press Release, SIA, SIA Board Endorses Program to Modernize 
Clearing and Settlement Process for Securities, STP Connections 
(July 18, 2002) (statement from the SIA Board of Directors endorsing 
straight-through processing); see also Letter from Jeffrey C. 
Bernstein, Chairman, SIA STP Steering Committee, SIA (June 16, 2004) 
(commenting on the Commission's 2004 Securities Transaction 
Settlement Concept Release, Exchange Act Release No. 49405 (Mar. 11, 
2004), 69 FR 12922, 12923 (Mar. 18, 2004)).
    \90\ Id. at 3.
    \91\ Id. at 7.
---------------------------------------------------------------------------

b. Securities Transaction Concept Release
    In March 2004, the Commission published a concept release 
(``Concept Release'') seeking comment on methods to improve the safety 
and operational efficiency of the U.S. clearance and settlement system 
and to help the U.S. securities industry achieve STP.\92\ Specifically, 
the Commission sought comment on, among other things, (i) the benefits 
and costs of shortening the settlement cycle to a timeframe less than 
T+3; (ii) whether the Commission should adopt a new rule or the SROs 
should be required to amend their existing rules to require the 
completion of the confirmation/affirmation process on trade date 
(``T+0''); and (iii) reducing the use of physical securities.\93\ The 
purpose of the Concept Release was to build upon the domestic 
initiatives and continue the exploration of methods to improve the 
operations of the national clearance and settlement system. The 
Commission received sixty-three comment letters from a wide variety of 
commenters, both domestic and international, including but not limited 
to, broker-dealers, transfer agents, issuers, individual and 
institutional investors, academics, service providers, and industry 
associations.\94\ While the comments were informative and relevant at 
the time, technological, operational and regulatory changes in the 
interim have addressed many of the issues raised by the commenters.
---------------------------------------------------------------------------

    \92\ Securities Transactions Settlements, Exchange Act Release 
No 49405 (Mar. 11, 2004), 69 FR 12922 (Mar. 18, 2004).
    \93\ Id.
    \94\ The comment letters submitted pursuant to the Commission's 
request for comment in the Concept Release are available at https://www.sec.gov/rules/concept/s71304.shtml.
---------------------------------------------------------------------------

    The Commission received thirty-four comment letters expressing a 
position
on shortening the settlement cycle,\95\ with the majority of the 
commenters

[[Page 69253]]

either: (i) Supporting shortening the settlement cycle to a timeframe 
less than T+3 (primarily T+1); (ii) supporting implementation of STP 
prior to shortening the settlement cycle; (iii) supporting 
implementation of STP in lieu of shortening the settlement cycle (in 
part because STP would derivatively drive shorter cycles) or (iv) 
expressing no opinion on either T+1 or STP, but rather discussing the 
need to address other post trade processing issues (e.g., streamlining 
the institutional transactional processing model, using RVP/DVP 
processing for both retail and institutional trades, addressing fails 
in the clearance and settlement system, and dematerializing securities 
certificates in the U.S. settlement cycle) prior to a regulatory 
mandate to shorten the U.S. settlement cycle.\96\ The comment letters 
that supported the implementation of a T+1 settlement cycle noted the 
benefits of a shortened settlement cycle, including reducing risks, 
reducing costs, improving efficiencies, and making accurate information 
more quickly available to investors. Several of the commenters also 
noted that T+1 would remove systemic risk and enable clients to have 
accurate information about their assets with finality the next trading 
day.\97\ Several commenters based their general support on the view 
that currently available technology (as it existed in 2004) would 
support a T+1 or T+0 settlement cycle,\98\ or that the operating costs 
of real time software would be dramatically lower than the staff it 
would replace.\99\ One of these commenters stated that even if the 
current technology facilitating ``real time settlement'' was not 
currently cost effective, it would be in the future as technology 
develops and advances.\100\ If real time settlement were feasible, this 
commenter noted, the market architecture would make sure that the 
securities and cash were available in good deliverable form for instant 
settlement before the execution of the trade, thereby eliminating 
failures to deliver or pay for securities, as well as totally eliminate 
systemic and counterparty risk.\101\
---------------------------------------------------------------------------

    \95\ Letters from Bruce Barrett (Mar. 13, 2004); David Patch 
(Mar. 13, 2004, and May 18, 2004); Robert Goldberg, President, e3m 
Investments Inc. (Apr. 5, 2004); James J. Angel, Ph.D., CFA, 
Associate Professor of Finance, McDonough School of Business, 
Georgetown University (Apr. 9, 2004); Michael Sweeney, Vice 
President, Custody Services, Sumitomo Trust & Banking, Co. (USA) 
(May 20, 2004); James Nesfield (May 23, 2004); Martin Wilson (May 
27, 2004); Sennett Kirk (May 27, 2004); Adam J. Bryan, President and 
CEO, Omgeo LLC (June 4, 2004); David G. Tittsworth, Executive 
Director, Investment Counsel Association of America (June 11, 2004); 
Michael Atkin, Vice President and Director, Financial Information 
Services Division, Software & Information Industry Association (June 
13, 2004); Donald J. Kenney, Chairman, President, and Chief 
Executive Officer, EquiServe, Inc. (June 14, 2004); Jeff Potter, 
Vice President, The Northern Trust Company (June 14, 2004); John T. 
W. Pace, President, Cape Securities, Inc. (June 14, 2004); Thomas 
Sargant, President, Regional Municipal Operations Association (June 
14, 2004); Steven G. Nelson, President and Chairman of the Board, 
Continental Stock Transfer & Trust Company (June 15, 2004); Will 
DuMond, Metropolitan College of New York--School of Business (June 
15, 2004); Diane M. Butler, Director--Transfer Agency & 
International Operations, Investment Company Institute (June 16, 
2004); Fionnuala Martin, STP Program Manager, BMO Nesbitt Burns 
(June 16, 2004); Frank DiMarco, Merrill Lynch & Co., Inc., Chair, 
STP Steering Committee, The Bond Market Association (June 16, 2004); 
Ian Gilholey, The Canadian Depository for Securities Limited (June 
16, 2004); Jeffrey C. Bernstein, Chairman, SIA STP Steering 
Committee, SIA (June 16, 2004); Kevin R. Smith, Chair, ISITC-IOA 
(North America) (June16, 2004); Michael J. Alexander, Senior Vice 
President, Charles Schwab & Co., Inc. (June 16, 2004); Michael 
O'Conor, Chairman, Global Steering Committee and Peter Randall, 
Executive Director, FIX Protocol Limited (June 16, 2004); Norman 
Eaker, Principal, Edward Jones (June 16, 2004); W. Leo McBlain, 
Chairman and Thomas J. Jordan, Executive Director, Financial 
Information Forum (June 16, 2004); Jill M. Considine, Chairman and 
Chief Executive Officer, The Depository Trust and Clearing 
Corporation (June 23, 2004); Margaret R. Blake, Counsel to the 
Association, and Dan W. Schneider, Counsel to the Association, The 
Association of Global Custodians (June 28, 2004); Ed Morgan (Mar. 
31, 2006); Jim Mulkey (June 10, 2006); Charles V. Rossi, President, 
The Securities Transfer Association (June 15, 2006); and Gene Finn 
(July 25, 2012, and Aug. 2, 2012).
    \96\ Letters from Robert Goldberg, President, e3m Investments 
Inc. (Apr. 5, 2004); James J. Angel, Ph.D., CFA, Associate Professor 
of Finance, McDonough School of Business, Georgetown University 
(Apr. 9, 2004); James Nesfield (May 23, 2004); Adam J. Bryan, 
President and CEO, Omgeo LLC (June 4, 2004); Donald J. Kenney, 
Chairman, President, and Chief Executive Officer, EquiServe, Inc. 
(June 14, 2004); Diane M. Butler, Director--Transfer Agency & 
International Operations, Investment Company Institute (June 16, 
2004); Fionnuala Martin, STP Program Manager, BMO Nesbitt Burns 
(June 16, 2004); Frank DiMarco, Merrill Lynch & Co., Inc., Chair, 
STP Steering Committee, The Bond Market Association (June 16, 2004); 
Jeffrey C. Bernstein, Chairman, SIA STP Steering Committee, SIA 
(June 16, 2004); Kevin R. Smith, Chair, ISITC-IOA (North America) 
(June 16, 2004); Michael J. Alexander, Senior Vice President, 
Charles Schwab & Co., Inc. (June 16, 2004); Norman Eaker, Principal, 
Edward Jones (June 16, 2004); W. Leo McBlain, Chairman and Thomas J. 
Jordan, Executive Director, Financial Information Forum (June 16, 
2004); Jill M. Considine, Chairman and Chief Executive Officer, The 
Depository Trust and Clearing Corporation (June 23, 2004); Margaret 
R. Blake, Counsel to the Association, and Dan W. Schneider, Counsel 
to the Association, The Association of Global Custodians (June 28, 
2004); Ed Morgan (Mar. 31, 2006); Jim Mulkey (June 10, 2006); 
Charles V. Rossi, President, The Securities Transfer Association 
(June 15, 2006); and Gene Finn (July 25, 2012, and Aug. 2, 2012).
    \97\ Letters from Robert Goldberg, President, e3m Investments 
Inc. (Apr. 5, 2004); and Fionnuala Martin, STP Program Manager, BMO 
Nesbitt Burns (June 16, 2004).
    \98\ Letters from Robert Goldberg, President, e3m Investments 
Inc. (Apr. 5, 2004); James J. Angel, Ph.D., CFA, Associate Professor 
of Finance, McDonough School of Business, Georgetown University 
(Apr. 9, 2004); James Nesfield (May 23, 2004); and Jim Mulkey (June 
10, 2006).
    \99\ Letter from Robert Goldberg, President, e3m Investments 
Inc. (Apr. 5, 2004).
    \100\ James J. Angel, Ph.D., CFA, Associate Professor of 
Finance, McDonough School of Business, Georgetown University (Apr. 
9, 2004).
    \101\ Id.
---------------------------------------------------------------------------

    Of the thirty-four comments on shortening the settlement cycle, 
fourteen commenters expressed a preference to defer a decision on 
changing the settlement cycle until the industry could implement STP or 
other complementary processes.\102\ Reasons for deferring the decision 
varied, but generally focused on the need for additional information or 
additional time for the industry to implement STP successfully.\103\ 
Some of these commenters also raised concerns about the costs 
associated with implementation of a shorter settlement cycle and 
regulatory costs that may arise

[[Page 69254]]

from the switch to T+1.\104\ One commenter, in particular, noted that a 
regulatory mandate for a shortened settlement cycle was not warranted 
by the SIA's cost benefit analysis and thought a better approach would 
be to encourage the development of market-driven initiatives to promote 
advances in STP.\105\
---------------------------------------------------------------------------

    \102\ Letters from Adam J. Bryan, President and CEO, Omgeo LLC 
(June 4, 2004); David G. Tittsworth, Executive Director, Investment 
Counsel Association of America (June 11, 2004); Jeff Potter, Vice 
President, The Northern Trust Company (June 14, 2004); Thomas 
Sargant, President, Regional Municipal Operations Association (June 
14, 2004); Charles V. Rossi, President, The Securities Transfer 
Association (June 15, 2004); Frank DiMarco, Merrill Lynch & Co., 
Inc., Chair, STP Steering Committee, The Bond Market Association 
(June 16, 2004); Ian Gilholey, The Canadian Depository for 
Securities Limited (June 16, 2004); Jeffrey C. Bernstein, Chairman, 
SIA STP Steering Committee, SIA (June 16, 2004); Michael J. 
Alexander, Senior Vice President, Charles Schwab & Co., Inc. (June 
16, 2004); Michael O'Conor, Chairman, Global Steering Committee and 
Peter Randall, Executive Director, FIX Protocol Limited (June 16, 
2004); Norman Eaker, Principal, Edward Jones (June 16, 2004); W. Leo 
McBlain, Chairman and Thomas J. Jordan, Executive Director, 
Financial Information Forum (June 16, 2004); Jill M. Considine, 
Chairman and Chief Executive Officer, The Depository Trust and 
Clearing Corporation (June 23, 2004); and Margaret R. Blake, Counsel 
to the Association, and Dan W. Schneider, Counsel to the 
Association, The Association of Global Custodians (June 28, 2004).
    \103\ Letters from Adam J. Bryan, President and CEO, Omgeo LLC 
(June 4, 2004); David G. Tittsworth, Executive Director, Investment 
Counsel Association of America (June 11, 2004); Jeff Potter, Vice 
President, The Northern Trust Company (June 14, 2004); Thomas 
Sargant, President, Regional Municipal Operations Association (June 
14, 2004); Charles V. Rossi, President, The Securities Transfer 
Association (June 15, 2004); Frank DiMarco, Merrill Lynch & Co., 
Inc., Chair, STP Steering Committee, The Bond Market Association 
(June 16, 2004); Ian Gilholey, The Canadian Depository for 
Securities Limited (June 16, 2004); Jeffrey C. Bernstein, Chairman, 
SIA STP Steering Committee, SIA (June 16, 2004); Michael J. 
Alexander, Senior Vice President, Charles Schwab & Co., Inc. (June 
16, 2004); Michael O'Conor, Chairman, Global Steering Committee and 
Peter Randall, Executive Director, FIX Protocol Limited (June 16, 
2004); Norman Eaker, Principal, Edward Jones (June 16, 2004); W. Leo 
McBlain, Chairman and Thomas J. Jordan, Executive Director, 
Financial Information Forum (June 16, 2004); Jill M. Considine, 
Chairman and Chief Executive Officer, The Depository Trust and 
Clearing Corporation (June 23, 2004); and Margaret R. Blake, Counsel 
to the Association, and Dan W. Schneider, Counsel to the 
Association, The Association of Global Custodians (June 28, 2004).
    \104\ See, e.g., Letter from Michael J. Alexander, Senior Vice 
President, Charles Schwab & Co., Inc. (June 16, 2004).
    \105\ Letter from David G. Tittsworth, Executive Director, the 
Investment Counsel Association of America (June 11, 2004) 
(commenting on the Concept Release).
---------------------------------------------------------------------------

c. Current Efforts To Shorten the Settlement Cycle in the U.S.
    Since the publication of the SIA Business Case Report in 2000 and 
the publication of the Concept Release in 2004, the Commission and 
market participants have continued to consider the possibility of 
further shortening the settlement cycle while observing significant 
changes in the securities industry with respect to post-trade processes 
and technology. Below is a discussion of a number of recent significant 
industry initiatives that have considered the question of whether and 
when to further shorten the standard settlement cycle and that have 
informed the Commission's proposal.
(1) BCG Study
    In May 2012, DTCC commissioned a study to examine and evaluate the 
necessary investments and resulting benefits associated with a 
shortened settlement cycle for U.S. equities and corporate and 
municipal bonds.\106\ The study, which was conducted by the Boston 
Consulting Group (``BCG'') and published in October 2012, analyzed the 
costs, benefits, opportunities and challenges associated with 
shortening the settlement cycle in the U.S. securities markets to 
either T+1 or T+2, respectively.\107\
---------------------------------------------------------------------------

    \106\ See DTCC Proposal to Launch a Cost-Benefit Analysis, supra 
note 68.
    \107\ The Boston Consulting Group, Cost Benefit Analysis of 
Shortening the Settlement Cycle, (Oct. 2012) (``BCG Study''), http:/
/www.dtcc.com/~/media/Files/Downloads/WhitePapers/
CBA_BCG_Shortening_the_Settlement_Cycle_October2012.pdf. The BCG 
Study also noted a ``T+0'' settlement cycle (i.e., settlement on 
trade date) ``was ruled out as infeasible for the industry to 
accomplish at this time, given the exceptional changes required to 
achieve it and weak support across the industry.'' Id. at 8. The BCG 
Study notes that a T+0 settlement cycle would result in major 
challenges with processes such as such as trade reconciliation and 
exception management, securities lending and transactions with 
foreign counterparties (especially where time zones are least 
aligned). Id. at 20. Moreover, the BCG Study concluded that payment 
systems utilized for final settlement would also need to be 
significantly altered to enable transactions late into the day. Id. 
For further discussion on the BCG Study and some of the study's 
limitations, see infra Part VI.C.5.a.
---------------------------------------------------------------------------

    The scope of BCG's analysis included U.S. equities, corporate 
bonds, and municipal bonds settling at DTC.\108\ The study covered 
clearing and settlement processes at various types of market 
participants (e.g., broker-dealers, buy-side firms, and custodian 
banks), in addition to processes closely related to clearance and 
settlement (such as corporate action processing and securities lending) 
and specific situations (such as post-trade processes for cross-border 
transactions involving securities lending in the U.S.).\109\
---------------------------------------------------------------------------

    \108\ Id. at 13.
    \109\ Id.
---------------------------------------------------------------------------

    The BCG Study did not advocate any specific approach to shortening 
the settlement cycle, but noted that moving to a T+2 settlement cycle 
would be significantly less costly and take less time to implement than 
either an immediate or gradual transition to T+1, while still 
delivering significant benefits.\110\
---------------------------------------------------------------------------

    \110\ Id. at 8-11, 29-44.
---------------------------------------------------------------------------

    The BCG Study noted that market participants were aware that a T+2 
settlement cycle could be accomplished through mere compression of 
timeframes and corresponding rule changes but that implementing a 
transition to T+2 without certain building blocks or enablers would 
limit the amount of savings that would be realized across the 
industry.\111\ In particular, BCG identified the following T+2 
enablers: (i) Migration to trade data matching; \112\ (ii) a cross-
industry settlement instruction solution; (iii) dematerialization of 
physical securities; (iv) ``access equals delivery'' \113\ for all 
products,\114\ and (v) increased penalties for fails.\115\ The study 
further concluded that T+1 could be built on the aforementioned T+2 
enablers but would also require infrastructure for near-real-time trade 
processing, and transforming securities lending and foreign buyer 
processes.\116\
---------------------------------------------------------------------------

    \111\ Id. at 9.
    \112\ This migration would essentially entail a mandated ``match 
to settle.'' Mandated ``match to settle'' would require 
institutional trades to be matched before settlement at DTC could 
occur. See BCG Study, supra note 107, at 65.
    \113\ In 2005, the Commission adopted Securities Act Rule 172, 
which, with certain exclusions, provides an ``access equals 
delivery'' model that permits final prospectus delivery obligations 
to be satisfied by the filing of the final prospectus with the 
Commission, rather than delivery of the prospectus to purchasers. 
See Securities Offering Reform, Exchange Act Release No. 52056 (July 
19, 2005), 70 FR 44722, 44783-85 (Aug. 3, 2005).
    \114\ BCG Study, at 9, 64-68.
    \115\ BCG Study, at 9, 69-70.
    \116\ Id. at 9, 70-72.
---------------------------------------------------------------------------

    In addition, BCG noted that acceleration of retail client funding 
processes ``may'' need to take place to enable T+1 settlement.\117\ 
Finally, BCG identified certain changes it believed that regulators, 
including the Commission, DTCC, FINRA, the MSRB, and NYSE, would need 
to make to their rules to enable a shorter settlement cycle.\118\ These 
changes included, among others, amending Exchange Act Rule 15c6-1.\119\
---------------------------------------------------------------------------

    \117\ Id. at 25.
    \118\ Id. at 26, 50, 68-69.
    \119\ Id. at 50, 68. See also, infra Part III.B. for a 
discussion of the impact of other Commission rules.
---------------------------------------------------------------------------

    Based on the foregoing, in April 2014, DTCC recommended shortening 
the U.S. trade settlement cycle for equities, municipal bonds, and unit 
investment trusts to T+2 and stated it would work with the industry to 
establish an implementation timeline.\120\ Once achieved, DTCC 
recommended a pause and further assessment of industry readiness and 
appetite for a future move to T+1.\121\ The recommendation was based 
on: (1) Results from risk studies that measure exposure and NSCC's 
liquidity needs; (2) the results of the BCG Study; (3) input from 
industry associations; and (4) one-on-one interviews with more than 50 
firms across the securities industry, which helped DTCC define 
behavioral and system changes required to shorten the settlement 
cycle.\122\
---------------------------------------------------------------------------

    \120\ See DTCC Recommends Shortening the U.S. Trade Settlement 
Cycle, supra note 76.
    \121\ Id. at 2.
    \122\ Id.
---------------------------------------------------------------------------

(2) Industry Steering Committee and Industry Planning
    In October 2014, DTCC, in collaboration with the Investment Company 
Institute (``ICI''), the Securities Industry and Financial Markets 
Association (``SIFMA''), and other market participants, formed an 
Industry Steering Group (``ISC'') and an industry working group to 
facilitate the transition to a T+2 settlement cycle for U.S. trades in 
equities, corporate and municipal bonds, and UITs.\123\ The impetus for 
moving to a T+2 settlement cycle, as stated by the ISC, was to (i) 
reduce credit and liquidity risks to the industry and investors, (ii) 
reduce operational risk; (iii) reduce liquidity costs and free up 
capital for broker-dealers by reducing the required NSCC clearing fund 
contributions; (iv) enable investors to gain quicker access to funds 
and securities following a trade

[[Page 69255]]

execution, and better protect investors from the risk of a broker-
dealer default between trade date and settlement date; (v) reduce 
operational costs; and (vi) increase global harmonization.\124\
---------------------------------------------------------------------------

    \123\ Press Release, DTCC, Industry Steering Committee and 
Working Group Formed to Drive Implementation of T+2 in the U.S. 
(Oct. 2014), https://www.dtcc.com/news/2014/october/16/ust2.aspx.
    \124\ Id.
---------------------------------------------------------------------------

    In June 2015, PricewaterhouseCoopers LLP, in conjunction with the 
ISC, published a white paper,\125\ which included certain ``industry-
level requirements'' and ``sub-requirements'' that the ISC believed 
would be required for a successful migration to a T+2 settlement cycle 
to occur. The ISC White Paper also included an implementation timeline 
that targeted the transition to T+2 by the end of the third quarter of 
2017.
---------------------------------------------------------------------------

    \125\ ISC White Paper, supra note 77.
---------------------------------------------------------------------------

    Deloitte & Touche LLP, in conjunction with the ISC, published the 
T+2 Industry Implementation Playbook (``T+2 Playbook'') in December 
2015, which sets forth the requested implementation timeline with 
milestones and dependencies, as well as detailing ``remedial 
activities'' that impacted market participants should consider to 
prepare for migration to the T+2 settlement cycle.\126\ Each of the 
remedial activities identified in the T+2 Playbook reference specific 
industry-level requirements and sub-requirements that were identified 
in the ISC White Paper.
---------------------------------------------------------------------------

    \126\ Deloitte & Touche LLP & ISC, T+2 Industry Implementation 
Playbook (Dec. 2015), https://www.ust2.com/pdfs/T2-Playbook-12-21-15.pdf. For a further discussion on the T+2 Playbook, see infra Part 
VI.C.5.b.
---------------------------------------------------------------------------

    Consistent with the ISC White Paper, the timeline provided in the 
T+2 Playbook targeted the third quarter of 2017 for completing the 
migration to a T+2 settlement cycle.\127\ In addition to providing an 
implementation schedule, the T+2 Playbook was intended to serve as an 
industry resource for individual firms as they make the necessary 
changes to procedures and technology for transition to a T+2 settlement 
cycle.\128\
---------------------------------------------------------------------------

    \127\ Id. at 8.
    \128\ Id. at 16.
---------------------------------------------------------------------------

(3) Investor Advisory Committee Recommendations
    In February 2015, the Commission's Investor Advisory Committee 
(``IAC'') \129\ issued a public statement noting that shortening the 
settlement cycle will mitigate operational and systemic risk, as well 
as ``reduce credit, liquidity, and counterparty exposure risks,'' which 
will benefit both the securities industry and individual 
investors.\130\ In its recommendation, the IAC stated that it 
``strongly endorsed the direction of the recommendation by DTCC'' to 
shorten the settlement cycle to T+2, but recommended implementing a T+1 
settlement cycle (rather than a T+2 settlement cycle), noting that 
retail investors would significantly benefit from a T+1 settlement 
cycle.\131\ In the event that a T+2 standard settlement cycle is 
pursued, the IAC recommended that the Commission work with industry 
participants to create a clear plan for moving to T+1 shortly 
thereafter.\132\
---------------------------------------------------------------------------

    \129\ Section 911 of the Dodd-Frank Act established the IAC to 
advise the Commission on regulatory priorities, the regulation of 
securities products, trading strategies, fee structures, the 
effectiveness of disclosure, and initiatives to protect investor 
interests, and to promote investor confidence and the integrity of 
the securities marketplace. See 15 U.S.C. 78pp. The Dodd-Frank Act 
authorizes the IAC to submit findings and recommendations for review 
and consideration by the Commission. Id.
    \130\ Investor Advisory Committee, U.S. Securities and Exchange 
Commission, Recommendation of the Investor Advisory Committee: 
Shortening the Settlement Cycle in U.S. Financial Markets (Feb. 12, 
2015), https://www.sec.gov/spotlight/investor-advisory-committee-2012/settlement-cycle-recommendation-final.pdf.
    \131\ Id. According to the IAC, moving to a T+1 settlement 
cycle, matching the settlement cycle that already exists for 
treasuries and mutual funds, would greatly reduce systemic risk and 
benefit investors. See also Committee on Payment and Settlement 
Systems, Technical Committee of the International Organization of 
Securities Commissions, Recommendations for Securities Settlement 
Systems (Nov. 2001), at 4, 10, https://www.bis.org/cpmi/publ/d46.pdf 
(recommending that the benefits and costs of a settlement cycle 
shorter than T+3 should be evaluated).
    \132\ Id.
---------------------------------------------------------------------------

B. Transition to T+2 in Non-U.S. Securities Markets
    As market participants have worked to develop plans to shorten the 
standard settlement cycle in the U.S. to T+2, several non-U.S. 
securities markets have already shifted to a T+2 settlement cycle, and 
certain other non-U.S. securities markets have announced plans to 
transition to a T+2 settlement cycle.\133\ These efforts to transition 
to a T+2 settlement cycle in markets outside the U.S. have been driven 
in part by considerations specific to the needs of the particular 
geographic region or market structure, as well as certain 
considerations identified by policy makers, market participants, and 
industry experts as to how shortening the settlement cycle to T+2 would 
reduce risk in the relevant market and increase the operational 
efficiency of post-trade processes. The Commission preliminarily 
believes that many of the reasons motivating efforts in other 
jurisdictions to shorten the settlement cycle to T+2 are, in principle, 
similar to those identified by the Commission in this proposal.
---------------------------------------------------------------------------

    \133\ In addition to the non-U.S. markets that have moved to a 
T+2 settlement cycle, certain non-U.S. markets are on a settlement 
cycle shorter than T+2, including Israel, Chile, and Saudi Arabia, 
which are on a T+0 cycle, and China, which is on a T+1 cycle.
---------------------------------------------------------------------------

    For example, national markets in the European Union (``EU'') moved 
to a harmonized settlement cycle of T+2 \134\ to both achieve a 
successful integration of settlement infrastructures across the EU as 
well as realize perceived benefits a shorter settlement cycle would 
bring in reducing counterparty credit risk (and associated market and 
liquidity risks), greater automation of back-office processes and 
reduced collateral requirements, and reduced costs for market 
participants.\135\
---------------------------------------------------------------------------

    \134\ Prior to the so-called ``big bang'' migration to a T+2 
settlement cycle on October 6, 2014, the standard settlement cycle 
for exchange-traded shares was T+3 in all European securities 
markets except Germany, Slovenia and Bulgaria, which already 
operated on a T+2 settlement cycle. The 29 national markets that 
moved to a T+2 settlement cycle on October 6, 2014 were: Austria, 
Belgium, Croatia, Cyprus, the Czech Republic, Denmark, Estonia, 
Finland, France, Greece, Hungary, Iceland, Italy, Ireland, the 
Netherlands, Latvia, Lichtenstein, Lithuania, Luxembourg, Malta, 
Norway, Poland, Portugal, Romania, Slovakia, Spain (certain fixed 
income trades only), Sweden, Switzerland, and the United Kingdom. 
See also, ``A very smooth transition to T+2'', European Central 
Securities Depositories Association (Oct. 2014), https://ecsda.eu/archives/3793 (discussing the European markets transition from T+3 
to T+2 settlement cycle).
    \135\ See European Commission, Commission Staff Working Document 
Impact Assessment COD 2012/0029 (Mar. 7, 2012), https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52012SC0022&from=EN; see also CESAME II Harmonization of 
Settlement Cycles Working Group (``CESAME II''), The Case for 
Harmonizing Settlement Cycles (Oct. 5, 2010), https://ec.europa.eu/internal_market/financial-markets/docs/cesame2/subgroup/20100921_case_en.pdf; CESAME II, The Role of Settlement Cycles in 
Corporate Actions Processing (Oct. 5, 2010), https://ec.europa.eu/internal_market/financial-markets/docs/cesame2/subgroup/20100921_hsc_role_en.pdf.
---------------------------------------------------------------------------

    Australia and New Zealand transitioned to a T+2 settlement cycle in 
March 2016. Industry support in those markets was predicated on the 
widespread agreement that shortening the settlement cycle to T+2 would 
reduce counterparty, credit and operational risks, increase market 
liquidity, reduce CCP margin requirements and reduce capital 
requirements for broker-dealers and their clients.\136\ In addition, 
the major Australian and New Zealand exchanges acknowledged the 
existence of a global

[[Page 69256]]

move toward shortened settlement cycles and the importance of 
international harmonization with respect to shortened settlement 
cycles.\137\ Japanese and Canadian policy makers, regulators and market 
participants are also considering a transition to a T+2 settlement 
cycle,\138\ with Canadian market participants of the view that, given 
the interconnectedness between the Canadian and U.S. securities 
markets, a transition in Canada to a T+2 settlement cycle should occur 
at the same time such a transition is achieved in the U.S. 
markets.\139\
---------------------------------------------------------------------------

    \136\ See ASX Ltd., Shortening the Settlement Cycle in 
Australia: Transitioning to T+2 for Cash Equities (Feb. 25, 2014), 
https://www.asx.com.au/documents/public-consultations/T2_consultation_paper.PDF; see also NZX Ltd., Shortening of the 
Settlement Cycle: The Move to T+2 (Nov. 12, 2014), https://nzx.com/files/static/cms-documents/FINAL%20T%202%20Consultation%20Paper%2012%20November%202014.pdf; 
GBST Holding Ltd. & Stockbrokers Association of Australia, 
Introducing T+2 for the Australian Equities Market (Jan. 30, 2014), 
https://www.gbst.com/wp-content/uploads/2016/02/GBST-SAA-Tplus2-in-Australia-Whitepaper.pdf.
    \137\ See ASX Ltd., Shortening the Settlement Cycle in 
Australia: Transitioning to T+2 for Cash Equities (Feb. 25, 2014), 
https://www.asx.com.au/documents/public-consultations/T2_consultation_paper.PDF; see also NZX Ltd., Shortening of the 
Settlement Cycle: The Move to T+2 (Nov. 12, 2014), https://nzx.com/files/static/cms-documents/FINAL%20T%202%20Consultation%20Paper%2012%20November%202014.pdf.
    \138\ See Japan Securities Dealers Association, Move to T+2 
Settlement in Japan, https://www.jsda.or.jp/en/activities/research-studies/files/t2_en_cyukan_201603.pdf; see also Canadian Securities 
Administrators, Staff Notice 24-312 (Apr. 2, 2015), https://www.osc.gov.on.ca/en/SecuritiesLaw_sn_20150402_24-312_t2-settlement.htm.
    \139\ See Canadian Securities Administrators, Staff Notice 24-
312 (Apr. 2, 2015), https://www.osc.gov.on.ca/en/SecuritiesLaw_sn_20150402_24-312_t2-settlement.htm.
---------------------------------------------------------------------------

III. Discussion

A. Proposal

1. Current Rule 15c6-1
    The Commission's adoption of Exchange Act Rule 15c6-1 created a 
standard settlement cycle for broker-dealer transactions.\140\ The 
Commission took this step in part because it believed that implementing 
faster settlement of securities transactions and improving the 
clearance and settlement process would better protect investors.\141\ 
Rule 15c6-1(a) provides that, unless otherwise expressly agreed by the 
parties at the time of the transaction, a broker-dealer is prohibited 
from entering into a contract for the purchase or sale of a security 
(other than an exempted security, government security, municipal 
security, commercial paper, bankers' acceptances, or commercial bills) 
that provides for payment of funds and delivery of securities later 
than the third business day after the date of the contract.\142\ Rule 
15c6-1(a) covers all securities except for the exempted securities 
enumerated in paragraph (a)(1) of the rule. The Commission extended 
application of Rule 15c6-1(a) to the purchase and sale of securities 
issued by investment companies (including mutual funds),\143\ private-
label mortgage-backed securities, and limited partnership interests 
that are listed on an exchange.\144\ The rule also allows a broker-
dealer to agree that settlement will take place in more or less than 
three business days, provided that such an agreement is express and 
reached at the time of the transaction.\145\
---------------------------------------------------------------------------

    \140\ See T+3 Adopting Release, 58 FR 52891; see also Securities 
Transactions Settlement, Exchange Act Release No. 34952 (Nov. 9, 
1994), 59 FR 59137 (Nov. 16, 1994) (extending effective date for 
Rule 15c6-1 from June 1, 1995 to June 7, 1995).
    \141\ See T+3 Adopting Release, 58 FR 52891.
    \142\ 17 CFR 240.15c6-1(a).
    \143\ The Commission applied Rule 15c6-1 to broker-dealer 
contracts for the purchase and sale of securities issued by 
investment companies, including mutual funds, because the Commission 
recognized that these securities represented a significant and 
growing percentage of broker-dealer transactions. See T+3 Adopting 
Release, 58 FR at 52900.
    \144\ With regard to limited partnerships, the Commission 
excluded non-listed limited partnerships due to complexities related 
to processing the trades in these securities and the lack of an 
active secondary market. In contrast, the Commission included listed 
limited partnerships primarily to ensure exclusion of these 
securities would not unnecessarily contribute to the bifurcation of 
the settlement cycle for listed securities generally. See T+3 
Adopting Release, 58 FR at 52899.
    \145\ 17 CFR 240.15c6-1(a).
---------------------------------------------------------------------------

    Rule 15c6-1(b) provides an exclusion for contracts involving the 
purchase or sale of limited partnership interests that are not listed 
on an exchange or for which quotations are not disseminated through an 
automated quotation system of a registered securities association. In 
recognition of the fact that the Commission may not have identified all 
situations or types of trades where settlement on T+3 would be 
problematic, paragraph (b) of the rule also provides that the 
Commission may exempt by order additional types of trades from the 
requirements of the T+3 settlement timeframe, either unconditionally or 
on specified terms and conditions, if the Commission determines that 
such an exemption is consistent with the public interest and the 
protection of investors.\146\
---------------------------------------------------------------------------

    \146\ 17 CFR 240.15c6-1(b).
---------------------------------------------------------------------------

    Pursuant to Rule 15c6-1(b), the Commission has granted an exemption 
for securities that do not generally trade in the U.S.\147\ Under this 
exemptive order, all transactions in securities that do not have 
transfer or delivery facilities in the U.S. are exempt from the scope 
of Rule 15c6-1. Furthermore, if less than 10% of the annual trading 
volume in a security that has U.S. transfer or deliver facilities 
occurs in the U.S., the transaction in such security will be exempt 
from the rule unless the parties clearly intend T+3 settlement to 
apply. In addition, an ADR is considered a separate security from the 
underlying security. Thus, if there are no transfer facilities in the 
U.S. for a foreign security but there are transfer facilities for an 
ADR receipt based on such foreign security, under the order, only the 
foreign security will be exempt from Rule 15c6-1. The Commission has 
also granted an exemption for contracts for the purchase or sale of any 
security issued by an insurance company (as defined in Section 2(a)(17) 
of the Investment Company Act \148\) that is funded by or participates 
in a ``separate account'' (as defined in Section 2(a)(37) of the 
Investment Company Act \149\), including a variable annuity contract or 
a variable life insurance contract, or any other insurance contract 
registered as a security under the Securities Act.\150\
---------------------------------------------------------------------------

    \147\ See Securities Transactions Settlement, Exchange Act 
Release No. 35750 (May 22, 1995), 60 FR 27994, 27995 (May 26, 1995) 
(granting exemption for certain transactions in foreign securities).
    \148\ 15 U.S.C. 80a-2(a)(17).
    \149\ 15 U.S.C. 80a-2(a)(37).
    \150\ See Securities Transactions Settlement, Exchange Act 
Release No. 35815 (June 6, 1995), 60 FR 30906, 30907 (June 12, 1995) 
(granting exemption for transactions involving certain insurance 
contracts). Certain insurance contracts, including variable annuity 
contracts and variable life insurance contracts, have been deemed to 
be securities under the Securities Act. SEC v. Variable Annuity Life 
Ins. Co. of America, 359 U.S. 65 (1959) (variable annuity contracts 
are ``securities'' which must be registered with the Commission 
under the Securities Act); Adoption of Rule 3c-4 under the 
Investment Company Act of 1940, Exchange Act Release No. 9972, 1 SEC 
Docket 17 (Jan. 31, 1973) (a public offering of variable life 
insurance contracts involved an offering of securities required to 
be registered under the Securities Act).
---------------------------------------------------------------------------

    Rule 15c6-1(c) provides a T+4 settlement cycle in firm commitment 
underwritings for securities that are priced after 4:30 p.m. Eastern 
time. \151\ Specifically, paragraph (c) states that the three-day 
settlement requirement in paragraph (a) does not apply to contracts for 
the sale of securities that are priced after 4:30 p.m. Eastern time on 
the date that such securities are priced and that are sold by an issuer 
to an underwriter pursuant to a firm commitment offering registered 
under the Securities Act or sold to an initial purchaser by a broker-
dealer participating in such offering provided that the broker or 
dealer does not effect or enter into a contract for the purchase or 
sale of those securities that provides for payment of funds and 
delivery of securities later than the fourth business day after the 
date of the contract unless otherwise expressly agreed to by the 
parties at the time of the transaction.
---------------------------------------------------------------------------

    \151\ 17 CFR 240.15c6-1(c).
---------------------------------------------------------------------------

    Rule 15c6-1(d) provides that, for purposes of paragraphs (a) and 
(c) of the rule, parties to a contract shall be deemed to have 
expressly agreed to an alternate date for payment of funds and

[[Page 69257]]

delivery of securities at the time of the transaction for a contract 
for the sale for cash of securities pursuant to a firm commitment 
offering if the managing underwriter and the issuer have agreed to such 
date for all securities sold pursuant to such offering and the parties 
to the contract have not expressly agreed to another date for payment 
of funds and delivery of securities at the time of the 
transaction.\152\
---------------------------------------------------------------------------

    \152\ 17 CFR 240.15c6-1(d).
---------------------------------------------------------------------------

2. Proposed Amendment to Rule 15c6-1 to Shorten the Standard Settlement 
Cycle to T+2
    The Commission proposes to amend Rule 15c6-1(a) to prohibit a 
broker-dealer from effecting or entering into a contract for the 
purchase or sale of a security (other than an exempted security, 
government security, municipal security, commercial paper, bankers' 
acceptances, or commercial bills) that provides for payment of funds 
and delivery of securities later than the second business day after the 
date of the contract unless otherwise expressly agreed to by the 
parties at the time of the transaction.\153\
---------------------------------------------------------------------------

    \153\ Rule 15c6-1(a) provides that the payment of funds and 
delivery of securities (other than certain securities exempted) must 
occur no later than T+3, unless otherwise expressly agreed to by the 
parties at the time of the transaction. At the time that Rule 15c6-
1(a) was adopted, the Commission stated its belief that usage of 
this provision ``was intended to apply only to unusual transactions, 
such as seller's option trades that typically settle as many as 
sixty days after execution as specified by the parties to the trade 
at execution.'' T+3 Adopting Release, 58 FR at 52902. The Commission 
preliminarily believes that use of this provision should continue to 
be applied in limited cases to ensure that the settlement cycle set 
by Rule 15c6-1(a) remains a standard settlement cycle.
---------------------------------------------------------------------------

3. Reasons to Transition from T+3 to T+2
    As previously discussed, the length of the settlement cycle can 
impact the nature and level of risk exposure for various market 
participants.\154\ The Commission preliminarily believes that the 
proposal to shorten the standard settlement cycle from three days to 
two days would potentially offer market participants (e.g., CCPs, 
broker-dealers, custodians, and investors) significant benefits through 
the reduction of exposure to credit, market, and liquidity risk, as 
well as related reductions to systemic risk. Assuming current levels of 
trading activity remain constant, shortening the time period between 
trade execution and trade settlement decreases the total number of 
unsettled trades that exists at any point in time, as well as the total 
market value of all unsettled trades. This reduction in the number and 
total value of unsettled trades should, in turn, correspond to a 
reduction in market participants' exposure to credit, market, liquidity 
and systemic risk arising from those unsettled transactions. The 
reduction of these risks should, in turn, improve the stability of the 
U.S. markets, and ultimately enhance investor protection.
---------------------------------------------------------------------------

    \154\ For a more detailed discussion on risk, see supra Part 
II.A.4.
---------------------------------------------------------------------------

    In the case of a CCP, fewer unsettled trades and a reduced time 
period of exposure to such trades will reduce the CCP's credit, market 
and liquidity risk exposure to its members. As discussed earlier, a 
CCP, through novation, acts as the counterparty to its members and 
faces resultant credit risk in that a clearing member, both on behalf 
of purchasers of securities who may fail to deliver the payment, and on 
behalf of sellers of securities who may fail to deliver the securities. 
In each case, the CCP is required to meet its obligation to its 
members, which in respect of the buyer is to deliver securities, and in 
respect of the seller is to deliver cash.
    The CCP also faces market risk where, during the settlement cycle, 
a member defaults and the CCP may be forced to liquidate open positions 
of the defaulting member and any financial resources of the member it 
may hold (i.e., collateral) to cover losses and expenses in adverse 
market circumstances. For example, if the market value of the 
securities has increased in the interim between trade date and 
settlement date, the CCP may be forced to obtain the replacement 
securities in the market at a higher price.
    Finally, the CCP can face liquidity risks during the settlement 
cycle when a member defaults, resulting in the CCP deploying financial 
resources to meet the CCP's end-of-day settlement obligations.\155\ In 
each instance, the amount and period of risk to which the CCP is 
exposed is a function of the length of the settlement cycle, and 
therefore shortening the settlement cycle should reduce the CCP's 
overall exposure to those risks.
---------------------------------------------------------------------------

    \155\ The costs associated with deploying such resources are 
ultimately borne by the CCP members, both in the ordinary course of 
the CCP's daily risk management process and in the event of an 
extraordinary event where members may be subject to additional 
liquidity assessments. As discussed earlier, these costs may be 
passed on through the CCP members to broker-dealers and investors.
---------------------------------------------------------------------------

    The Commission preliminarily believes that shortening the standard 
settlement cycle to T+2 will also result in related reductions in 
liquidity risk for broker-dealers that are CCP members, and by 
extension introducing broker-dealers and investors that clear their 
trades through CCP members.\156\ As noted earlier, a CCP may take a 
number of measures to manage the risks its members present, including 
through member financial resource contributions and netting down the 
total outstanding exposure of a particular member. However, the extent 
to which a CCP must apply these risk mitigation tools is dictated by 
the amount of unsettled trades that remain outstanding as well as the 
time during which the CCP remains exposed to these risks. Thus, by 
reducing the amount of unsettled trades and the period of time during 
which the CCP is exposed to such trades, the Commission preliminarily 
anticipates a reduction in financial resource obligations for CCP 
members. This anticipated benefit to CCP members should have, in turn, 
a positive impact on the liquidity risks and costs faced by broker-
dealers and investors. First, it should reduce the amount of financial 
resources that CCP member broker-dealers may have to provide for the 
CCP's risk management process, both on an ordinary course basis as well 
as in less predictable or procyclical instances where adverse general 
market conditions or a CCP member default results in a sudden liquidity 
demand by the CCP for additional financial resources from market 
participants.\157\ This reduction in the potential need for financial 
resources should, in turn, reduce the liquidity costs and capital 
demands clearing broker-dealers face in the current environment.
---------------------------------------------------------------------------

    \156\ See supra note 77 (discussing mutual fund settlement 
timeframes and related liquidity risk, which may be exacerbated 
during times of stress). The Commission preliminarily believes that 
shortening settlement timeframes for portfolio securities to T+2 
will assist in reducing liquidity and other risks for funds that 
must satisfy investor redemption requests subject to shorter 
settlement timeframes (e.g., T+1).
    \157\ See supra Part II.A.4. for a discussion regarding 
procyclicality. See also DTCC Recommends Shortening the U.S. Trade 
Settlement Cycle, supra note 76.
---------------------------------------------------------------------------

    Second, this anticipated reduction in CCP financial resource 
demands on its members may, in turn, result in reduced margin charges 
and other fees that clearing broker-dealers may pass down to 
introducing broker-dealers, institutional investors and retail 
investors, thereby reducing trading costs and freeing up capital for 
deployment elsewhere in the markets by those entities. Third, a shorter 
settlement cycle should enable market participants to gain quicker 
access to funds and securities following trade execution, which should 
further reduce liquidity risks and financing costs faced by market 
participants who may use those proceeds to transact in other markets,

[[Page 69258]]

including the derivatives markets and non-U.S. markets, that operate on 
a mismatched settlement cycle. Similarly, by more closely aligning and 
harmonizing the settlement cycles across markets, the rule would reduce 
the degree and period of time during which market participants are 
exposed to credit, market and liquidity risk arising from unsettled 
transactions.
    The Commission also preliminarily believes that the reduction in 
credit, market and liquidity risks described above should reduce 
systemic risk. Because of the procyclicality of financial resource and 
other liquidity demands by CCPs and other market participants during 
times of market volatility and stress, efforts to reduce these 
liquidity demands through a shorter settlement cycle are expected to 
reduce systemic risk.\158\ As the Commission noted in adopting Rule 
15c6-1 in 1993, reducing the total volume and value of outstanding 
obligations in the settlement pipeline at any point in time will better 
insulate the financial sector from the potential systemic consequences 
of serious market disruptions.\159\ The Commission believes these views 
are even more apt today given the increasing interconnectivity and 
interdependencies among markets and market participants.\160\ In 
addition, reducing the period of time during which a CCP is exposed to 
credit, market and liquidity risk should enhance the overall ability of 
the CCP to serve as a source of stability and efficiency in the 
national clearance and settlement system, thereby reducing the 
likelihood that disruptions in the clearance and settlement process 
will trigger consequential disruptions that extend beyond the cleared 
markets.\161\
---------------------------------------------------------------------------

    \158\ See DTCC Recommends Shortening the U.S. Trade Settlement 
Cycle, 2, 3, supra note 76. See also, infra Part VI.C.1.
    \159\ See T+3 Adopting Release, 58 FR at 52894; see also ISC 
White Paper, supra note 77 (noting the benefits associated with 
shortening the settlement cycle); BCG Study, supra note 107 
(discussing systemic risk).
    \160\ See Clearing Agency Standards Adopting Release, 77 FR at 
66254 (discussing the need for default procedures to allow the 
clearing agency to take action resulting from one or more member 
defaults in order to contain resultant losses and liquidity 
pressures). Also, for a discussion on issues related to 
interconnectivity and interdependence of market participants, see 
DTCC, Understanding Interconnectedness Risks--To Build a More 
Resilient Financial System (Oct. 2015), https://www.dtcc.com/news/2015/october/12/understanding-interconnectedness-risks-article.
    \161\ See CCA Proposal, 79 FR at 29598. Clearing members are 
often members of larger financial networks, and the ability of a 
covered clearing agency to meet payment obligations to its members 
can directly affect its members' ability to meet payment obligations 
outside of the cleared market. Thus, management of liquidity risk 
may mitigate the risk of contagion between asset markets.
---------------------------------------------------------------------------

    Lastly, the Commission preliminarily believes that significant 
advances in technology and substantive changes in market 
infrastructures and operations that have occurred since 1993, and which 
we believe are widely assimilated into market practices, provide a 
basis to accommodate a further reduction in the standard settlement 
cycle to two days. For example, the market has improved the 
confirmation/affirmation and matching process through the emergence and 
integration of Matching/ETC Providers into the national clearance and 
settlement infrastructure. According to statistics published by DTCC in 
2011 regarding affirmation rates achieved through industry utilization 
of a certain Matching/ETC Provider, on average, 45% of trades were 
affirmed on trade date, while 90% were affirmed on T+1, and 92% were 
affirmed by noon on T+2.\162\ Additionally, the number of securities 
immobilized or dematerialized in U.S. markets has continued to 
substantially increase in recent years.\163\
---------------------------------------------------------------------------

    \162\ DTCC Proposal to Launch a Cost-Benefit Analysis, supra 
note 68, at 12.
    \163\ See generally DTCC, Strengthening the U.S Financial 
Markets: A Proposal to Fully Dematerialize Physical Securities, 
Eliminating the Cost and Risks They Incur, A White Paper to the 
Industry, at 1, 3-6 (July 2012), https://www.dtcc.com/news/2012/july/01/proposal-to-fully-dematerialize-physical-securities-eliminating-the-costs-and-risks-they-incur.
---------------------------------------------------------------------------

    The Commission notes that progress by market participants in this 
respect has become particularly evident in recent years. For example, 
DTCC published in 2011 a report that included a review of the status of 
the building blocks originally identified in the SIA Business Case 
Report.\164\ According to the DTCC report, many of the impediments 
identified in the SIA Business Case Report have since been resolved and 
significant progress has been made toward achieving many of the 
building blocks. Since that 2011 report was published, the Commission 
has observed that market participants have begun to accelerate 
collective progress, largely under the auspices of the ISC, to prepare 
for a transition to a T+2 settlement cycle.\165\
---------------------------------------------------------------------------

    \164\ See DTCC Proposal to Launch a Cost-Benefit Analysis, at 
12-15.
    \165\ See generally the industry documentation available via the 
T+2 Settlement Project Web site (www.UST2.com) established by the 
ISC in 2014 as a public information hub for information relating to 
the T+2 initiative, including details pertaining to the progress 
being made to move toward a T+2 settlement cycle by the ISC and 
working groups. See also, infra Part VI.C.5.a. for a discussion of 
the impact of technological improvements on costs estimates to 
comply with a shorter standard settlement cycle.
---------------------------------------------------------------------------

    More recently, the ISC, through its T+2 Playbook, has mapped out 
the technological and operational changes necessary to support a two 
day settlement cycle. In many cases, these changes require only 
incremental modifications to existing market infrastructures and 
systems and processes. For example, the Commission preliminarily 
anticipates that a shortened settlement cycle may require incremental 
increases in utilization by certain market participants of Matching/ETC 
Providers, with a focus on improving and accelerating affirmation/
confirmation processes, as well as relative enhancements to 
efficiencies in the services and operations of the Matching/ETC 
Providers themselves. The Commission preliminarily expects that these 
changes may be necessary in a T+2 environment because certain steps 
related to the allocation, confirmation, and affirmation of 
institutional trades will need to occur earlier in the settlement cycle 
compared to in a T+3 environment.\166\ The Commission also notes that 
market participants have raised a number of additional anticipated 
benefits that may arise from shortening the settlement cycle to T+2. In 
particular, the Commission observes that the ISC identified the 
reduction in operational costs as an additional reason to move to a T+2 
settlement cycle at this time.\167\
---------------------------------------------------------------------------

    \166\ See generally BCG Study, supra note 107.
    \167\ See Press Release, DTCC, Industry Steering Committee and 
Working Group Formed to Drive Implementation of T+2 in the U.S. 
(Oct. 2014), https://www.dtcc.com/news/2014/october/16/ust2.aspx.
---------------------------------------------------------------------------

    For all the reasons cited above, the Commission preliminarily 
believes that it is appropriate to shorten the standard settlement 
cycle from T+3 to T+2. The Commission, however, seeks public comment on 
these, and other potential benefits, that may be realized in the 
current market structure by shortening the standard settlement cycle to 
T+2.
    Notwithstanding the Commission's preliminary expectation of the 
risk-reducing benefits noted above, the Commission also understands 
that the standard settlement cycle can have a significant influence 
upon the activities and operations of a wide range of market 
participants--from individual investors to financial services 
professionals to systemically important FMUs, such as certain 
registered clearing agencies. When the Commission proposed Rule 15c6-1 
in 1993, a number of commenters raised for consideration potential 
costs and burdens that various market participants would have to assume 
to ensure compliance with an orderly transition

[[Page 69259]]

from T+5 to T+3.\168\ In adopting the final rule and establishing a 
standard settlement cycle of T+3, the Commission acknowledged the 
likelihood of market participant costs and burdens, but ultimately 
determined, based on consideration of the anticipated benefits and 
contemporaneous industry initiatives to achieve a T+3 environment, to 
adopt the rule.\169\ In addition, the Commission noted that calibrating 
the final rule's implementation date to afford market participants 
sufficient time to prepare for a T+3 environment was an important 
measure to address commenters' concerns about burdens and costs.\170\
---------------------------------------------------------------------------

    \168\ T+3 Adopting Release, 58 FR at 52895. As discussed more 
fully in the release, cost issues included, but were not limited to, 
costs associated with the receipt of confirmations, payments by 
check, financing costs, interest expenses, and hiring additional 
personnel.
    \169\ Id.
    \170\ Id. at 52897.
---------------------------------------------------------------------------

    For the purposes of its current proposal, the Commission 
acknowledges that a transition from a T+3 to T+2 standard settlement 
cycle, and implementation of the necessary operational, technical, and 
business changes, will likely result in varying burdens, costs and 
benefits for a wide range of market participants. According to the BCG 
Study published in 2012, the total industry investments would be $550 
million for a T+2 settlement cycle and nearly $1.8 billion for a T+1 
settlement cycle.\171\ The Commission has remained mindful and 
observant of industry initiatives and progress targeted at facilitating 
an environment where a shortened standard settlement cycle could be 
achieved in a manner that reduces risk for market participants while 
also minimizing the likelihood of disruptive burdens and costs.
---------------------------------------------------------------------------

    \171\ See BCG Study, supra note 107, at 9, 40. See also, infra 
Part VI.C.5.1.a. for discussion of certain limitations of the BCG 
Study.
---------------------------------------------------------------------------

    Having taken these industry initiatives and their relative progress 
into careful consideration, the Commission preliminarily believes there 
has been collective progress by market participants sufficient to 
facilitate a transition to a T+2 environment \172\ and believes that 
this progress will continue, such as through the increased use of the 
matching services provided by Matching/ETC Providers to achieve 
STP.\173\ Therefore, the Commission preliminarily believes that the 
risk-reducing benefits described above justify the anticipated burdens 
and costs of moving to a T+2 settlement cycle at this time.
---------------------------------------------------------------------------

    \172\ See supra note 87 for a list of the ten building blocks 
identified in the July 2000 SIA Business Case Report.
    \173\ See infra Part VI.A. for a discussion of certain market 
frictions related to investments required to implement a shorter 
settlement cycle.
---------------------------------------------------------------------------

    Accordingly, similar to the approach taken when Rule 15c6-1 was 
adopted, the Commission anticipates providing a compliance date that 
would afford market participants sufficient time to complete any 
outstanding preparations in a manner that minimizes transition risks 
and avoids disruptive or inefficient burdens and costs. The Commission, 
however, is seeking public comment on the burdens and costs associated 
with implementing this proposal.
4. Consideration of Settlement Cycle Shorter than T+2
    The Commission recognizes that amending Rule 15c6-1(a) to shorten 
the standard settlement cycle further than T+2 (i.e., T+1 or T+0) could 
potentially result in further risk reduction in the national clearance 
and settlement system, and accordingly seeks input from commenters on a 
future shortening of the settlement cycle, including relevant 
factors.\174\
---------------------------------------------------------------------------

    \174\ See infra Part V for related requests for comment.
---------------------------------------------------------------------------

    Such potential risk reduction notwithstanding, the Commission 
preliminarily believes that shortening the standard settlement cycle to 
T+2 is the appropriate step to take at this time for several reasons. 
Information from market participants regarding the technologies and 
processes used to settle securities transactions in the U.S. indicates 
that a successful transition to a settlement cycle that is shorter than 
T+2 would comparatively require larger investments by market 
participants to adopt new systems and processes.\175\ In particular, 
transitioning to a settlement cycle that is shorter than T+2 would 
require near real-time capabilities for certain settlement processes, 
such as institutional matching.
---------------------------------------------------------------------------

    \175\ See BCG Study, supra note 107. See also, infra Part 
VI.D.1. for a discussion on the BCG Study in the context of a T+1 
settlement cycle alternative.
---------------------------------------------------------------------------

    Additionally, the lead time and level of coordination by market 
participants required to implement the changes to technology and post-
trade processes that would enable a transition to a T+1 standard 
settlement cycle could be longer and greater than the time and 
coordination required to move to a T+2 settlement cycle in the near 
term.\176\ Accordingly, the additional time that market participants 
may need to transition to T+1 settlement cycle in a coordinated fashion 
would delay the realization of the expected risk-reducing benefits of 
shortening the settlement cycle.
---------------------------------------------------------------------------

    \176\ See BCG study, supra note 107, at 11, 48-49.
---------------------------------------------------------------------------

    Also, movement towards adoption of a standard settlement cycle that 
is shorter than T+2 at this time may increase funding costs for market 
participants who rely on the settlement of foreign currency exchange 
(or ``FX'') transactions to fund securities transactions that settle 
regular way. Because the settlement of FX transactions occurs on T+2, 
market participants who seek to fund a cross-border securities 
transaction with the proceeds of an FX transaction would, in a T+1 or 
T+0 environment, be required to fund the securities transaction before 
the FX transaction settled. Finally, the Commission preliminarily 
believes that shortening the settlement cycle to T+2 would assist 
market participants with the settlement of cross-border transactions 
because the U.S. settlement cycle would be harmonized with non-U.S. 
markets that have already transitioned to a T+2 settlement cycle.\177\
---------------------------------------------------------------------------

    \177\ For further discussion regarding the potential benefits of 
harmonization of settlement cycles for market participants engaging 
in cross-border transactions, see infra Part VI.C.1.
---------------------------------------------------------------------------

B. Impact on Other Commission Rules

1. General
    The Commission has reviewed its existing regulatory framework to 
consider the potential impact a T+2 standard settlement cycle may have 
on other Commission rules. Based on this review, the Commission 
preliminarily believes that no amendments to other Commission rules are 
required at this time. However, shortening the standard settlement 
cycle to T+2 could have ancillary consequences for how market 
participants comply with existing regulatory obligations. In this 
regard, some Commission rules require market participants to perform 
certain regulatory obligations on settlement date, within a specified 
number of business days after the settlement date, or are otherwise 
keyed off of settlement date. Below are examples, by way of 
illustration, of such rules. If the standard settlement cycle is 
shortened by one day, as proposed, market participants will have to 
perform those regulatory obligations within a shorter time period, and 
as a result it may become necessary to implement changes to existing 
internal policies and processes.\178\ The Commission requests comment 
on whether it is necessary to amend or provide interpretive guidance

[[Page 69260]]

concerning any other Commission rules that may be impacted by 
shortening the standard settlement cycle to T+2. The Commission also 
requests comment on the proposed amended Regulation SHO interpretation 
set forth below.\179\
---------------------------------------------------------------------------

    \178\ For a discussion of the economic implications of 
shortening the standard settlement cycle to T+2 on other Commission 
rules, see Part VI.C.3. of this release.
    \179\ The Commission further notes that certain SRO rules 
reference Rule 15c6-1 or currently define ``regular way'' settlement 
as occurring on T+3 and, as such, may need to be amended in 
connection with shortening the standard settlement cycle to T+2. 
Further, certain timeframes or deadlines in SRO rules key off of the 
current settlement date, either expressly or indirectly. In such 
cases, the SROs may need to amend these rules in connection with 
shortening the standard settlement cycle to T+2.
---------------------------------------------------------------------------

2. Regulation SHO
    Shortening the standard settlement cycle to T+2 would reduce the 
timeframes to effect a close-out under Rule 204 of Regulation SHO 
(``Rule 204'').\180\ Rule 204 provides that a participant \181\ of a 
registered clearing agency must deliver securities to a registered 
clearing agency for clearance and settlement on a long or short sale in 
any equity security by settlement date, or if a participant has a fail 
to deliver position, the participant shall, by no later than the 
beginning of regular trading hours on the applicable close-out date, 
immediately close-out the fail to deliver position by borrowing or 
purchasing securities of like kind and quantity.\182\ If a fail to 
deliver position results from a short sale, the participant must close-
out the fail to deliver position by no later than the beginning of 
regular trading hours on the settlement day following the settlement 
date.\183\ Under the current T+3 standard settlement cycle, the close-
out for short sales is required by the beginning of regular trading 
hours on T+4. If a fail to deliver position results from a long sale or 
bona fide market making activity, the participant must close-out the 
fail to deliver position by no later than the beginning of regular 
trading hours on the third consecutive settlement day following the 
settlement date.\184\ Under the current T+3 standard settlement cycle, 
the close-out for long sales or bona fide market making activity is 
required by the beginning of regular trading hours on T+6. However, if 
a T+2 settlement cycle is implemented, the existing close-out 
requirement for fail to deliver positions resulting from short sales 
would be reduced from T+4 to T+3 based on the existing definition of 
settlement date in Rule 204.\185\ Similarly, with regard to fail to 
deliver positions resulting from long sales or bona fide market making 
activity, the existing close-out requirement would be reduced from T+6 
to T+5.
---------------------------------------------------------------------------

    \180\ 17 CFR 242.204.
    \181\ For purposes of Regulation SHO, the term ``participant'' 
has the same meaning as in Section 3(a)(24) of the Exchange Act, 15 
U.S.C. 78c(a)(24). See Amendments to Regulation SHO, Exchange Act 
Release No. 60388 (July 27, 2009), 74 FR 38266, 38268 n.34 (July 31, 
2009) (``Rule 204 Adopting Release'').
    \182\ 17 CFR 242.204(a).
    \183\ Id.
    \184\ See 17 CFR 242.204(a)(1) and (a)(3).
    \185\ See 17 CFR 242.204(g)(1).
---------------------------------------------------------------------------

    Shortening the standard settlement cycle to T+2 may also impact the 
application of other provisions in Regulation SHO. Under Rule 200(g) of 
Regulation SHO,\186\ a broker-dealer may only mark a sale as ``long'' 
if the seller is ``deemed to own'' the security being sold under 
paragraphs (a) through (f) of Rule 200 \187\ and either (i) the 
security is in the broker-dealer's physical possession or control; or 
(ii) it is reasonably expected that the security will be in the broker-
dealer's possession or control by settlement of the transaction.\188\ 
In the Rule 204 Adopting Release,\189\ the Commission stated that ``if 
a person that has loaned a security to another person sells the 
security and a bona fide recall of the security is initiated within two 
business days after trade date, the person that has loaned the security 
will be `deemed to own' the security for purposes of Rule 200(g)(1) of 
Regulation SHO, and such sale will not be treated as a short sale . . . 
. In addition, a broker-dealer may mark such orders as `long' sales 
provided such marking is also in compliance with Rule 200(c) of 
Regulation SHO.'' \190\ Thus, broker-dealers that initiate bona fide 
recalls \191\ on T+2 of loaned securities that sellers are ``deemed to 
own'' under paragraphs (a) through (f) of Rule 200 may currently mark 
such orders as ``long.'' \192\ The Commission limited this 
interpretation of Rule 200(g)(1) regarding the marking of sales of 
loaned securities ``long'' to those in which bona fide recalls are 
initiated on or before the business day preceding settlement date under 
the current T+3 settlement cycle because such recalls would likely be 
delivered, under the industry standard for loaned but recalled 
securities,\193\ within three business days after initiation of a 
recall. As a result, such recalled securities would be available by T+5 
to close-out the fail to deliver on a ``long'' sale, or before the 
close-out for fails on sales marked ``long'' is otherwise required by 
Rule 204 (i.e., no later than the beginning of regular trading hours on 
T+6).
---------------------------------------------------------------------------

    \186\ See 17 CFR 242.200(g).
    \187\ See 17 CFR 242.200(a)-(f).
    \188\ See 17 CFR 242.200(g)(1).
    \189\ See Rule 204 Adopting Release, 74 FR at 38270.
    \190\ Id. at 38270 n.55 (citations omitted).
    \191\ Because a recall must be initiated by no later than the 
business day preceding the settlement date to be delivered prior to 
the required Rule 204 close-out, any cancellation or modification of 
a recall of a security would not constitute a bona fide recall.
    \192\ In the release adopting the ``naked'' short selling 
antifraud rule, Rule 10b-21, 17 CFR 240.10b-21, we stated that ``a 
seller would not be making a representation at the time it submits 
an order to sell a security that it can or intends to deliver 
securities on the date delivery is due if the seller submits an 
order to sell securities that are held in a margin account but the 
broker-dealer has loaned out the shares pursuant to the margin 
agreement. Under such circumstances, it would be reasonable for the 
seller to expect that the securities will be in the broker-dealer's 
physical possession or control by settlement date.'' See ``Naked'' 
Short Selling Antifraud Rule, Exchange Act Release No. 58774 (Oct. 
14, 2008), 73 FR 61666, 61672 (Oct. 17, 2008). Thus, a seller of 
securities would not be deemed to be deceiving a broker-dealer under 
Rule 10b-21 if the seller submits a sell order to an executing 
broker-dealer and informs the executing broker-dealer that the 
seller's shares are in the physical possession or control of a prime 
broker, but neither the seller nor the executing broker-dealer knows 
or has reason to know that the prime broker has loaned out the 
securities pursuant to a margin agreement. We note that this 
interpretation, which concerns whether a seller has made a 
misrepresentation regarding the deliverability of its securities in 
time for settlement, does not apply to rules other than Rule 10b-21.
    \193\ See Master Securities Loan Agreement (``MSLA''), Paragraph 
6.1(a), discussing the termination of a loan of securities (``Unless 
otherwise agreed, either party may terminate a Loan on a termination 
date established by notice given to the other party prior to the 
Close of Business on a Business Day. The termination date 
established by a termination notice shall be a date no earlier than 
the standard settlement date that would apply to a purchase or sale 
of the Loaned Securities (in the case of notice given by Lender) or 
the noncash Collateral securing the Loan (in the case of a notice 
given by Borrower) entered into at the time of such notice, which 
date shall, unless Borrower and Lender agree to the contrary, be (i) 
in the case of Government Securities, the next Business Day 
following such notice and (ii) in the case of all other Securities, 
the third Business Day following such notice''). A sample MSLA can 
be found at: https://www.sec.gov/Archives/edgar/data/59440/000095014405003873/g94498exv10w1.htm.
---------------------------------------------------------------------------

    However, if a T+2 standard settlement cycle is implemented, bona 
fide recalls initiated on T+2 (per footnote 55 in the Rule 204 Adopting 
Release described above) would likely not be delivered before the 
close-out requirement for fails on sales marked ``long'' under Rule 204 
(i.e., no later than the beginning of regular trading hours on T+5 
under a T+2 settlement cycle).\194\ Accordingly, the Commission 
preliminarily believes that it would be appropriate to modify its 
interpretation to account for a T+2 standard settlement cycle to help 
ensure that such loaned but recalled securities would be available by 
T+4 before the

[[Page 69261]]

close-out period for fails on sales marked ``long'' would otherwise be 
required by Rule 204 (i.e., no later than the beginning of regular 
trading hours on T+5). Specifically, if a T+2 standard settlement cycle 
is implemented, a broker-dealer seeking to mark an order ``long'' using 
this interpretation would need to initiate a bona fide recall of a 
security on the settlement day before the settlement date (i.e., T+1), 
provided the seller is also net long under Rule 200(c) of Regulation 
SHO. Otherwise, the general requirements of Rule 200 of Regulation SHO 
would govern, and sales of loaned securities could only be marked 
``long'' if the seller is ``deemed to own'' the security being sold and 
either (i) the security is in the broker-dealer's physical possession 
or control; or (ii) it is reasonably expected that the security will be 
in the broker-dealer's possession or control by settlement of the 
transaction.\195\
---------------------------------------------------------------------------

    \194\ We note that a participant may not offset the amount of 
its fail to deliver position with shares that the participant 
receives or will receive during the applicable close-out date (i.e., 
during T+4 or T+6, as applicable) but must take affirmative action, 
by borrowing or purchasing securities of like kind and quantity, at 
or before the beginning of regular trading hours on the applicable 
close-out date. See Rule 204 Adopting Release, supra note 181, 74 FR 
at 38272.
    \195\ See 17 CFR 242.200(g).
---------------------------------------------------------------------------

3. Financial Responsibility Rules Under the Exchange Act
    Certain provisions of the Commission's broker-dealer financial 
responsibility rules \196\ reference explicitly or implicitly the 
settlement date of a securities transaction. For example, paragraph (m) 
of Exchange Act Rule 15c3-3 uses settlement date to prescribe the 
timeframe in which a broker-dealer must complete certain sell orders on 
behalf of customers.\197\ As another example, settlement date is 
incorporated into paragraph (c)(9) of Exchange Act Rule 15c3-1,\198\ 
which explains what it means to ``promptly transmit'' funds and 
``promptly deliver'' securities within the meaning of paragraphs 
(a)(2)(i) and (a)(2)(v) of Rule 15c3-1.\199\ Further, the concepts of 
promptly transmitting funds and promptly delivering securities are 
incorporated in other provisions of the financial responsibility rules, 
including paragraphs (k)(1)(iii), (k)(2)(i), and (k)(2)(ii) of Rule 
15c3-3,\200\ paragraph (e)(1)(A) of Rule 17a-5,\201\ and paragraph 
(a)(3) of Rule 17a-13.\202\ The Commission is seeking comment regarding 
the potential impact that shortening the standard settlement cycle from 
T+3 to T+2 may have on the ability of broker-dealers to comply with the 
Commission's financial responsibility rules.
---------------------------------------------------------------------------

    \196\ The term ``financial responsibility rules,'' for purposes 
of this release, includes any rule adopted by the Commission 
pursuant to Sections 8, 15(c)(3), 17(a) or 17(e)(1)(A) of the 
Exchange Act, any rule adopted by the Commission relating to 
hypothecation or lending of customer securities, or any rule adopted 
by the Commission relating to the protection of funds or securities. 
The Commission's broker-dealer financial responsibility rules 
include Exchange Act Rules 15c3-1 (17 CFR 240.15c3-1), 15c3-3 (17 
CFR 240.15c3-3), 17a-3 (17 CFR 240.17a-3), 17a-4 (17 CFR 240.17a-4), 
17a-5 (17 CFR 240.17a-5), 17a-11 (17 CFR 240.17a-11), and 17a-13 (17 
CFR 240.17a-13).
    \197\ 17 CFR 240.15c3-3(m).
    \198\ 17 CFR 240.15c3-1(c)(9).
    \199\ 17 CFR 240.15c3-1(a)(2)(i), (a)(2)(v).
    \200\ 17 CFR 240.15c3-3(k)(1)(iii), (k)(2)(i), (k)(2)(ii).
    \201\ 17 CFR 240.17a-5(e)(1)(A).
    \202\ 17 CFR 240.17a-13(a)(3).
---------------------------------------------------------------------------

4. Exchange Act Rule 10b-10
    Providing customers with confirmations pursuant to Exchange Act 
Rule 10b-10 serves a significant investor protection function. 
Confirmations provide customers with a means of verifying the terms of 
their transactions, alerting investors to potential conflicts of 
interest with their broker-dealers, acting as a safeguard against 
fraud, and providing investors a means to evaluate the costs of their 
transactions and the quality of their broker-dealers' execution.\203\
---------------------------------------------------------------------------

    \203\ See Confirmation Requirements for Transactions of Security 
Futures Products Effected in Futures Accounts, Exchange Act Release 
No. 46471 (Sept. 6, 2002), 67 FR 58302, 58303 (Sept. 13, 2002).
---------------------------------------------------------------------------

    Rule 10b-10 requires that a broker-dealer send a customer a written 
confirmation disclosing information relevant to the transaction ``at or 
before completion'' of the transaction.\204\ Generally, Rule 15c1-1 
defines ``completion of the transaction'' to mean the time when: (i) A 
customer is required to deliver the security being sold; (ii) a 
customer is required to pay for the security being purchased; or (iii) 
a broker-dealer makes a bookkeeping entry showing a transfer of the 
security from the customer's account or payment by the customer of the 
purchase price.\205\
---------------------------------------------------------------------------

    \204\ See 17 CFR 240.10b-10(a).
    \205\ See 17 CFR 240.15c1-1(b).
---------------------------------------------------------------------------

    While the confirmation must be sent ``at or before completion'' of 
the transaction, Commission rules do not require that the customer 
receive a confirmation prior to settlement. In connection with the 
adoption of amendments to Rule 15c6-1 in 1993 to establish a T+3 
standard settlement cycle, the Commission at that time noted that 
broker-dealers typically send customer confirmations on the day after 
trade date. Today, the Commission understands that, while broker-
dealers may continue to send physical customer confirmations on the day 
after trade date, broker-dealers may also send electronic confirmations 
to customers on trade date. Accordingly, the Commission preliminarily 
believes that implementation of a T+2 settlement cycle will not create 
problems with regard to a broker-dealer's ability to comply with the 
requirement under Rule 10b-10 to send a confirmation ``at or before 
completion'' of the transaction. Nonetheless, the Commission notes that 
broker-dealers will have a shorter timeframe to comply with the 
requirements of Rule 10b-10 in a T+2 settlement cycle.

IV. Compliance Date

    The Commission recognizes that the compliance date for the proposed 
amendment to Rule 15c6-1(a) must allow sufficient time for broker-
dealers, clearing agencies, and other market participants to plan for, 
implement and test the changes to their systems, operations, policies 
and procedures in a manner that allows for an orderly transition to a 
T+2 standard settlement cycle, taking into account any burdens on 
broker-dealers, clearing agencies, institutional and retail investors 
and others, and any potential disruptions in the securities markets. In 
addition, the Commission recognizes that a compliance date should 
provide sufficient time for broker-dealers to address concerns 
regarding the potential for the transition to a T+2 settlement cycle to 
inconvenience certain retail investors.\206\ As previously mentioned, 
failure to appropriately implement a transition to T+2 settlement may 
heighten certain operational risks for the markets.
---------------------------------------------------------------------------

    \206\ A shortened settlement cycle may require, for example, 
certain retail investors to fund their securities transactions 
earlier, and may require broker-dealers to educate their customers, 
update communications, and take other steps to minimize potential 
burdens on retail investors.
---------------------------------------------------------------------------

    On the other hand, delaying the transition to a T+2 standard 
settlement cycle further than is necessary for these activities to 
occur would delay realization of the benefits that are expected to 
result from shortening the settlement cycle.
    As of March 2016, the industry identified September 5, 2017 as the 
target date for the transition to a T+2 settlement cycle to occur,\207\ 
and, as noted above, the ISC has proposed a timeline for implementing 
the necessary industry changes. The September 5, 2017 T+2 
implementation date was based on a timeline reflected in the T+2 
Playbook, which identified certain regulatory and industry 
contingencies

[[Page 69262]]

that would have to transpire, including necessary regulatory actions, 
over a period of approximately a year and a half.\208\ If the proposed 
amendment to Rule 15c6-1(a) is adopted, the Commission then would 
consider that date as well as other dates in setting a compliance 
date.\209\ The Commission would take into consideration such factors as 
any investor outreach efforts and other changes that firms may need to 
undertake to address concerns that the transition may temporarily 
inconvenience retail investors. The compliance date would be set at an 
appropriate time to help avoid, in light of the scope of the industry 
changes that will be required, setting a transition occurring too 
quickly, which could have negative consequences for the industry and 
investors, and could result in disruptions to the securities markets.
---------------------------------------------------------------------------

    \207\ See Press Release, ISC, US T+2 ISC Recommends Move to 
Shorter Settlement Cycle On September 5, 2017 (Mar. 7, 2016), https://www.ust2.com/pdfs/T2-ISC-recommends-shorter-settlement-030716.pdf. 
In this press release, the ISC noted that ``[t]he T+2 implementation 
date was chosen by the T+2 ISC after careful consideration, input 
from industry participants and consultation with other markets 
globally.'' Id.
    \208\ See T+2 Industry Playbook, supra note 126.
    \209\ The Commission understands that since the publication of 
the T+2 Playbook in December 2015, industry planning and preparation 
for a move to T+2 has continued. In considering an appropriate 
compliance date, should the Commission determine to adopt the 
proposed amendment discussed herein, the Commission could take into 
account the current status of industry preparation at that time, 
including progress that has occurred since the publication of the 
T+2 Playbook timeline.
---------------------------------------------------------------------------

V. Request for Comment

    The Commission is requesting comment regarding all aspects of the 
proposed amendment to Rule 15c6-1(a) that would shorten the current T+3 
standard settlement cycle to T+2 for securities transactions, subject 
to the exceptions in the rule. The Commission also seeks comment on the 
particular questions set forth below, and encourages commenters to 
submit any relevant data or analysis in connection with their answers.
    1. The Commission invites commenters to address the merits of the 
proposed amendment to Rule 15c6-1(a). Is it appropriate to amend Rule 
15c6-1 to shorten the standard settlement cycle to T+2? Why or why not?
    2. The Commission invites commenters to provide their views on 
whether the standard settlement cycle should instead be shortened to 
T+1 or some other shorter settlement cycle. Why or why not?
    3. Is the current scope of securities covered by Rule 15c6-1, 
including the exemptions provided in Rule 15c6-1(a), still appropriate 
in light of the Commission's proposal to shorten the standard 
settlement cycle to T+2? Are there any asset classes, securities as 
defined in Section 3(a)(10) of the Exchange Act, or types of securities 
transactions for which the proposed amendment to Rule 15c6-1(a) would 
present compliance problems for broker-dealers? What would be the 
quantitative and qualitative impacts of maintaining those exemptions?
    4. Are there market participants today that agree to settle 
securities transactions later than T+3? If so, to what extent does this 
occur and what are the circumstances that motivate these market 
participants to settle later than T+3? If Rule 15c6-1(a) is amended to 
shorten the standard settlement cycle from T+3 to T+2, is it 
anticipated that these market participants would continue to settle 
securities transactions on a longer settlement cycle and/or is it 
anticipated that additional market participants would settle securities 
transactions later than T+2? Conversely, are there circumstances where 
expedited settlements (on timeframes less than T+3) are conducted, and 
if so, how often and under what circumstances? What are the 
circumstances that motivate earlier settlements? If Rule 15c6-1(a) is 
amended to shorten the standard settlement cycle from T+3 to T+2, how 
will the proposed amendment affect these expedited settlement 
decisions?
    5. Should the temporary exemptive relief from compliance with Rule 
15c6-1 for transactions in security-based swaps be extended? \210\ If 
so, why or why not?
---------------------------------------------------------------------------

    \210\ As noted in note 10, supra, certain of the exemptions 
included in the Commission's 2011 exemptive order (including the 
exemption for Rule 15c6-1) are set to expire on February 5, 2017.
---------------------------------------------------------------------------

    6. Should the Commission consider any amendments to other 
provisions of Rule 15c6-1 for the purposes of shortening the standard 
settlement cycle to T+2? If so, which provisions and why?
    7. In conjunction with a change to the standard settlement cycle 
from T+3 to T+2 under Rule 15c6-1(a), should the Commission amend the 
settlement cycle timeframe under Rule 15c6-1(c) for firm commitment 
offerings priced after 4:30 p.m. Eastern Time from the current 
requirement of T+4 to a settlement cycle timeframe shorter than T+4, 
such as T+3 or T+2? If so, what settlement timeframe would be 
appropriate for transactions covered by Rule 15c6-1(c)? What would be 
the impact on risk, costs or operations of retaining the current 
provision for firm commitment offerings but shortening the settlement 
cycle to T+2 for regular-way transactions, as proposed? What would be 
the impact on risk, costs or operations of shortening the settlement 
cycle for such offerings to a T+3 or T+2 timeframe? Please provide data 
to the extent feasible on the costs/burdens that might be incurred/
borne, and benefits that may be realized, by market participants as a 
result of shortening settlement cycle for firm commitment offerings 
priced after 4:30 p.m. Eastern Time.
    8. Are the conditions set forth in the Commission's exemptive order 
for securities traded outside the United States still appropriate? 
\211\ If not, why not? If the exemption should be modified, how should 
it be modified and why? Are the conditions set forth in the 
Commission's exemptive order for variable annuity contracts still 
appropriate? \212\ If not, why not? If the exemption should be 
modified, how should it be modified and why? Are there other securities 
or types of transactions for which the Commission should consider 
providing exemptive relief under Rule 15c6-1(b)?
---------------------------------------------------------------------------

    \211\ See supra note 147 and accompanying text.
    \212\ See supra note 150 and accompanying text.
---------------------------------------------------------------------------

    9. Commenters are invited to provide data on the costs/burdens that 
may be incurred/borne, and benefits that may be realized, by any 
category of persons as a result of the proposed amendment to Rule 15c6-
1(a), including, without limitation, broker-dealers, clearing agencies, 
custodians, institutional investors, retail investors, and others.
    10. Would shortening the standard settlement cycle to T+2 as 
proposed create difficulties for broker-dealers to comply with the 
requirements of Rule 15c6-1? Please provide examples.
    11. How would retail investors be impacted by new processes that 
broker-dealers may implement in support of a T+2 standard settlement 
cycle? For example, would broker-dealers require retail investors to 
have a funded cash account prior to trade execution? Would shortening 
the standard settlement cycle to T+2 result in retail investors 
encountering ongoing costs due to a delay in their ability to make 
investments? Would shortening the standard settlement cycle to T+2 
result in any benefits to retail investors?
    12. In addition to the prospective impact on costs/burdens, the 
Commission seeks comments related to the credit, market, liquidity, 
legal, and operational risks (increase or decrease) associated with 
shortening the standard settlement cycle, and in particular, 
quantification of such risks.
    13. What impact, if any, would the proposed amendment to Rule 15c6-
1(a) have on market participants who engage in cross-border 
transactions? To what extent would harmonization of the U.S. settlement 
cycle with other markets that are on a T+2 settlement cycle result in 
increased or decreased operational costs to market participants? To 
what extent

[[Page 69263]]

would harmonization increase or decrease risks associated with cross-
border transactions or related transactions, such as financing 
transactions?
    14. What impact, if any, would the proposed amendment to Rule 15c6-
1(a) have on market participants who engage in trading activity across 
various financial product classes, including derivatives and ETPs? 
\213\ For example, would shortening the settlement cycle for ETPs 
affect the costs, such as net capital charges related to collateral 
requirements, of creating or redeeming shares in ETPs that hold 
portfolio securities that are on a different settlement cycle? \214\ If 
so, would such a change in costs affect the efficiency or effectiveness 
of the arbitrage between an ETP's secondary market price and the value 
of its underlying assets?
---------------------------------------------------------------------------

    \213\ ETPs constitute a diverse class of financial products that 
seek to provide investors with exposure to financial instruments, 
financial benchmarks, or investment strategies across a wide range 
of asset classes. ETP trading occurs on national securities 
exchanges and other secondary markets that are regulated by the 
Commission under the Exchange Act, making ETPs widely available to 
market participants, from individual investors to institutional 
investors, including hedge funds and pension funds. The largest 
category of ETPs is comprised of ETFs, which are open-end fund 
vehicles or unit investment trusts that are registered as investment 
companies under the Investment Company Act. See Request for Comment 
on Exchange-Traded Products, Exchange Act Release No. 75165 (June 
12, 2015), 80 FR 34729 (June 17, 2015).
    \214\ For example, the way a market participant executes a 
creation or redemption of an ETF share resembles a stock trade in 
the secondary market. A market participant typically referred to as 
an ``Authorized Participant'' or ``AP'' submits an order to create 
or redeem (``CR'') ETF shares much like an investor submits an order 
to his broker to buy or sell a stock. Also, similar to a stock 
trade, the CR order settles on a T+3 settlement cycle through NSCC. 
See ICI, ICI Research Perspective Vol. 20 No. 5, 14 (Sept. 2014), 
https://www.ici.org/pdf/per20-05.pdf; see also DTCC, Exchange Traded 
Fund (ETF) Processing, https://www.dtcc.com/clearing-services/equities-trade-capture/etf; DTCC, ETFs and CNS Processing, https://www.dtcclearning.com/learning/clearance/topics/exchange-traded-funds-etf/about-etf/etfs-and-cns-processing.html.
---------------------------------------------------------------------------

    15. To what extent, if any, would a T+2 standard settlement cycle 
impact the interaction of the creation and redemption process with the 
clearance and settlement process?
    16. What impact, if any, would shortening the standard settlement 
cycle to T+2 have on the levels of liquidity risk that currently exist 
as a result of mismatches between the settlement cycles for different 
markets? For example, would shortening the standard settlement cycle to 
T+2 reduce the level of liquidity risk mutual funds face as a result of 
the mismatch between the current T+1 settlement cycle for transactions 
in open-end mutual fund shares that are settled through NSCC and the 
T+3 settlement cycle that is applicable to many portfolio securities 
held by mutual funds?
    17. The Commission seeks comment on the status and readiness of the 
technology and processes in the industry that could support a T+2 or 
shorter settlement cycle at this time, including data metrics used to 
substantiate such support. The Commission also seeks comment on the 
additional costs, including changes to business processes, associated 
with the transition to T+1 or a shorter standard settlement cycle 
relative to the costs with respect to a transition to a T+2 standard 
settlement cycle, as well as any operational or technological obstacles 
that market participants may need to overcome before such shorter 
standard settlement cycle could be implemented effectively. In 
addition, the Commission seeks comment on the additional benefits that 
may be realized by market participants as a result of shortening the 
standard settlement cycle to T+1 or a shorter settlement cycle relative 
to benefits with respect to a T+2 standard settlement cycle, as well as 
the time that market participants would need to make necessary system 
changes in support of a transition to a T+1 standard settlement cycle.
    18. Which, if any, Commission rules would need to be amended, and 
is there a need to provide interpretive guidance concerning any 
Commission rules, to accommodate a T+2 standard settlement cycle? The 
Commission invites commenters to describe any concerns they may have 
regarding such prospective changes to Commission rules and/or new 
interpretive guidance.
    19. If a T+2 standard settlement cycle is adopted, the Commission's 
Regulation SHO marking interpretation would necessitate loaned but 
recalled securities being recalled on T+1 instead of T+2. What 
operational issues might arise if this were the case? Would specific 
operational difficulties arise for persons that lend securities?
    20. What impact, if any, would the proposed amendment to Rule 15c6-
1(a) have on the ability of broker-dealers to comply with existing 
requirements under the Commission's financial responsibility rules? In 
particular, would a T+2 standard settlement cycle or a shorter standard 
settlement cycle create operational difficulties or other problems for 
broker-dealers that may impact their ability to comply with the 
Commission's financial responsibility rules? In addition, would the 
proposed amendment to Rule 15c6-1(a) increase the costs and burdens 
that broker-dealers may incur in order to comply with the Commission's 
financial responsibility rules?
    21. Would a T+2 standard settlement cycle create compliance or 
operational problems with regard to a broker-dealer's ability to meet 
the requirement under Rule 10b-10 to send a confirmation ``at or before 
completion'' of the transaction?
    22. Would the adoption of a T+2 settlement cycle create any legal 
or operational concerns for issuers or broker-dealers in their ability 
to comply with the prospectus delivery obligations under Rule 172? 
\215\
---------------------------------------------------------------------------

    \215\ For a more detailed discussion regarding Rule 172 and the 
``access equals delivery'' model, see supra note 113.
---------------------------------------------------------------------------

    23. Is the status of the building blocks toward implementing a T+1 
settlement cycle, as discussed in the DTCC Proposal to Launch a Cost-
Benefit Analysis, accurate and, if not, what efforts would need to be 
made to advance the building blocks to support a T+2 settlement cycle?
    24. What parameters should guide the Commission in identifying an 
appropriate compliance date for the proposed amendment to Rule 15c6-1? 
Please provide analysis to support your position. The Commission 
encourages commenters to include in their responses discussion 
regarding the implementation date proposed by the ISC (i.e., September 
5, 2017). Specifically, the Commission notes that there are a number of 
milestones and dependencies described in the T+2 Playbook, and solicits 
comment on the length of the compliance period that would be needed to 
provide enough lead time for these industry preparations to be 
completed and ensure an orderly transition from a T+3 to a T+2 
settlement cycle.
    25. Should the compliance date occur immediately following a 
weekend (including a holiday weekend), with the view that two or three 
non-business days would provide additional time for performing any 
final system changes or testing in anticipation of the transition to a 
T+2 settlement cycle? If not, which day of the week would be most 
suitable for the transition to occur? Are there times of the month or 
year that should be avoided in order to facilitate a successful 
implementation of the system changes necessary to support a T+2 
settlement cycle?
    26. A new technology, known as ``blockchain'' or ``distributed 
ledger'' technology, is being tested in a variety of settings to 
determine whether it has utility in the securities industry.\216\

[[Page 69264]]

What utility, if any, would a distributed ledger system or such related 
technology have in the context of a shortened settlement cycle, and if 
any, how would it be used? What regulatory actions, if any, would be 
necessary to facilitate the use of that technology? How would market 
participants ensure their use of or interaction with such technology 
would comply and be consistent with federal securities laws and 
regulations? Please explain.
---------------------------------------------------------------------------

    \216\ See generally, DTCC, ``Embracing Disruption, Tapping the 
Potential of Disrupted Ledgers to Improve the Post-Trade 
Landscape,'' (Jan. 2016), https://www.gpo.gov/fdsys/pkg/FR-2015-12-31/pdf/2015-32755.pdf. See also Nasdaq, ``Building on the 
Blockchain'' (Mar. 23, 2016), https://business.nasdaq.com/marketinsite/2016/Building-on-the-Blockchain.html (discussing the 
future use of Blockchain technology in the markets); Matthew 
Leising, ``Blockchain Potential for Markets Grabs Exchange CEOs' 
Attention'', Bloomberg Business (Nov. 4, 2015), https://www.bloomberg.com/news/articles/2015-11-04/futures-market-ceos-says-blockchain-shows-serious-potential (discussing financial services 
industry's interest in blockchain technology).
---------------------------------------------------------------------------

VI. Economic Analysis

    The following economic analysis begins with a discussion of the 
risks inherent in the settlement cycle and how a reduction in the 
length of the settlement cycle may impact the management and mitigation 
of these risks. Next, it discusses market frictions that potentially 
impair the ability of market participants to shorten the settlement 
cycle in the absence of a Commission rule. These settlement cycle risks 
and market frictions frame our analysis of the rule's benefits and 
costs in later sections. The Commission preliminarily believes that the 
proposed amendment to Rule 15c6-1(a) ameliorates these market frictions 
and thus reduces the risks inherent in settlement.
    This discussion of the economic effects of the proposed amendment 
to Rule 15c6-1(a) begins with a baseline of current practices. The 
economic analysis then discusses the likely economic effects of the 
proposed amendment, such as the costs and benefits of the proposed 
amendment as well as its effects on efficiency, competition, and 
capital formation.\217\ The Commission has, where possible, attempted 
to quantify the economic effects expected to result from this proposal. 
In many cases, and as noted below in further detail, the Commission is 
unable to quantify the economic effects of the proposed amendment to 
Rule 15c6-1(a) and solicits comment, including estimates and data from 
interested parties, that could help it form useful estimates of the 
economic effects of the proposed amendment.
---------------------------------------------------------------------------

    \217\ Section 3(f) of the Exchange Act requires the Commission, 
when engaging in rulemaking that requires the Commission to consider 
or determine whether an action is necessary or appropriate in the 
public interest, to consider, in addition to the protection of 
investors, whether the action will promote efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f). Further, Section 23(a)(2) 
of the Exchange Act requires the Commission, when adopting rules 
under the Exchange Act, to consider the impact that any new rule 
would have on competition, and provides that the Commission shall 
not adopt any rule that would impose a burden on competition that is 
not necessary or appropriate in furtherance of the purposes of the 
Exchange Act. 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

A. Background

    The proposed amendment to Rule 15c6-1(a) would prohibit a broker-
dealer from effecting or entering into a contract for the purchase or 
sale of a security (other than an exempted security, government 
security, municipal security, commercial paper, bankers' acceptances, 
or commercial bills) that provides for payment of funds and delivery of 
securities later than the second business day after the date of the 
contract unless otherwise expressly agreed to by both parties at the 
time of the transaction, subject to certain exceptions provided in the 
rule. In its analysis of the economic impacts of the proposal, the 
Commission has considered the risks that market participants, including 
broker-dealers, clearing agencies, and institutional and retail 
investors are exposed to during the settlement cycle and how those 
risks change with the length of the settlement cycle.
    The settlement cycle spans the length of time between when a trade 
is executed and when cash and securities are delivered to the seller 
and buyer, respectively. During this period of time, each party to a 
trade faces the risk that its counterparty may fail to meet its 
obligations to deliver cash or securities. When a counterparty defaults 
or fails to meet its obligations to deliver cash or securities, the 
trade must be closed-out. Regardless of whether the non-defaulting 
party chooses to enter into a new transaction as a result of the failed 
trade, it is likely to bear costs as a result of counterparty default. 
For example, a party that chooses to enter into a new transaction must 
find a new counterparty to contract with and must trade at a price that 
may not be the same as the price of the original trade.\218\ The length 
of the settlement cycle influences this risk in two ways: (i) Through 
its effect on counterparty exposures to price volatility, and (ii) 
through its effect on the value of outstanding obligations.
---------------------------------------------------------------------------

    \218\ As described above, in its role as a CCP, NSCC becomes 
counterparty to both initial parties to a transaction. In the case 
of cleared transactions, while each initial party is not exposed to 
the risk that their original counterparty defaults, both are exposed 
to the risk of CCP default. Similarly, the CCP is exposed to the 
risk that either initial party defaults.
---------------------------------------------------------------------------

    First, additional time allows asset prices to move further away 
from the price of the original trade. For example, if daily asset 
returns are statistically independent, then the variance of prices over 
t days is equal to t multiplied by the daily variance of asset returns. 
Thus when daily returns are independent and daily variance of returns 
is constant, the variance of returns increases linearly in the number 
of days.\219\ In other words, the more days that elapse between when a 
trade is executed and when a counterparty defaults, the larger the 
variance of prices will be, and the more likely it will be that the 
difference between execution price and the price ultimately paid will 
be larger. For example, if a buyer whose counterparty fails decides to 
enter into a new transaction to buy the same security, the buyer faces 
the risk that the price of the security will have deviated from the 
price of the original transaction. The price change could be positive 
or negative, but in the event of a price increase, the buyer must pay 
more than the original execution price; in the event of a price 
decrease, the buyer may buy the security for less than the original 
execution price.\220\
---------------------------------------------------------------------------

    \219\ More generally, because total variance over multiple days 
is equal to the sum of daily variances and variables related to the 
correlation between daily returns, total variance increases with 
time so long as daily returns are not highly negatively correlated. 
See, e.g., Morris H. DeGroot, Probability and Statistics 216 
(Addison-Wesley Publishing Co. 1986).
    \220\ Similarly, a seller whose counterparty fails faces similar 
risks with respect to the security, albeit in opposite directions.
---------------------------------------------------------------------------

    Second, the length of the settlement cycle directly influences the 
quantity of transactions awaiting settlement. For example, assuming no 
change in transaction volumes, the volume of unsettled trades under a 
T+2 settlement cycle is two-thirds the volume of unsettled trades under 
T+3 settlement cycle. Thus, counterparties would have to enter into a 
new transaction, or otherwise close out two-thirds the number of trades 
in a T+2 standard settlement cycle due to counterparty defaults than in 
a T+3 standard settlement cycle. This means that for a given adverse 
move in prices, the financial losses resulting from counterparty 
default will be two-thirds as large under a T+2 standard settlement 
cycle than under a T+3 standard settlement cycle.
    Market participants manage and mitigate settlement risk in a number 
of specific ways that are discussed in Part II.A. of this release. 
Generally, these

[[Page 69265]]

methods entail costs to market participants. In some cases, these costs 
may be explicit. For instance, broker-dealers may explicitly charge 
customers for providing them with the implicit option to default on 
payment or delivery obligations. Other costs are implicit, such as the 
opportunity cost of assets posted as collateral, or limitations on the 
amount of credit that broker-dealers are willing to provide to their 
customers.
    By shortening the standard settlement cycle, each trade will be 
subject to credit and market risk for a shorter amount of time, 
allowing for less time between trade execution and settlement for the 
transactions to generate losses. In addition, a shorter standard 
settlement cycle would reduce liquidity risks that could arise between 
derivative and cash markets by allowing investors to obtain the 
proceeds of securities transactions sooner. These are risks that affect 
all market participants, are difficult to diversify away, and require 
resources to manage and mitigate. CCPs and clearing members require 
participants to post financial resources in order to secure members' 
obligations to deliver cash and securities to the CCP. To the extent 
that collateral is posted to CCPs and clearing members for the purposes 
of mitigating the risks of the clearance and settlement process, that 
may represent an allocative inefficiency.
    This allocative inefficiency could take on several forms. First, 
financial resources that are used to mitigate the risks of the 
clearance and settlement process could have been put to alternative 
uses, such as investment in less liquid assets. Second, assets that are 
valuable because they are particularly suited to meeting financial 
resource obligations may have been better allocated to market 
participants that hold these assets for their fundamental risk and 
return characteristics. These allocative inefficiencies may reduce 
capital formation. Reducing the financial risks associated with the 
overall clearance and settlement process would thereby reduce the 
amount of collateral required to mitigate these risks, which would 
reduce the costs that market participants bear to manage and mitigate 
these risks and the allocative inefficiencies that may stem from risk 
management practices.\221\ Hence, the Commission preliminarily believes 
that these benefits generally provide securities market participants 
with incentives to shorten the settlement cycle.
---------------------------------------------------------------------------

    \221\ See infra Part VI.B. for further discussion of financial 
resources collected to mitigate and manage financial risks; see 
also, infra Part VI.C. for more information about risk reduction.
---------------------------------------------------------------------------

    However, the Commission acknowledges that certain market frictions 
may prevent securities markets from shortening the settlement cycle in 
the absence of regulatory intervention. The Commission has considered 
two key market frictions related to investments required to implement a 
shorter settlement cycle. The first is a coordination problem that 
arises when some of the benefits of actions taken by market 
participants are only realized when other market participants take a 
similar action. For example, absent regulatory intervention such as the 
proposed amendment to Rule 15c6-1(a), if a particular institutional 
investor makes a technological investment necessary to reduce the time 
it requires to match and allocate trades while its clearing broker-
dealers do not, the institutional investor cannot fully realize the 
benefits of its investment, as the settlement process is limited by the 
capabilities of the clearing agency for trade matching and allocation. 
More generally, when each market participant must bear the costs of an 
upgrade in order for the entire market to enjoy a benefit, the result 
is a coordination problem, where each market participant is reluctant 
to make the necessary investments until it can be sure that others will 
also do so. In general, these coordination problems may be resolved if 
all parties can credibly commit to the necessary infrastructure 
investments. Regulatory intervention is one possible way of 
coordinating market participants to undertake the investments necessary 
to support a shorter settlement cycle. Such intervention could come 
through Commission rulemaking or through a coordinated set of SRO rule 
changes.
    In addition to coordination problems, a second market friction 
related to the settlement cycle involves situations where one market 
participant's investments result in benefits for other market 
participants. For example, if a market participant invests in a 
technology that reduces the error rate in its trade matching, not only 
does it benefit from fewer errors, but its counterparties and other 
market participants may also benefit from more robust trade matching. 
However, because market participants do not necessarily take into 
account the benefits that may accrue to other market participants (also 
known as ``externalities'') when market participants choose the level 
of investment in their systems, the level of investment in technologies 
that reduce errors might be less than efficient for the entire market. 
More generally, underinvestment may result because each participant 
only takes into account its own costs and benefits when choosing which 
infrastructure improvements or investments to make, and does not take 
into account the costs and benefits that may accrue to its 
counterparties, other market participants, or other financial markets.
    Moreover, because market participants that incur similar costs to 
enable a move to a shorter settlement cycle may nevertheless experience 
different levels of economic benefits, there is likely heterogeneity 
across market participants in the demand for a shorter settlement 
cycle. This heterogeneity may exacerbate coordination problems and 
underinvestment. Market participants that do not expect to receive 
direct benefits from settling transactions earlier may lack incentives 
to invest in infrastructure to support a shorter settlement cycle and 
thus could make it difficult for the market as a whole to realize the 
overall risk reduction that the Commission preliminarily believes a 
shorter settlement cycle may bring.
    For example, the level and nature of settlement risk exposures vary 
across different types of market participants. A market participant's 
characteristics and trading strategies can influence the level of 
settlement risk it faces. For example, large market participants will 
generally be exposed to more settlement risk than small market 
participants because they trade in larger volume. However, large market 
participants also trade across a larger variety of assets and may face 
less idiosyncratic risk in the event of counterparty default if the 
portfolio of trades that would have to be remade is diversified.\222\ 
As a corollary, a market participant who trades a single security in a 
single direction against a given counterparty may face more 
idiosyncratic risk in the event of counterparty failure than a market 
participant who trades in both directions with that counterparty.
---------------------------------------------------------------------------

    \222\ See Ananth Madhavan, Morris Mendelson & Junius W. Peake, 
Risky Business: The Clearance and Settlement of Financial 
Transactions, (Wharton Sch. Rodney L. White Ctr. for Fin. Research, 
Working Paper No. 40-88, 1988); see also John H. Cochrane, Asset 
Pricing (Princeton University Press rev. ed. 2009), at 15 (defining 
the idiosyncratic component of any payoff as the part that is 
uncorrelated with the discount factor).
---------------------------------------------------------------------------

    Further, the extent to which a market participant experiences any 
economic benefits that may stem from a shortened standard settlement 
cycle likely depends on the market participant's relative bargaining 
power. While large intermediaries, such as clearing broker-dealers, may 
experience direct benefits

[[Page 69266]]

from a shorter settlement cycle as a result of being required to post 
less collateral with a CCP, if they do not effectively compete for 
customers through fees and services as a result of market power, they 
may pass only a portion of these cost savings through to their 
customers.\223\
---------------------------------------------------------------------------

    \223\ See infra Parts VI.C.1. and VI.C.2.
---------------------------------------------------------------------------

    In light of the above, the Commission preliminarily believes that 
the proposed amendment to Rule 15c6-1(a), which would shorten the 
standard settlement cycle from T+3 to T+2 may mitigate the market 
frictions of coordination and underinvestment described above. The 
Commission preliminarily believes that by mitigating these market 
frictions, the transition to a shorter standard settlement cycle will 
reduce the risks inherent in the clearance and settlement process.
    The shorter standard settlement cycle might also have an impact on 
the level of operational risk that exists in the U.S. clearance and 
settlement system as a result of existing clearance and settlement 
processes. By shortening the settlement cycle by one day, market 
participants involved in a securities transaction will have one less 
day to resolve any errors that might occur in the clearance and 
settlement process. As a result, tighter operational timeframes and 
linkages required under a shorter standard settlement cycle might 
introduce new fragility that could impact financial market 
participants, specifically an increased risk that operational issues 
could impact transaction processing and related securities 
settlement.\224\
---------------------------------------------------------------------------

    \224\ For example, the ability to compute an accurate net asset 
value (``NAV'') within the settlement timeframe is a key component 
for settlement of ETF transactions. See, e.g., Barrington Partners, 
An Extraordinary Week: Shared Experiences from Inside the Fund 
Accounting Systems Failure of 2015, at 10 (Nov. 2015), https://www.mfdf.org/images/uploads/blog_files/SharedExperiencefromFASystemFailure2015.pdf.
---------------------------------------------------------------------------

    Market participants may incur initial costs for the investments 
necessary to comply with a shorter standard settlement cycle.\225\ 
However, these costs may differ across market participants and these 
differences may exacerbate coordination problems. First, differences in 
operational costs across clearing agency members may be driven by 
member transaction volume, and so the extent to which many of the 
upgrades necessary for a T+2 standard settlement cycle are optimal for 
a member to adopt unilaterally may depend on its transaction volume. 
For example, certain upgrades necessary for a T+2 standard settlement 
cycle may result in economies of scale, where large clearing members 
are able to comply with the proposed amendment to Rule 15c6-1(a) at a 
lower per transaction cost than smaller members. As a result, larger 
members might take a short time to recover their initial costs for 
upgrades; smaller members with lower transaction volumes might take 
longer to recover their initial cost outlays and might be more 
reluctant to make the upgrades in the absence of the proposed 
amendment.
---------------------------------------------------------------------------

    \225\ See infra Part VI.C.2.
---------------------------------------------------------------------------

    In addition, the Commission acknowledges that the upgrades 
necessary to implement a shorter standard settlement cycle may produce 
indirect economic effects. We analyze some of these indirect effects, 
such as the impact on competition and third-party service providers, in 
the following section. However, other indirect effects, such as the 
ancillary benefits and costs mentioned in the BCG Study,\226\ of 
investments and changes to market practices that enhance the speed and 
efficiency of the settlement process, but which are unrelated to a 
shorter standard settlement cycle, are not within the scope of the 
economic analysis of this release.
---------------------------------------------------------------------------

    \226\ See BCG Study, supra note 107, at 8.
---------------------------------------------------------------------------

B. Baseline

    In order to perform its analysis of the likely economic effects of 
the proposed amendment to Rule 15c6-1(a), as well as the proposed 
amendment's effects on efficiency, competition, and capital formation, 
the Commission uses as its baseline the clearance and settlement 
process as it exists at the time of this proposal. In addition to the 
current process that is described in Part II.A.3., the baseline 
includes rules adopted by the Commission, including rules governing the 
clearance and settlement system, SRO rules,\227\ as well as rules 
adopted by regulators in other jurisdictions to regulate securities 
settlement in those jurisdictions.\228\ The following section discusses 
several additional elements of the baseline that are relevant for the 
economic analysis of the proposed amendment to Rule 15c6-1(a) because 
they are related to the financial risks faced by market participants 
that clear and settle transactions and the specific means by which 
market participants manage these risks.
---------------------------------------------------------------------------

    \227\ See supra note 179.
    \228\ See supra Part II.B.
---------------------------------------------------------------------------

1. Clearing Agencies
    As discussed above, one way NSCC mitigates the credit, market, and 
liquidity risk it assumes through its novation and guaranty of trades 
is via multilateral netting of the delivery and payment obligations 
across clearing members. By offsetting these obligations, NSCC reduces 
the aggregate market value of securities and cash it must deliver to 
clearing members after the trade is novated and the trade guaranty 
attaches. While netting reduces NSCC's settlement obligations by an 
average of 97% on each day, it does not fully eliminate the risk posed 
by unsettled trades because NSCC is still responsible for payments or 
deliveries on trades it cannot fully net. NSCC reported clearing an 
average of approximately $872 billion each day during the fourth 
quarter of 2015,\229\ suggesting an average net settlement obligation 
of approximately $26.2 billion each day.\230\ Based on these estimates, 
and given that, under current practices, NSCC's trade guaranty attaches 
at midnight on T+1, the average notional value of unsettled trades 
approaches $52.3 billion.\231\
---------------------------------------------------------------------------

    \229\ See NSCC, Q4 2015 Fixed Income Clearing Corporation and 
NSCC Quantitative Disclosure for Central Counterparties, at 14 (Mar. 
2016), https://www.dtcc.com/legal/policy-and-compliance.
    \230\ Calculated as $872 billion x 3% = $26.16 billion.
    \231\ Calculated as $26.16 billion x 2 days between attachment 
of the trade guaranty and settlement on T+3 = $52.32 billion.
---------------------------------------------------------------------------

    The aggregate settlement risk faced by NSCC is also a function of 
the probability of clearing member default. NSCC manages the risk of 
clearing member default by imposing certain financial responsibility 
requirements on its members. For example, as of 2015, broker-dealer 
members of NSCC that are not municipal securities brokers and do not 
intend to clear and settle transactions for other broker-dealers must 
have excess net capital over the minimum net capital requirement 
imposed by the Commission in the amount of $500,000.\232\ Further, each 
NSCC member is subject to ongoing membership requirements, including a 
requirement to furnish NSCC with assurances of the member's financial 
responsibility and operational capability, including, but not limited 
to, periodic reports of its financial and operational condition.\233\
---------------------------------------------------------------------------

    \232\ See NSCC Rules and Procedures, supra note 26, Rule 2A, 
Section 1A, and Addendum B, Section 1.B.1.
    \233\ See, e.g., id., Rule 15, Section 2.
---------------------------------------------------------------------------

    In addition to managing the risk of member default, clearing 
agencies also take steps to mitigate the risks generated by member 
default. For example, in the normal course of business, CCPs are not 
exposed to market or liquidity risk because they expect to receive 
every security from a seller they are obligated to deliver to a buyer 
and they expect to

[[Page 69267]]

receive every payment from a buyer that they are obligated to deliver 
to a seller. However, when a clearing member defaults, the CCP can no 
longer expect the defaulting member to deliver securities or make 
payments. CCPs mitigate this risk by requiring clearing members to make 
contributions of financial resources to the CCP. The level of financial 
resources CCPs require clearing members to post may be based on, among 
other things, the market and liquidity risk of a member's portfolio, 
the correlation between the assets in the member's portfolio and the 
member's own default probability, and the liquidity of the collateral 
assets.
2. Market Participants--Investors, Broker-Dealers, and Custodians
    As discussed in Part II.A.3., broker-dealers serve both retail and 
institutional customers. Aggregate statistics from the Board of 
Governors of the Federal Reserve System suggest that at the end of 
2015, U.S. households held approximately 39% of the value of corporate 
equity outstanding, and 50% of the value of mutual fund shares 
outstanding, which provide a general picture of the share of holdings 
by retail investors.\234\
---------------------------------------------------------------------------

    \234\ See Board of Governors of the Federal Reserve System, 
Statistical Release Z.1 Financial Accounts of the United States, 
Flow of Funds, Balance Sheets, and Integrated Macroeconomic 
Accounts, at tables L.223 and L.224 (First Quarter 2016), https://www.federalreserve.gov/releases/z1/20151210/z1.pdf.
---------------------------------------------------------------------------

    In the fourth quarter of 2015, approximately 4,100 broker-dealers 
filed FOCUS Reports \235\ with FINRA. These firms varied in size, with 
median assets of approximately $700,000 and average assets of nearly $1 
billion dollars. Approximately 30 broker-dealers held 80% of the assets 
of broker-dealers overall, indicating a high degree of concentration in 
the industry. Of the 4,100 filers, 186 reported self-clearing public 
customer accounts, while 1,497 reported acting as an introducing broker 
and sending orders to another broker-dealer for clearing. Broker-
dealers that identified themselves as self-clearing broker-dealers, on 
average, had higher total assets than broker-dealers that identified 
themselves as introducing broker-dealers. While the decision to self-
clear may be based on many factors, this evidence is consistent with 
the argument that there may currently be high barriers to entry for 
providing clearing services as a broker-dealer.
---------------------------------------------------------------------------

    \235\ FOCUS Reports, or ``Financial and Operational Combined 
Uniform Single'' Reports, are monthly, quarterly, and annual reports 
that broker-dealers generally are required to file with the 
Commission and/or SROs pursuant to Exchange Act Rule 17a-5, 17 CFR 
240.17a-5.
---------------------------------------------------------------------------

    Clearing broker-dealers face liquidity risks as they are obligated 
to make payments to clearing agencies on behalf of customers who 
purchase securities. As discussed in more detail below, from the 
perspective of clearing broker-dealers, customers have an option to 
default on their payment obligations, particularly when the price of a 
purchased security declines during the settlement cycle.\236\ 
Therefore, clearing broker-dealers take measures to reduce the risks 
posed by their customers. For example, clearing broker-dealers may 
require customers to contribute financial resources in the form of 
margin to margin accounts, to pre-fund purchases in cash accounts, or 
may restrict the use of unsettled funds. These measures are in many 
ways analogous to measures taken by clearing agencies to reduce and 
mitigate the risks posed by their clearing members. In addition, 
clearing broker-dealers may also mitigate the risks posed by customers 
by charging higher transaction fees that reflect the value of the 
customer's option to default, thereby causing customers to internalize 
the cost of the default options inherent in the settlement 
process.\237\ While not directly reducing the risk posed by customers 
to clearing members, these higher transaction fees at least allocate to 
customers the direct expected costs of customer default.
---------------------------------------------------------------------------

    \236\ See id.
    \237\ See infra Part VI.C.2. and Part VI.C.4.
---------------------------------------------------------------------------

    Another way the settlement cycle may affect transaction prices is 
related to the use of funds during the settlement cycle. To the extent 
that buyers may use the cash to purchase securities during the 
settlement cycle for other purposes, they may derive value from the 
length of time it takes to settle a transaction. Testing this 
hypothesis, studies have found that sellers demand compensation for the 
benefit that buyers receive from deferring payment during the 
settlement cycle and that this compensation is incorporated in equity 
returns.\238\
---------------------------------------------------------------------------

    \238\ See Victoria Lynn Messman, Securities Processing: The 
Effects of a T+3 System on Security Prices (May 2011) (Ph.D. 
dissertation, University of Tennessee--Knoxville), https://trace.tennessee.edu/utk_graddiss/1002/; Josef Lakonishok & Maurice 
Levi, Weekend Effects on Stock Returns: A Note, 37 J. Fin. 883 
(1982), https://www.jstor.org/stable/pdf/2327716.pdf; Ramon P. 
DeGennaro, The Effect of Payment Delays on Stock Prices, 13 J. Fin. 
Res. 133 (1990), https://onlinelibrary.wiley.com/doi/10.1111/j.1475-6803.1990.tb00543.x/abstract.
---------------------------------------------------------------------------

    The settlement process also exposes investors to certain risks. The 
length of the settlement cycle sets the minimum amount of time between 
when an investor places an order to sell securities and when the 
customer can expect to have access to the proceeds of that sale. 
Investors take this into account when they plan transactions to meet 
liquidity needs. For example, under T+3 settlement, investors who 
experience liquidity shocks, such as unexpected expenses that must be 
met within two days, could not rely on obtaining funding solely through 
a sale of securities because the proceeds of the sale would be 
available in three days, at the earliest, and not two. One possible 
strategy to deal with such a shock under T+3 settlement would be to 
borrow cash on day two to meet payment obligations on day two and repay 
the loan on day three with the proceeds from a sale of securities, 
incurring the cost of one day of interest on the short-term loan. 
Another strategy that investors may use is to hold financial resources 
to insure themselves from liquidity shocks.
3. Investment Companies
    As noted above,\239\ shares issued by investment companies settle 
on different timeframes. ETFs and certain closed-end funds generally 
settle on T+3. By contrast, mutual funds generally settle on a T+1 
basis, except for certain retail funds which settle on T+3. Mutual 
funds that settle on a T+1 basis currently face liquidity risk as a 
result of a mismatch between the timing of mutual fund transaction 
order settlements and the timing of fund portfolio security transaction 
order settlements. Mutual funds may manage these particular liquidity 
needs by, among other methods, using cash reserves, back-up lines of 
credit, or interfund lending facilities to provide cash to cover the 
settlement mismatch.\240\ As of the end of 2015, there were 9,156 open-
end funds (excluding money market funds, but including ETFs).\241\ The 
assets of these funds were approximately $14.95 trillion.\242\ Within 
these figures, there were 1,521 ETFs with $2.1 trillion in assets.\243\
---------------------------------------------------------------------------

    \239\ See supra note 11.
    \240\ See Open-End Fund Liquidity Risk Management Programs; 
Swing Pricing; Re-Opening of Comment Period for Investment Company 
Reporting Modernization Release, Investment Company Act Release No. 
31835 (Sept. 22, 2015), 80 FR 62274, 62285 n.100 (Oct. 15, 2015).
    \241\ See ICI, 2015 Investment Company Fact Book (2016), at 176, 
183 (``2016 ICI Fact Book''), https://www.ici.org/pdf/2016_factbook.pdf.
    \242\ See id. at 174, 182.
    \243\ See id. at 182-83.
---------------------------------------------------------------------------

    Under Section 22(e) of the Investment Company Act, an open-end fund 
is required to pay shareholders who tender shares for redemption within 
seven days

[[Page 69268]]

of their tender.\244\ In addition to this requirement, as a practical 
matter open-end funds that are sold through broker-dealers meet 
redemptions within three days because broker-dealers are subject to 
Rule 15c6-1(a). Furthermore, Rule 22c-1 under the Investment Company 
Act,\245\ the ``forward pricing'' rule, requires funds, their principal 
underwriters, and dealers to sell and redeem fund shares at a price 
based on the current NAV next computed after receipt of an order to 
purchase or redeem fund shares, even though cash proceeds from 
purchases may be invested or fund assets may be sold in subsequent days 
in order to satisfy purchase requests or meet redemption obligations.
---------------------------------------------------------------------------

    \244\ See 15 CFR 270.80a-22(e).
    \245\ 17 CFR 270.22c-1.
---------------------------------------------------------------------------

4. The Current Market for Clearance and Settlement Services
    As described in Part II.A.2., two affiliated entities, NSCC and 
DTC, facilitate clearance and settlement activities in U.S. securities 
markets in most instances. There is limited competition in the 
provision of the services that these entities provide. NSCC is the CCP 
for trades between broker-dealers involving equity securities, 
corporate and municipal debt, and UITs for the U.S. market. DTC is the 
CSD that provides custody and book-entry transfer services for the vast 
majority of securities transactions in the U.S. market involving 
equities, corporate and municipal debt, money market instruments, ADRs, 
and ETFs. There is also limited competition in the provision of 
Matching/ETC services--three entities that have obtained exemptions 
from registration as a clearing agency from the Commission to operate 
as Matching/ETC Providers.\246\
---------------------------------------------------------------------------

    \246\ See supra note 45.
---------------------------------------------------------------------------

    Broker-dealers compete to provide services to retail and 
institutional customers. Based on the large number of broker-dealers, 
there is likely a high degree of competition among broker-dealers. 
However, the markets that broker-dealers serve may be segmented along 
lines relevant for the analysis of competitive impacts of the proposed 
amendment to Rule 15c6-1(a). As noted above, the set of broker-dealers 
that indicate they clear public customer accounts by self-clearing 
tends to be smaller than the set of broker-dealers that indicate they 
do so by introducing and not self-clearing. This could mean that 
introducing broker-dealers compete more intensively for customers than 
clearing broker-dealers. Further, clearing broker-dealers must meet 
requirements set by NSCC and DTC, such as financial responsibility 
requirements and clearing fund requirements. These requirements may 
represent barriers to entry for clearing broker-dealers, limiting 
competition among these entities.
    Competition for customers impacts how the costs associated with the 
clearance and settlement process are allocated among market 
participants. In managing the expected costs of risks from their 
customers and the costs of compliance with SRO and Commission rules, 
clearing broker-dealers decide what fraction of these costs to pass 
through to their customers in the form of fees and margin requirements, 
and what fraction of these costs to bear themselves. The level of 
competition that a clearing broker-dealer faces for customers will 
dictate the extent to which it is able to exercise market power in 
passing through these costs to their customers; a clearing broker-
dealer with little competition for customers is likely to pass on a 
majority of its costs to its customers, while one with heavy 
competition is likely to choose to bear the cost internally to avoid 
losing market share.
    In addition, several factors impact the current levels of 
efficiency and capital formation in this market. First, at a general 
level, market participants occupying various positions in the clearance 
and settlement system must post or hold liquid financial resources, and 
the level of these resources is a function of the length of the 
settlement cycle. For example, NSCC collects clearing fund 
contributions from members to ensure that it has sufficient financial 
resources in the event that one of its members defaults on its 
obligations to NSCC. As discussed above, the length of the settlement 
cycle is one determinant of the size of NSCC's exposure to clearing 
members. As another example, mutual funds may manage liquidity needs 
by, among other methods, using cash reserves, back-up lines of credit, 
or interfund lending facilities to provide cash. These liquidity needs, 
in turn, are related to the mismatch between the timing of mutual fund 
transaction order settlements and the timing of fund portfolio security 
transaction order settlements.
    Holding liquid assets solely for the purpose of mitigating 
counterparty risk or liquidity needs that arise as part of the 
settlement process could represent an allocative inefficiency, as 
discussed above, both because firms that are required to hold these 
assets might prefer to put them to alternative uses and because these 
assets may be more efficiently allocated to other market participants 
who value them for their fundamental risk and return characteristics 
rather than for their collateral value. To the extent that 
intermediaries bear costs as a result of inefficient allocation of 
collateral assets, these may be reflected in transaction costs.
    The settlement cycle may also have more direct impacts on 
transaction costs. As noted above, clearing broker-dealers may charge 
higher transaction fees to reflect the value of the customer's option 
to default and these fees may cause customers to internalize the cost 
of the default options inherent in the settlement process. However, 
these fees also make transactions costly and may, at the margin, 
influence the willingness of market participants to efficiently share 
risks or to supply liquidity to securities markets. Taken together, 
inefficiencies in the allocation of resources and risks across market 
participants may serve to impair capital formation.
    Finally, market participants may make processing errors in the 
clearance and settlement process.\247\ Industry participants have 
commented that a lack of automation and manual processing have led to 
processing errors. Although some of these errors may be resolved within 
the settlement cycle and not result in a failed trade, those that are 
not may result in failed trades, which appear in the failure to deliver 
data above.\248\ Further, market participants may incorporate the 
likelihood that processing errors result in delays in payments or 
deliveries into securities prices.\249\ Although errors and the 
correction of errors are a part of current market practices in a 
clearance and settlement system, the Commission does not have data 
available to estimate the rate of processing errors and the time needed 
to correct these processing errors, but invites commenters to provide 
relevant qualitative and quantitative information to inform our 
analysis of these errors.
---------------------------------------------------------------------------

    \247\ See, e.g., Omgeo, Mitigating Operational Risk and 
Increasing Settlement Efficiency through Same Day Affirmation (SDA), 
at 12 (Oct. 2010), https://www.omgeo.com/page/sda_whitepaper.
    \248\ See supra Part II.A.2(1); see also Statement by The 
Depository Trust & Clearing Corporation, U.S. Securities and 
Exchange Commission, Securities Lending and Short Sales Roundtable, 
at 3 (Sept. 30, 2009), https://www.sec.gov/comments/4-590/4590-32.pdf.
    \249\ See Messman, supra note 238.

---------------------------------------------------------------------------

[[Page 69269]]

C. Analysis of Benefits, Costs, and Impact on Efficiency, Competition, 
and Capital Formation

1. Benefits
    The proposed amendment is likely to yield benefits associated with 
the reduction of risk in the settlement cycle. By shortening the 
settlement cycle, the proposed amendment would reduce both the 
aggregate market value of all unsettled trades and the amount of time 
that CCPs or the counterparties to a trade may be subject to market and 
credit risk from an unsettled trade.\250\ First, holding transaction 
volumes constant, the market value of transactions awaiting settlement 
at any given point in time under a T+2 settlement cycle will be 
approximately one third lower than under a T+3 settlement cycle. In 
addition, given that most trades are novated and guaranteed by NSCC at 
midnight on T+1, unsettled trades are currently guaranteed for two 
days. Shortening the settlement cycle by one day would reduce the time 
that unsettled transactions are guaranteed by NSCC by approximately one 
half. Using the risk mitigation framework described in Part VI.B.1., 
based on published statistics from the last quarter of 2015 \251\ and 
holding average dollar volumes constant, the aggregate notional value 
of unsettled transactions at NSCC would fall from nearly $52.3 billion 
to approximately $26.2 billion.\252\
---------------------------------------------------------------------------

    \250\ See supra Part III.A.3.
    \251\ See Q4 2015 Fixed Income Clearing Corporation and NSCC 
Quantitative Disclosure for Central Counterparties, supra note 229, 
at 14.
    \252\ See supra note 230. Calculated as $52.32 billion/2 days = 
$26.16 billion.
---------------------------------------------------------------------------

    Second, a market participant that experiences counterparty default 
and enters into a new transaction under a T+3 settlement cycle is 
exposed to more market risk than would be the case under a T+2 
settlement cycle. As a result, market participants that are exposed to 
market, credit, and liquidity risks would be exposed to less risk under 
a T+2 settlement cycle. This reduction in risk may also extend to 
mutual fund transactions conducted with broker-dealers that currently 
settle on a T+3 basis.\253\ To the extent that these transactions 
currently give rise to counterparty risk exposures between mutual funds 
and broker-dealers, these exposures may decrease as a consequence of a 
shorter settlement cycle.
---------------------------------------------------------------------------

    \253\ See supra note 11 and Part VI.B.3, and infra Part VI.C.1.
---------------------------------------------------------------------------

    The Commission notes that industry participants have suggested 
further benefits of a T+2 standard settlement cycle relative to a T+3 
standard settlement cycle as a result of reduced procyclicality of 
counterparty exposures and clearing fund requirements, and presented an 
analysis consistent with such benefits.\254\ These benefits depend on 
the assumptions that underlie models of counterparty exposures and 
clearing fund requirements.
---------------------------------------------------------------------------

    \254\ See DTCC Recommends Shortening the U.S. Trade Settlement 
Cycle, supra note 76, at 2-3.
---------------------------------------------------------------------------

    A portion of the savings by intermediaries from less costly risk 
management under a T+2 standard settlement cycle relative to a T+3 
standard settlement cycle may flow through to investors. Intermediaries 
such as broker-dealers may mitigate settlement risks through collateral 
requirements on their customers in the form of securities or cash. Such 
protection is likely to require less collateral to manage settlement 
risks when settlement cycles are shorter. To the extent that lower 
collateral needs result in lower collateral requirements, investors may 
be able to profitably redeploy financial resources once used to satisfy 
collateral requirements by, for example, converting them into less-
liquid assets that offer higher returns in exchange for bearing 
additional liquidity risk.
    Industry participants might also individually benefit through 
reduced clearing fund deposit requirements. In 2012, the BCG Study 
estimated that cost reductions related to reduced clearing fund 
contributions would amount to $25 million per year.\255\ In addition, a 
shorter settlement cycle might reduce liquidity risk by allowing 
investors to obtain the proceeds of their securities transactions 
sooner. Reduced liquidity risk may be a benefit to individual 
investors, but it may also reduce the volatility of securities markets 
by reducing liquidity demands in times of adverse market conditions, 
potentially reducing the correlation between market prices and the risk 
management practices of market participants.\256\
---------------------------------------------------------------------------

    \255\ See BCG Study, supra note 107, at 10.
    \256\ See Peter F. Christoffersen & Francis X. Diebold, How 
Relevant is Volatility Forecasting for Financial Risk Management?, 
82 Rev. Econ. & Stat. 12 (2000), https://www.mitpressjournals.org/doi/abs/10.1162/003465300558597#.V6xeL_nR-JA. The paper shows that 
volatility can be predicted in the short run, and concludes that 
short run forecastable volatility would be useful for risk 
management practices.
---------------------------------------------------------------------------

    In addition, the harmonization of settlement cycles may reduce the 
need for some market participants engaging in cross-border and cross-
asset transactions to hedge risks stemming from mismatched settlement 
cycles, resulting in additional benefits. For example, under the 
current T+3 settlement cycle, a market participant selling a security 
in U.S. equity markets to fund a purchase of securities in European 
markets would face a one day lag between settlement in Europe and 
settlement in the U.S. The participant could choose between bearing an 
additional day of market risk in the European trading markets by 
delaying the purchase by a day, or funding the purchase of European 
shares with short-term borrowing. Additionally, because the FX market 
has a T+2 settlement cycle,\257\ the participant would also be faced 
with a choice between bearing an additional day of currency risk due to 
the need to purchase Euros as part of the transaction, or to incur the 
cost related to hedging away this risk in the forward market. 
Synchronization of settlement cycles across U.S. equity markets, 
currency markets, and European equity markets and other markets would 
remove the need for market participants to bear additional risk or 
incur costs related to borrowing or hedging risks.
---------------------------------------------------------------------------

    \257\ See, e.g., John W. McPartland, Foreign exchange trading 
and settlement: Past and present, The Federal Reserve Bank of 
Chicago, Essays on Issues No. 223 (Feb. 2006), https://
www.chicagofed.org/~/media/publications/chicago-fed-letter/2006/
cflfebruary2006-223-pdf.pdf.
---------------------------------------------------------------------------

    The benefits of harmonized settlement cycles may also accrue to 
mutual funds. As described above,\258\ transactions in mutual fund 
shares typically settle on a T+1 basis even when transactions in their 
portfolio securities settle on a T+3 basis. As a result, there is a 
two-day mismatch between when these funds make payments to shareholders 
that redeem shares and when they receive cash proceeds for portfolio 
securities they sell. This mismatch represents a source of liquidity 
risk for mutual funds. Shortening the settlement cycle by one day will 
reduce the length of this mismatch. As a result, mutual funds that 
settle on a T+1 basis may be able to reduce the size of cash reserves 
or the size of back up credit facilities that some currently use to 
manage liquidity risk from the mismatch in settlement cycles.
---------------------------------------------------------------------------

    \258\ See supra note 9 and Part VI.B.3.
---------------------------------------------------------------------------

    The Commission preliminarily believes that these benefits are 
unlikely to be substantially mitigated by the exceptions to Rule 15c6-
1(a) discussed in Part III.A.1. Market participants that rely on Rule 
15c6-1(b) in order to transact in limited partnership interests that 
are not listed on an exchange or for which quotations are not 
disseminated through an automated quotation system of a registered 
securities association are likely to continue to make use of that 
exception under the proposed amendment to Rule 15c6-1(a). Similarly, 
market participants involved

[[Page 69270]]

in offerings that currently settle by the fourth business day under 
Rule 15c6-1(c) will likely continue to settle by T+4. There may be 
transactions covered by Rules 15c6-1(b) and (c) that in the past did 
not make use of these exceptions because they settled within three 
business days, but that may require use of these exceptions under the 
proposed amendment because they require more than two days to settle. 
However, these markets are opaque and the Commission does not have data 
on transactions in these categories that currently settle within three 
days but that might make use of this exception under the proposed 
amendment. In addition, market participants involved in transactions 
which now voluntarily settle in two days or less may experience fewer 
risk reduction benefits as a result of the proposed amendment to Rule 
15c6-1(a) than market participants that currently settle in the 
standard three business days.
    Finally, the extent to which different types of market participants 
experience any benefits that stem from the proposed amendment to Rule 
15c6-1(a) may depend on their market power. As shown in the discussion 
and diagrams above,\259\ the clearance and settlement system involves a 
number of intermediaries that provide a range of services between the 
ultimate buyer and seller of a security. Those market participants that 
have a greater ability to negotiate with customers or service providers 
may be able to retain a larger portion of the operational cost savings 
from a shorter settlement cycle than others, as they may be able to use 
their market power to avoid passing along the cost savings to their 
clients.
---------------------------------------------------------------------------

    \259\ See supra Part II.A.3. for diagrams of retail and 
institutional trade settlement flow.
---------------------------------------------------------------------------

2. Costs
    The Commission preliminarily believes that compliance with a T+2 
standard settlement cycle will involve initial fixed costs to update 
systems and processes.\260\ While the Commission does not have all of 
the data necessary to form its own estimates of the costs of updates to 
systems and processes, the Commission has used inputs provided by 
industry studies discussed in this release to quantify these costs to 
the extent possible in Part VI.C.5.
---------------------------------------------------------------------------

    \260\ Industry estimates have suggested some updates to systems 
and processes might yield operational cost savings after the initial 
update. See infra Part VI.C.5.a. for industry estimates of the costs 
and benefits of the proposed amendment to Rule 15c6-1(a).
---------------------------------------------------------------------------

    The operational cost burdens associated with the proposed amendment 
to Rule 15c6-1(a) for different market participants might vary 
depending on each participant's degree of direct or indirect inter-
connectivity to the clearance and settlement process, regardless of 
size.\261\ For example, market participants that internally manage more 
of their own post-trade processes will directly incur more of the 
upfront operational costs associated with the proposed amendment to 
Rule 15c6-1(a), because they must directly undertake more of the 
upgrades and testing necessary for a T+2 standard settlement cycle. As 
mentioned in Part II.A.2.c., other market participants might outsource 
the clearance and settlement of their transactions to third-party 
providers of back-office services. The exposures to the operational 
costs associated with shortening the standard settlement cycle will be 
indirect to the extent that third-party service providers pass through 
the costs of infrastructure upgrades to their customers. The degree to 
which customers bear operational costs depends on their bargaining 
position relative to third-party providers. Large customers with market 
power may be able to avoid internalizing these costs, while small 
customers in a weaker negotiation position relative to service 
providers may bear the bulk of these costs.
---------------------------------------------------------------------------

    \261\ See infra Part VI.C.5.b. for more detail of the specific 
operational cost burdens that each type of market participant may 
incur.
---------------------------------------------------------------------------

    Further, changes to initial and ongoing operational costs may make 
some self-clearing market participants alter their decision to continue 
internally managing the clearance and settlement of their transactions. 
Entities that currently internally manage their clearance and 
settlement activity may prefer to restructure their businesses to rely 
instead on third-party providers of clearance and settlement services 
that may be able to amortize the initial fixed cost of upgrade across a 
much larger volume of transaction activity.
    The way that different market participants are likely to bear costs 
as a result of the proposed amendment to Rule 15c6-1(a) may also vary 
based on their business structure. For example, a shorter standard 
settlement cycle will require payment for securities that settle 
regular-way by T+2 rather than T+3 (subject to the exceptions in the 
rule). Generally, regardless of current funding arrangements between 
investors and broker-dealers, removing a day between execution and 
settlement would mean that broker-dealers could choose between 
requiring investors to fund the purchase of securities one day earlier 
while extending the same level of credit they do under T+3 settlement, 
or providing an additional day of funding to investors. In other words, 
broker-dealers could pass through some of the costs of a shorter 
standard settlement cycle by imposing the same shorter cycle on 
investors, or they could pass these costs on to investors by raising 
transactions fees to compensate for the additional day of funding the 
broker-dealer may choose to provide. The extent to which these costs 
get passed through to customers may depend on, among other things, the 
market power of the broker-dealer. At most, the broker-dealer might 
pass through the entire initial investment cost to its customers, while 
if the broker-dealer faces perfect competition for its customers, the 
broker-dealer may not pass along any of these costs to its 
customers.\262\
---------------------------------------------------------------------------

    \262\ See supra Part VI.C.1. for more on the impact of broker-
dealer market power. See infra Part VI.C.5.b.3. for quantitative 
estimates of the costs to broker-dealers.
---------------------------------------------------------------------------

    However, broker-dealers that predominantly serve retail investors 
may experience the burden of an earlier payment requirement differently 
from broker-dealers with more institutional clients or large custodian 
banks because of the way retail investors fund their accounts. Retail 
investors may find it difficult to accelerate payments associated with 
their transactions, which may cause broker-dealers who are unwilling to 
extend additional credit to retail investors to instead require that 
these investors pre-fund their transactions.\263\ These broker-dealers 
may also experience costs unrelated to funding choices. For instance, 
retail investors may require additional or different services such as 
education regarding the impact of the shorter standard settlement 
cycle.
---------------------------------------------------------------------------

    \263\ See infra Part VI.C.5.b.(3) for more on retail investors 
and their broker-dealers.
---------------------------------------------------------------------------

    At the same time, some market participants may face lower 
implementation costs as a result of their current business structure 
and practices. As mentioned earlier, 2011 DTCC affirmation data show 
that, on average, 45% of trades were affirmed on trade date, while 90% 
were affirmed on T+1.\264\ In addition, market participants that trade 
in markets that have already implemented a T+2 settlement cycle may 
face lower costs in transitioning to a T+2 cycle in the U.S., as many 
of the systems and process improvements may already have been adopted 
in order to support settlement in other markets.
---------------------------------------------------------------------------

    \264\ See supra Part VI.C.5(5) for discussion of foreign broker-
dealers.
---------------------------------------------------------------------------

    Finally, a shorter settlement cycle may result in higher costs 
associated with liquidating a defaulting member's position, as a 
shorter horizon may result

[[Page 69271]]

in larger price impacts, particularly for less liquid assets. For 
example, when a clearing member defaults, NSCC is obligated to fulfill 
its trade guaranty with the defaulting member's counterparty. One way 
it accomplishes this is by liquidating assets from clearing fund 
contributions from clearing members. However, the liquidation of assets 
in a short period of time may have an adverse impact on the price of an 
asset. Shortening the standard settlement cycle from three days to two 
days would reduce the amount of time that NSCC would have to liquidate 
its assets, which may exacerbate the price impact of liquidation.
3. Economic Implications Through Other Commission Rules
    In Part 0., the Commission noted that the proposed amendment to 
Rule 15c6-1(a), by shortening the standard settlement cycle, could have 
ancillary consequences for how market participants comply with existing 
regulatory obligations that relate to the settlement timeframe. The 
Commission also provided illustrative examples of specific Commission 
rules that include such requirements or are otherwise are keyed-off of 
settlement date, including Regulation SHO,\265\ and certain provisions 
included in the Commission's financial responsibility rules.\266\
---------------------------------------------------------------------------

    \265\ 17 CFR 242.200 et seq.
    \266\ See supra Part III.B.3.
---------------------------------------------------------------------------

    Financial markets and regulatory requirements have evolved 
significantly since the Commission adopted Rule 15c6-1 in 1993. Market 
participants have responded to these developments in diverse ways, 
including implementing a variety of systems and processes, some of 
which may be unique to the market participant and its business, and 
some of which may be integrated throughout the market participant's 
operations. Because of the broad variety of ways in which market 
participants currently satisfy regulatory obligations pursuant to 
Commission rules, in most circumstances it is difficult to identify 
with precision those practices that market participants will need to 
change in order to meet these other obligations. Under these 
circumstances, and without additional information, the Commission is 
unable to provide an estimate of these ancillary economic consequences. 
The Commission invites commenters to provide quantitative and 
qualitative information about these potential economic consequences.
    In certain cases, based on information about current market 
practices, the Commission preliminarily believes that the proposed 
amendment to Rule 15c6-1(a) is unlikely to change the means by which 
market participants comply with existing regulatory requirements. For 
example, under the proposed amendment, broker-dealers will have a 
shorter timeframe to comply with the customer confirmation requirements 
of Rule 10b-10. However, it is the Commission's understanding that 
broker-dealers typically send physical customer confirmations on the 
day after trade date and many broker-dealers send electronic 
confirmations to customers on trade date. The Commission preliminarily 
believes that because of the lack of ancillary consequences in these 
cases, market participants are unlikely to bear additional costs to 
comply with these requirements under a shorter standard settlement 
cycle.
    In certain cases, however, the proposed amendment may incrementally 
increase the costs associated with complying with other Commission 
rules where those rules potentially require broker-dealers to engage in 
purchases of securities. Two examples of these types of rules are 
Regulation SHO and the Commission's financial responsibility rules. In 
most instances, Regulation SHO governs the timeframe in which a 
``participant'' of a registered clearing agency must close out a fail 
to deliver position by purchasing or borrowing securities. Similarly, 
some of the Commission's financial responsibility rules relate to 
actions or notifications that reference the settlement date of a 
transaction. For example, Rule 15c3-3(m) \267\ uses settlement date to 
prescribe the timeframe in which a broker-dealer must complete certain 
sell orders on behalf of customers. As noted above, settlement date is 
also incorporated into paragraph (c)(9) of Rule 15c3-1,\268\ which 
explains what it means to ``promptly transmit'' funds and ``promptly 
deliver'' securities within the meaning of paragraphs (a)(2)(i) and 
(a)(2)(v) of Rule 15c3-1. As explained above, the concepts of promptly 
transmitting funds and promptly delivering securities are incorporated 
in other provisions of the financial responsibility rules.\269\ Under 
the proposed amendment to Rule 15c6-1(a), the timeframes included in 
these rules will be one day closer to the trade date.
---------------------------------------------------------------------------

    \267\ 17 CFR 240.15c3-3(m).
    \268\ 17 CFR 240.15c3-1(c)(9).
    \269\ See, e.g., 17 CFR 240.15c3-1(a)(2)(i), (a)(2)(v); 17 CFR 
240.15c3-3(k)(1)(iii), (k)(2)(i), (k)(2)(ii); 17 CFR 240.17a-
5(e)(1)(A); 17 CFR 240.17a-13(a)(3).
---------------------------------------------------------------------------

    The Commission preliminarily believes that shortening these 
timeframes will not materially affect the costs that broker-dealers are 
likely to incur to meet their Regulation SHO obligations and 
obligations under the Commission's financial responsibility rules after 
the settlement date. Nevertheless, the Commission acknowledges that a 
shorter settlement cycle could affect the processes by which broker-
dealers manage the likelihood of incurring these obligations. For 
example, broker-dealers may currently have in place inventory 
management systems that help them avoid failing to deliver securities 
by T+3. Broker-dealers may incur incremental costs in order to update 
these systems to support a shorter settlement cycle.
    In cases where market participants will need to adjust the way in 
which they comply with other Commission rules, the magnitude of the 
costs associated with these adjustments is difficult to quantify. As 
noted above, market participants employ a wide variety of strategies to 
meet regulatory obligations. For example, broker-dealers may ensure 
that they have securities available to meet their obligations by using 
inventory management systems or they may choose instead to borrow 
securities. An estimate of costs is further complicated by the 
possibility that market participants could change their compliance 
strategies as a result of shortening the standard settlement cycle.
    The Commission invites commenters to provide quantitative and 
qualitative information about the impact of the proposed amendment to 
Rule 15c6-1(a) on the costs associated with compliance with other 
Commission rules.
4. Effect on Efficiency, Competition, and Capital Formation
    A shorter settlement cycle might improve the efficiency of the 
clearance and settlement process through several channels. The 
Commission preliminarily believes that the primary effect that a 
shorter settlement cycle would have on the efficiency of the settlement 
process would be a reduction in the credit, market, and liquidity risks 
that broker-dealers, CCPs, and other market participants are subject to 
during the standard settlement cycle. A shorter standard settlement 
cycle will generally reduce the volume of unsettled transactions that 
could potentially pose settlement risk to counterparties. By shortening 
the period between trade execution and settlement, trades can be

[[Page 69272]]

settled with less aggregate risk to counterparties or the CCP. A 
shorter standard settlement cycle may also decrease liquidity risk by 
enabling market participants to access the proceeds of their 
transactions sooner, which may reduce the cost market participants 
incur to handle idiosyncratic liquidity shocks (i.e., liquidity shocks 
that are uncorrelated with the market). That is, because the time 
interval between a purchase/sale of securities and payment is reduced 
by one day, market participants with immediate payment obligations that 
they could cover by selling securities would be required to obtain 
short-term funding for one less day.\270\ As a result of reduced cost 
associated with covering their liquidity needs, market participants 
may, under particular circumstances, be able to shift assets that would 
otherwise be held as liquid collateral towards more productive uses, 
improving allocative efficiency.\271\
---------------------------------------------------------------------------

    \270\ See supra Part VI.B.2.
    \271\ See supra Part VI.A. for more on collateral and allocative 
efficiency.
---------------------------------------------------------------------------

    In addition, a shorter standard settlement cycle may increase price 
efficiency through its effect on credit risk exposures between 
financial intermediaries and their customers. In particular, a prior 
study noted that certain intermediaries that transact on behalf of 
investors, such as broker-dealers, may be exposed to the risk that 
their customers default on payment obligations when the price of 
purchased securities declines during the settlement cycle.\272\ As a 
result of the option to default on payment obligations, customers' 
payoffs from securities purchases resemble European call options and, 
from a theoretical standpoint, can be valued as such. Notably, the 
value of European call options are increasing in the time to maturity 
\273\ suggesting that the value of call options held by customers who 
purchase securities is increasing in the length of the settlement 
cycle. In order to compensate itself for the call option that it 
writes, an intermediary may include the cost of these call options as 
part of its transaction fee and this cost may become a component of 
bid-ask spreads for securities transactions. By reducing the value of 
customers' option to default by reducing the option's time to maturity, 
a shorter standard settlement cycle may reduce transaction costs in 
U.S. securities markets. In addition, to the extent that any benefit 
buyers receive from deferring payment during the settlement cycle is 
incorporated in securities returns,\274\ the proposed amendment may 
reduce the extent to which these returns deviate from returns 
consistent with changes to fundamentals.
---------------------------------------------------------------------------

    \272\ See Madhavan et al., supra note 222.
    \273\ All other things equal, an option with a longer time to 
maturity is more likely to be in the money given that the variance 
of the underlying security's price at the exercise date is higher.
    \274\ See supra Part Part VI.B.2.
---------------------------------------------------------------------------

    As discussed in more detail above, the Commission preliminarily 
believes that the proposed amendment to Rule 15c6-1(a) will likely 
require market participants to incur costs related to infrastructure 
upgrades and will likely yield benefits to market participants, largely 
in the form of reduced financial risks related to settlement. As a 
result, the Commission preliminarily believes that the proposed 
amendment to Rule 15c6-1(a) could affect competition in a number of 
different, and potentially offsetting, ways.
    The prospective reduction in financial risks related to shortening 
the standard settlement cycle may represent a reduction in barriers to 
entry for certain market participants. Reductions in the financial 
resources required to cover an NSCC member's clearing fund requirements 
that result from a shorter standard settlement cycle could encourage 
financial firms that currently clear transactions through NSCC clearing 
members to become clearing members themselves. Their entry into the 
market could promote competition among clearing members at NSCC. 
Furthermore, if a reduction in settlement risks results in lower 
transaction costs for the reasons discussed above, market participants 
that were, on the margin, discouraged from supplying liquidity to 
securities markets due to these costs could choose to enter the market 
for liquidity suppliers, increasing competition.
    At the same time, the Commission acknowledges that the process 
improvements required to enable a shorter standard settlement cycle 
could adversely affect competition. Among clearing members, where such 
process improvements might be necessary to comply with the shorter 
standard settlement cycle required under the proposed amendment to Rule 
15c6-1(a), the cost associated with compliance might create barriers to 
entry, because new firms will incur higher fixed costs associated with 
a shorter standard settlement cycle if they wish to enter the market. 
Clearing members might choose to comply by upgrading their systems and 
processes or may choose instead to exit the market for clearing 
services. The exit of clearing members could have negative consequences 
for competition between clearing members. Clearing activity tends to be 
concentrated among larger broker-dealers.\275\ Clearing member exit 
could result in further concentration and additional market power for 
those clearing members that remain.
---------------------------------------------------------------------------

    \275\ See id.
---------------------------------------------------------------------------

    Alternatively, some current clearing members may choose to comply 
by ceasing to be clearing members and instead outsourcing their 
operational needs to third-party service providers. Use of third-party 
service providers may represent a reasonable response to the 
operational costs associated with the proposed amendment to Rule 15c6-
1(a). To the extent that third-party service providers are able to 
spread the fixed costs of compliance across a larger volume of 
transactions than their clients, the Commission preliminarily believes 
that the use of third-party service providers might impose a smaller 
compliance cost on clearing members, including smaller broker-dealers, 
than if these firms directly bore the costs of compliance. The 
Commission preliminarily believes that this impact may stretch beyond 
just clearing members. The use of third-party service providers may 
mitigate the extent to which the proposed amendment to Rule 15c6-1(a) 
raises barriers to entry for broker-dealers. Because these barriers to 
entry may have adverse effects on competition between clearing members, 
we preliminarily believe that the use of third-party service providers 
may mitigate the adverse effects of the proposed amendment to Rule 
15c6-1(a) on competition between broker-dealers.
    Existing market power may also affect the distribution of 
competitive impacts stemming from the proposed amendment to Rule 15c6-
1(a) across different types of market participants. While, as noted 
above, reductions in settlement risk could promote competition among 
clearing members and liquidity suppliers, these groups may benefit to 
differing degrees, depending on the extent to which they are able to 
capture the benefits of a shortened standard settlement cycle. For 
example, clearing brokers tend to be larger than other broker-
dealers,\276\ and may generally be able to appropriate more of the 
savings from clearing fund deposit reductions for themselves if they 
have market power relative to their customers by passing only a small 
portion of savings through to their customers through fees or 
transactions costs. However, those that predominantly serve retail 
investors may be in a better bargaining position

[[Page 69273]]

relative to those that predominantly serve institutional investors, and 
therefore may capture more of the benefits stemming from the proposed 
amendment to Rule 15c6-1(a). Broker-dealers that serve retail investors 
may similarly be able to use their market power relative to their 
customers to retain more of the clearing fund deposit reduction as 
profits by maintaining their transaction costs and fees instead of 
passing these through to their customers. Institutional investors may 
be in a relatively better bargaining position by virtue of their large 
size and may be more likely to successfully negotiate lower fees or 
transaction costs and share in the savings associated with lower 
clearing fund deposits.
---------------------------------------------------------------------------

    \276\ Id.
---------------------------------------------------------------------------

    Finally, a shorter standard settlement cycle might also improve the 
capital efficiency of the clearance and settlement process, which would 
promote capital formation in U.S. securities markets and in the 
financial system generally.\277\ A shorter standard settlement cycle 
would reduce the amount of time that collateral must be held for a 
given trade, thus freeing the collateral to be used elsewhere earlier. 
For a given quantity of trading activity, collateral would be committed 
to clearing fund deposits for a shorter amount of time. The greater 
collateral efficiency promoted by a shorter settlement cycle might also 
indirectly promote capital formation for market participants in the 
financial system in general, because the improved capital efficiency of 
a shorter settlement cycle means that a given amount of collateral can 
support a larger amount of economic activity.
---------------------------------------------------------------------------

    \277\ See supra Part VI.A. and Part VI.C.4. for more discussion 
about capital formation and efficiency.
---------------------------------------------------------------------------

5. Quantification of Direct and Indirect Effects of a T+2 Settlement 
Cycle
    As mentioned previously, several industry groups have released cost 
estimates for compliance with a shorter standard settlement cycle, 
including the SIA, the ISC, and BCG. However, only the BCG Study 
performed a cost-benefit analysis of a T+2 standard settlement cycle. 
We first summarize the cost estimates in the BCG Study in the 
subsection immediately below and then, in the following subsections, we 
provide our own evaluation of these estimates as part of our discussion 
of the potential direct and indirect compliance costs related to the 
proposed amendment to Rule 15c6-1(a). In addition, the Commission 
encourages commenters to provide additional information to help 
quantify the economic effects that we are currently unable to quantify 
due to data limitations.
a. Industry Estimates of Costs and Benefits
    The BCG Study concluded that the transition to a T+2 settlement 
cycle would cost approximately $550 million in incremental initial 
investments across industry constituent groups,\278\ which would result 
in annual operating savings of $170 million and $25 million in annual 
return on reinvested capital from clearing fund reductions.\279\
---------------------------------------------------------------------------

    \278\ The BCG Study generally refers to ``institutional broker-
dealers,'' ``retail broker-dealers,'' ``buy side'' firms, and 
``custodian banks,'' without defining these particular groups. The 
Commission uses these terms when referring to estimates provided by 
the BCG Study but notes that its own definitions of various affected 
parties may differ from those in the BCG Study.
    \279\ See BCG Study, at 9-10.
---------------------------------------------------------------------------

    The BCG Study also estimated that the average level of required 
investments per firm could range from $1 to 5 million, with large 
institutional broker-dealers incurring the largest amount of 
investments on a per-firm basis, and buy side firms at the lower end of 
the spectrum.\280\ The investment costs for ``other'' entities, 
including DTCC, Omgeo, service bureaus, RIAs and non-self-clearing 
broker-dealers totaled $70 million for the entire group. Within this 
$70 million, DTCC and Omgeo were estimated to have a compliance cost of 
$10 million each. The operational cost savings per entity ranged from 
$30-55 million per year, with broker-dealers serving retail investors 
saving the largest absolute amount, and buy side firms saving the 
least. Custodian banks were estimated to save approximately $40 million 
per year.\281\
---------------------------------------------------------------------------

    \280\ Id. at 30-31.
    \281\ See id. at 41.
---------------------------------------------------------------------------

    The BCG Study also estimated the annual clearing fund reductions 
resulting from reductions in clearing firms' clearing funds 
requirements to be $25 million per year. The study estimated this by 
considering the reduction in clearing fund requirements and multiplied 
it by the average Federal Funds target rate for the 10-year period up 
until 2008 (3.5%). The BCG Study also estimated the value of the risk 
reduction in buy side exposure to the sell side. The implied savings 
were estimated to be $200 million per year, but these values were not 
included in the overall cost-benefit calculations.
    Several factors limit the usefulness of the BCG Study's estimates 
of potential costs and benefits of the proposed amendment to Rule 15c6-
1(a). First, technological improvements, such as the increased use of 
computers and automation in post-trade processes, that have been made 
since 2012, when the report was first published, may have reduced the 
cost of the upgrades necessary to comply with a shorter settlement 
cycle. While this may, in turn, reduce the costs associated with the 
proposed amendment, it may also reduce the scope of investments 
required by the proposed amendment,\282\ as a larger portion of market 
participants may have already adopted many processes that would reduce 
the cost of a transition to a T+2 settlement cycle. In addition, the 
BCG Study considered as a part of its cost estimates operational cost 
savings as a result of improvements to operational efficiency, which 
the Commission preliminarily considers an ancillary benefit of a 
shorter settlement cycle.
---------------------------------------------------------------------------

    \282\ See supra Part VI.A. While market participants may have 
already made investments consistent with implementing a shorter 
settlement cycle, the fact that these investments have not resulted 
in a shorter settlement cycle is consistent with the existence of 
coordination problems among market participants.
---------------------------------------------------------------------------

    Lastly, the BCG Study was premised on survey responses by a subset 
of market participants that may be affected by the rule--surveys were 
sent to 270 market participants and 70 responses were received, 
including 20 institutional broker-dealers, prime brokers and 
correspondent clearers; 12 retail broker-dealers; 17 buy side firms; 14 
registered investment advisors (RIAs); and seven custodian banks. Given 
the low response rate, as well as the uncertainty regarding the sample 
of market participants that was asked to complete the survey, we cannot 
conclude that the cost estimates in the BCG Study are representative of 
the costs of all market participants.\283\
---------------------------------------------------------------------------

    \283\ See BCG Study, supra note 103, at 15.
---------------------------------------------------------------------------

b. Commission Estimates of Costs
    The proposed amendment might generate direct and indirect costs for 
market participants, who may need to change multiple systems and 
processes to comply with a T+2 standard settlement cycle. As noted in 
Part II.A.5.c.(2), the T+2 Playbook included a timeline with milestones 
and dependencies necessary for a transition to a T+2 settlement cycle, 
as well as activities that market participants should consider in 
preparation for the transition. The Commission preliminarily believes 
that the majority of activities for migration to a T+2 settlement cycle 
will stem from behavior modification of market participants and systems 
testing, and thus the majority of the costs of

[[Page 69274]]

migration will be from labor.\284\ These modifications may include a 
compression of the settlement timeline, as well as an increase in the 
fees that brokers may impose on their customers for trade failures. 
Although the T+2 Playbook does not include any direct estimates of the 
compliance costs for a T+2 settlement cycle, we utilize the timeline in 
the T+2 Playbook for specific actions necessary to migrate to a T+2 
settlement cycle to directly estimate the inputs needed for migration, 
and form preliminary compliance cost estimates in the next section.
---------------------------------------------------------------------------

    \284\ See id. at 15.
---------------------------------------------------------------------------

    In addition, the T+2 Playbook, the ISC White Paper, and the BCG 
Study identify several categories of actions that market participants 
might need to take to comply with a T+2 settlement cycle--processing, 
asset servicing, and documentation.\285\ While the following cost 
estimates for these remedial activities span industry-wide requirements 
for a migration to a T+2 settlement cycle, we do not anticipate each 
market participant directly undertaking all of these activities for 
several reasons. First, as noted in Part II.A.2.c., some market 
participants work with third-party service providers for activities 
such as trade processing and asset servicing, and thus may only 
indirectly bear the costs of the requirements. Second, certain costs 
might only fall on specific categories of entities--for example, the 
costs of updating the CNS and ID Net system would only directly fall on 
NSCC, DTC, and members/participants of those clearing agencies. 
Finally, some market participants may already have the processes and 
systems in place to accommodate a T+2 settlement cycle or would be able 
to adjust to a T+2 settlement cycle with minimal cost. For example, 
some market participants may already have the systems and processes to 
reduce the amount of time needed for trade affirmation and 
matching.\286\ These market participants may thus bear a significantly 
lower cost to update their trade affirmation to comply with a T+2 
standard settlement cycle.\287\
---------------------------------------------------------------------------

    \285\ See T+2 Playbook, supra note 126, at 11.
    \286\ See BCG Study, supra note 107, at 23.
    \287\ The BCG Study, as it is based on survey responses from 
market participants, does reflect the heterogeneity of compliance 
costs for market participants. However, for reasons mentioned in 
Part VI.C.5.a., we are not able to fully accept the BCG Study's cost 
estimates.
---------------------------------------------------------------------------

    In the following section, we examine several categories of market 
participants and estimate the compliance costs for each category. Our 
estimate of the number and type of personnel is based on the scope of 
activities necessary for the participant to migrate to a T+2 settlement 
cycle, the participant's role within the clearance and settlement 
process, and the amount of testing required to ensure an error-free 
migration.\288\ Hourly salaries for personnel are from SIFMA's 
Management and Professional Earnings in the Securities Industry 
2013.\289\ Our estimates use the timeline from the T+2 Playbook to 
determine the length of time personnel would work on the activities 
necessary to support a T+2 settlement cycle. The timeline provides an 
indirect method to estimate the inputs necessary to migrate to a T+2 
settlement cycle, rather than relying directly on survey response 
estimates. We acknowledge many entities are already undertaking 
activities to support a migration to a T+2 settlement cycle in 
anticipation of the proposed amendment. However, to the extent that the 
costs of these activities have already been incurred, we consider these 
costs sunk, and do not include them in our analysis.
---------------------------------------------------------------------------

    \288\ For example, FMUs that play a critical role in the 
clearance and settlement infrastructure will require more testing 
associated with a T+2 settlement cycle than institutional investors.
    \289\ To monetize the internal costs, the Commission staff used 
data from SIFMA publications, modified by Commission staff to 
account for an 1800 hour work-year and multiplied by 5.35 
(professionals) or 2.93 (office) to account for bonuses, firm size, 
employee benefits and overhead. See SIFMA, Management and 
Professional Earnings in the Security Industry--2013 (Oct. 7, 2013), 
https://www.sifma.org/research/item.aspx?id=8589940603; SIFMA, Office 
Salaries in the Securities Industry--2013 (Oct. 7, 2013), https://www.sifma.org/research/item.aspx?id=8589940608. These figures have 
been adjusted for inflation using data published by the Bureau of 
Labor Statistics.
---------------------------------------------------------------------------

(1) FMUs--CCPs and CSDs
    CNS, NSCC/DTC's ID Net service, and other systems will require 
adjustment to support a T+2 standard settlement cycle. According to the 
T+2 Playbook and the ISC White Paper, regulation-dependent planning, 
implementation, testing, and migration activities associated with the 
transition to a T+2 settlement cycle could last up to five 
quarters.\290\ We preliminarily believe that these activities will 
impose a one-time compliance cost of $10.9 million \291\ for DTC and 
NSCC each. After this initial compliance cost, we preliminarily expect 
that both DTCC and NSCC will incur minimal ongoing costs from the 
transition to a T+2 settlement cycle, because we believe that the 
majority of costs will stem from pre-migration activities, such as 
implementation, updates, and testing.
---------------------------------------------------------------------------

    \290\ See T+2 Playbook, supra note 126, at 11. To monetize the 
internal costs, Commission staff used data from the SIFMA 
publications. Our time estimates account for the fact that a portion 
of the timeline has already elapsed in anticipation of a transition 
to a T+2 standard settlement cycle, and those costs are already 
sunk.
    \291\ The estimate is based on the T+2 Playbook timeline, which 
estimates regulation-dependent implementation activity, industry 
testing, and migration lasting five quarters. We assume 10 
operations specialists (at $129 per hour), 10 programmers (at $256 
per hour), and 1 senior operations manager (at $345/hour), working 
40 hours per week. (10 x $129 + 10 x $256 + 1 x $345) x 5 x 13 x 40 
= $10,907,000.
---------------------------------------------------------------------------

(2) Matching/ETC Providers--Exempt Clearing Agencies
    Matching/ETC Providers may need to adapt their trade processing 
systems to comply with a T+2 settlement cycle. This may include actions 
such as updating reference data, configuring trade match systems, and 
configuring trade affirmation systems to affirm trades by 12:00 p.m. on 
T+1. Matching/ETC Providers will also need to conduct testing and 
assess post-migration activities. We preliminarily estimate that these 
activities will impose a one-time compliance cost of up to $10.9 
million \292\ for each Matching/ETC Provider. However, we acknowledge 
that some ETC providers may have a higher cost burden than others based 
on the volume of transactions that they process. We expect that ETC 
providers will incur minimal ongoing costs after the initial transition 
to a T+2 settlement cycle because we preliminarily believe that the 
majority of the costs of migration to a T+2 settlement cycle entail 
behavioral changes of market participants and pre-migration testing.
---------------------------------------------------------------------------

    \292\ The estimate is based on the T+2 Playbook timeline, which 
estimates regulation-dependent implementation activity for trade 
systems, matching, affirmation, testing, and post-migration testing 
lasting five quarters. We assume 10 operations specialists (at $129 
per hour), 10 programmers (at $256 per hour), and 1 senior 
operations manager (at $345/hour), working 40 hours per week. (10 x 
$129 + 10 x $256 + 1 x $345) x 5 x 13 x 40 = $10,907,000.
---------------------------------------------------------------------------

(3) Market Participants--Investors, Broker-Dealers, and Custodians
    The overall compliance costs that a market participant incurs will 
depend on the extent to which it is directly involved in functions 
related to trade confirmation/affirmation, clearance and settlement, 
asset servicing, and other activities. For example, retail investors 
may bear few (if any) direct costs in a transition to a T+2 standard 
settlement cycle, because their respective broker-dealer handles the 
back-office functions of each transaction. However, as is discussed 
below, this does not imply that retail investors will not face indirect 
costs from the transition, such

[[Page 69275]]

as those passed through from broker-dealers or banks.
    Institutional investors may need to configure systems and update 
reference data, which may also include updates to trade funding and 
processing mechanisms, to operate in a T+2 environment. The Commission 
preliminarily estimates that this will require an initial expenditure 
of $2.32 million per entity.\293\ However, these costs may vary 
depending on the extent to which a particular institutional investor 
has already automated their trade processes. We preliminarily expect 
institutional investors will incur minimal ongoing direct compliance 
costs after the initial transition to a T+2 standard settlement cycle.
---------------------------------------------------------------------------

    \293\ The estimate is based on the T+2 Playbook timeline, which 
estimates regulation-dependent implementation activity for trade 
systems, reference data, and testing activity to last four quarters. 
We assume 2 operations specialists (at $129 per hour), 2 programmers 
(at $256 per hour), and 1 senior operations manager (at $345 per 
hour), working 40 hours per week. (2 x $129 + 2 x $256 + 1 x $345) x 
4 x 13 x 40 = $2,319,200.
---------------------------------------------------------------------------

    Broker-dealers that serve institutional investors will not only 
need to configure their trading systems and update reference data, but 
may also need to update trade confirmation/affirmation systems, 
documentation, cashiering and asset servicing functions, depending on 
the roles they assume with respect to their clients. We preliminarily 
estimate that, on average, each of these broker-dealers will incur an 
initial compliance cost of $4.72 million.\294\ We preliminarily expect 
that these broker-dealers will incur minimal ongoing direct compliance 
costs after the initial transition to a T+2 standard settlement cycle.
---------------------------------------------------------------------------

    \294\ The estimate is based on the T+2 Playbook timeline, which 
estimates regulation-dependent implementation activity for trade 
systems, reference data, documentation, asset servicing, and testing 
to last four quarters. We assume 5 operations specialists (at $129 
per hour), 5 programmers (at $256 per hour), and 1 senior operations 
manager (at $345 per hour), working 40 hours per week. (5 x $129 + 5 
x $256 + 1 x $345) x 4 x 13 x 40 = $4,721,600.
---------------------------------------------------------------------------

    Broker-dealers that serve retail investors may also need to spend 
significant resources to educate their clients about the shorter 
settlement cycle. We preliminarily estimate that these broker-dealers 
will incur an initial compliance cost of $8.6 million each.\295\ 
However, unlike previously mentioned market participants, we expect 
that broker-dealers that serve retail investors may face significant 
one-time compliance costs after the initial transition to T+2. Retail 
investors may require additional education and customer service, which 
may impose costs on their broker-dealers. The Commission preliminarily 
believes that a reasonable upper bound for the costs associated with 
this requirement is $30,000 per broker-dealer.\296\ Assuming all 
clearing and introducing broker-dealers must educate retail customers, 
the upper bound for the costs of retail investor education would be 
approximately $50.5 million.\297\
---------------------------------------------------------------------------

    \295\ The estimate is based on the T+2 Playbook timeline, which 
estimates regulation-dependent implementation activity for trade 
systems, reference data, documentation, asset servicing, customer 
education and testing to last five quarters. We assume 5 operations 
specialists (at $129 per hour), 5 programmers (at $256 per hour), 5 
trainers (at $208 per hour) and 1 senior operations manager (at $345 
per hour), working 40 hours per week. (5 x $129 + 5 x $256 + 5 x 
$208 + 1 x $345) x 5 x 13 x 40 = $8,606,000.
    \296\ This estimate is based on the assumption that a broker-
dealer chooses to educate customers using a 10-minute view that 
takes at most $3,000 per minute to produce. See Crowdfunding, 
Exchange Act Release No. 76324 (Oct. 30, 2015), 80 FR 71388, 71529 & 
n.1683 (Nov. 16, 2015).
    \297\ Calculated as $30,000 per broker-dealer x (186 broker-
dealers reporting as self-clearing + 1,497 broker-dealers reporting 
as introducing but not self-clearing) = $50,490,000.
---------------------------------------------------------------------------

    Custodian banks will need to update their asset servicing functions 
to comply with a shorter settlement cycle. We preliminarily estimate 
that custodian banks will incur an initial compliance cost of $1.16 
million,\298\ and expect them to incur minimal ongoing compliance costs 
after the initial transition because we preliminarily believe most of 
the costs will stem from pre-migration updates and testing.
---------------------------------------------------------------------------

    \298\ The estimate is based on the T+2 Playbook timeline, which 
estimates regulation-dependent implementation activity for asset 
servicing and testing to last two quarters. We assume 2 operations 
specialists (at $129 per hour), 2 programmers (at $256 per hour), 
and 1 senior operations manager (at $345 per hour), working 40 hours 
per week. (2 x $129 + 2 x $256 + 1 x $345) x 2 x 13 x 40 = 
$1,159,600.
---------------------------------------------------------------------------

(4) Indirect Costs
    In estimating these implementation costs, we note that market 
participants who bear the direct costs of the actions they undertake to 
comply with Rule 15c6-1 may pass these costs on to their customers. For 
example, retail and institutional investors might not directly bear the 
cost of all of the necessary upgrades for a T+2 settlement cycle, but 
might indirectly bear these costs as their broker-dealers might 
increase their fees to amortize the costs of updates among their 
customers. We are unable to quantify the overall magnitude of the 
indirect costs that retail and institutional investors may bear, 
because it will depend on the market power of each broker-dealer, and 
its willingness to pass on the costs of migration to a T+2 standard 
settlement cycle to their customers. However, we preliminarily believe 
that in situations where broker-dealers have little or no competition, 
broker-dealers may at most pass on the entire cost of the initial 
investment to their customers. As discussed above, this could be as 
high as $4.72 million for broker-dealers that serve institutional 
investors, and $8.6 million for broker-dealers that serve retail 
investors. However, in situations where broker-dealers face heavy 
competition for customers, broker-dealers may bear the costs of the 
initial investment entirely, and avoid passing on these costs to their 
customers.
    As noted in Part VI.B.4., the ability of market participants to 
pass implementation costs on to customers likely depends on their 
relative bargaining power. For example, CCPs, like many other 
utilities, exhibit many of the characteristics of natural monopolies 
and, as a result, may have market power, particularly relative to 
broker-dealers who submit trades for clearing. This means that they may 
be able to share implementation costs they directly face related to 
shortening the settlement cycle with broker-dealers through higher 
clearing fees. Conversely, if institutional investors have market power 
relative to broker-dealers, broker-dealers may not be in a position to 
impose indirect costs on them.
(5) Industry-Wide Costs
    To estimate the aggregate, industry-wide cost of a transition to a 
T+2 standard settlement cycle, we take our per-entity estimates and 
multiply them by our estimate of the respective number of entities. The 
Commission preliminarily estimates that there are 965 buy-side firms, 
186 broker-dealers, and 53 custodian banks.\299\ Additionally, as noted 
in Part II.A.2.b., there are three Matching/ETC Providers, and 1,683 
broker-dealers that will incur investor education costs. One way to 
establish a total industry initial compliance cost estimate would be to 
multiply each estimated per-entity cost by the respective number of 
entities and sum these values, which would result in an estimate of 
$4.0 billion.\300\ The

[[Page 69276]]

Commission, however, preliminarily believes that this estimate is 
likely to overstate the true initial cost of transition to a T+2 
settlement cycle for a number of reasons. First, our per-entity 
estimates do not account for the heterogeneity in market participant 
size, which may have a significant impact on the costs that market 
participants face. While the BCG Study included both estimates of the 
number of entities in different size categories as well as estimates of 
costs that an entity in each size category is likely to incur, it did 
not provide sufficient underlying information to allow the Commission 
to estimate the relationship between participant size and compliance 
cost and thus we cannot produce comparable estimates. The Commission 
seeks comment on the extent to which market participants believe that 
the compliance costs for the proposed rule will scale with market 
participant size.
---------------------------------------------------------------------------

    \299\ The estimate for the number of buy-side firms is based on 
the Commission's 13(f) holdings information filers with over $1 
billion in assets under management, as of December 31, 2015. The 
estimate for the number of broker-dealers is based on FINRA FOCUS 
Reports of firms reporting as self-clearing. See supra note 235 and 
accompanying text. The estimate for the number of custodian banks is 
based on the number of ``settling banks'' listed in DTC's Member 
Directories, available at https://www.dtcc.com/client-center/dtc-directories.
    \300\ Calculated as 186 broker-dealers (self-clearing) x 
$8,606,000 + 1683 broker-dealers (self-clearing and introducing) x 
$30,000 + 53 custodian banks x $1,159,000 + 965 buy-side firms x 
$2,319,000 + 3 Matching/ETC Providers x $10,900,000 + 2 FMUs x 
$10,900,000 = $ 4,005,034,800.
---------------------------------------------------------------------------

    Second, the Commission's estimate assumes that broker-dealers will 
not repurpose existing systems that allow them to participate in 
foreign markets that require settlement by T+2. For example, 
approximately 99 of the broker-dealers that reported self-clearing also 
reported that they were affiliates or subsidiaries of foreign broker-
dealers or banks. To the extent that a broker-dealer has a foreign 
affiliate or parent that already has systems in place to support T+2 
settlement in foreign markets, it may bear lower costs under the 
proposed amendment to Rule 15c6-1(a) than the estimate above. Removing 
all 99 of these broker-dealers from the computation of total industry 
initial compliance cost estimate presented above results in a reduction 
of this estimate to approximately $3.2 billion.\301\ The Commission 
seeks comment on the extent to which participants believe that the 
compliance costs for the proposed rule may be less for those broker-
dealers that can repurpose existing systems that they currently use for 
their activities in foreign markets.
---------------------------------------------------------------------------

    \301\ Calculated as 87 broker-dealers (self-clearing) x 
$8,606,000 + 1683 broker-dealers (self-clearing and introducing) x 
$30,000 + 53 custodian banks x $1,159,000 + 965 buy-side firms x 
$2,319,000 + 3 Matching/ETC Providers x $10,900,000 + 2 FMUs x 
$10,900,000 = $ 3,153,040,800.
---------------------------------------------------------------------------

    Third, investments by third-party service providers may mean that 
many of the estimated compliance costs for market participants are 
duplicated. The BCG Study suggests that ``leverage'' from service 
providers may yield a savings of $194 million, reducing aggregate costs 
by approximately 29%.\302\ Based on information gathered from the 
recent available financial reports of service providers, the Commission 
preliminarily believes that a reasonable range of estimates for the 
average cost reduction associated with service providers across all 
entities could be between 16% and 32%.\303\ However, the Commission 
seeks further comment on the extent to which the efficiencies generated 
by the investments of service providers might reduce the compliance 
costs of market participants. Applying this range to the total industry 
initial compliance cost estimate presented above yields a range of 
total industry initial compliance cost estimates between $2.7 billion 
and $3.4 billion.
---------------------------------------------------------------------------

    \302\ See BCG Study supra note 107, at 79.
    \303\ Commission Staff hand collected information on operating 
margins for business segments related to settlement services of 
three large service providers for fiscal years 2013, 2014, and 2015. 
The median estimate was 16.4%. To arrive at the lower bound of 16%, 
the Commission assumes service providers capture all of the cost 
reduction they provide; to arrive at the upper bound, the Commission 
assumes that service providers share half of the overall cost 
reduction with their customers. Generally, the extent to which 
service providers share the efficiencies they provide with their 
customers may depend on service providers' bargaining power. See, 
e.g., Binmore, Ken, Ariel Rubinstein, and Asher Wolinsky, The Nash 
Bargaining Solution In Economic Modelling, The RAND Journal of 
Economics, 17, no. 2, Summer, 1986, at 176-188.
---------------------------------------------------------------------------

    Taking into account potential cost reductions due to repurposing 
existing systems and using service providers as described above, the 
Commission preliminarily believes that $2.1 billion to $4.2 billion 
represents a reasonable range for the total industry initial compliance 
costs.\304\
---------------------------------------------------------------------------

    \304\ The lower bound of this range is calculated as ($4.0 
billion-$0.9 billion cost reduction related to broker-dealers with 
foreign parents or affiliates) - (1-0.32) = $2.1 billion.
---------------------------------------------------------------------------

    In addition to these initial costs, a transition to a shorter 
settlement cycle may also result in certain ongoing industry-wide 
costs. Though we preliminarily believe that a move to a shorter 
settlement cycle will generally bring with it a reduced reliance on 
manual processing, a shorter settlement cycle may also exacerbate 
remaining operational risk. This is because a shorter settlement cycle 
would provide market participants with less time to resolve errors. For 
example, if there is an entry error in the trade match details sent by 
either counterparty for a trade, both counterparties would have one 
extra day to resolve the error under the baseline than in a T+2 
environment. For these errors, a shorter settlement cycle may increase 
the probability that the error ultimately results in a settlement fail. 
However, given the variety of operational errors that are possible in 
the clearance and settlement process and the low probability of some of 
these errors, we are unable to quantify the impact that a shorter 
settlement cycle may have on the ongoing industry-wide costs stemming 
from a potential increase in operational risk.
    Another industry-wide potential cost of shortening the settlement 
cycle is related to CCP member default. A shorter settlement cycle may 
provide CCPs with a shorter horizon in which to manage a defaulting 
member's outstanding settlement obligations. Besides potentially 
increasing the operational risks associated with default management, a 
shorter settlement cycle may also have implications for CCPs that must 
liquidate a defaulting member's securities and, if circumstances 
require, the securities of non-defaulting members, in order to meet 
payment obligations for unsettled trades. A shorter settlement cycle 
leaves a CCP with less time in which to liquidate the securities and 
may increase the price impact associated with liquidation.
    Current margin models at CCPs may account for the price impact 
associated with liquidating collateral. Although a CCP's margining 
algorithm may account for the additional impact generated by a shorter 
liquidation horizon for the defaulting member's clearing fund deposits, 
margin requirements may not reflect the costs that a liquidation over a 
shorter horizon may impose on other market participants. For example, a 
CCP may impose haircuts on collateral to account for the costs of 
liquidating collateral in the event of a clearing member default, 
causing clearing members to internalize a portion of the cost of 
liquidating illiquid assets. While the haircut may mitigate the risk 
that the price impact associated with liquidation of collateral assets 
over a shorter period of time causes the CCP to fail to meet its 
settlement obligations, the reduction in the price of collateral assets 
may affect other market participants who may be sensitive to the value 
of these assets.

D. Alternatives

1. Shift to a T+1 Standard Settlement Cycle
    The Commission has considered the consequences of a shift to a T+1 
standard settlement cycle.\305\ The Commission preliminarily believes 
that

[[Page 69277]]

although a move to a T+1 standard settlement cycle could have similar 
qualitative benefits of market, credit, and liquidity risk reduction as 
a move to a T+2 standard settlement cycle, the types of necessary 
investments and changes necessary to move to a T+1 standard settlement 
cycle also introduce greater costs for market participants.
---------------------------------------------------------------------------

    \305\ See supra Part III.A.4. for a discussion on the 
consideration of a settlement cycle shorter than T+2.
---------------------------------------------------------------------------

    As stated earlier, a T+1 standard settlement cycle might result in 
a larger reduction in certain settlement risks than would result from a 
T+2 standard settlement cycle because, as explained above, the risks 
associated with counterparty default tend to increase with time. Price 
volatility, as measured by the standard deviation of the price, is 
concave in time, which means that as a period of time increases, 
volatility will increase, but at a decreasing rate. This suggests that 
the reduction in price volatility from moving from T+2 settlement to 
T+1 settlement is larger than the reduction in price volatility from 
moving from T+3 settlement to T+2 settlement. Similarly, assuming 
constant trading volume, the volume of unsettled trades for a T+1 
settlement cycle would be reduced again by one-third, and, as a result, 
for any given adverse movement in prices, the financial losses 
resulting from counterparty default will be two-thirds less than those 
under a T+3 settlement cycle.
    At the same time, the Commission preliminarily believes that the 
initial costs of complying with a T+1 settlement cycle will be greater 
than with a T+2 settlement cycle. Successful transition to a settlement 
cycle that is shorter than T+2 could require significantly larger 
investments by market participants to adopt new systems and processes. 
The upgrades necessary for a T+1 settlement cycle might include changes 
such as a transformation of lending and foreign buyer processes, real-
time or near real-time trade processing capabilities, as well as a 
further acceleration of the retail funding timeline, which would 
require larger structural changes to the settlement process and more 
cross-industry coordination than the upgrades for a T+2 settlement 
cycle would. Because these upgrades could require more changes across 
multiple markets and settlement systems, they may be more expensive to 
implement than the upgrades necessary for T+2 settlement. Additionally, 
the lead time and level of coordination by market participants required 
to implement such changes to transition to a T+1 standard settlement 
cycle would be longer and greater than the time and coordination 
required to move to a T+2 standard settlement cycle, which could delay 
the realization of the risk-reducing benefits of shortening the 
settlement cycle and increase the risk that market participants would 
not be able to transition to T+1 in a coordinated fashion.
    Further, and as noted above, a move to a T+1 standard settlement 
cycle could introduce additional financial risks and costs as a result 
of its impact on transactions in certain foreign markets. Because 
settlement of spot FX transactions occurs on T+2, market participants 
who transact in an environment with a shorter settlement cycle would be 
required to pre-fund securities transactions in foreign currencies. 
Under these circumstances, a market participant would either incur 
opportunity costs and currency risk associated with holding FX reserves 
or be exposed to price volatility by delaying securities transactions 
by one day to coordinate settlement of the securities and FX legs. In 
addition, shortening the settlement cycle to T+1 may make it more 
difficult for market participants to timely settle cross-border 
transactions because the U.S. settlement cycle would not be harmonized 
with non-U.S. markets that have already transitioned to a T+2 
settlement cycle.\306\ The disparity between the settlement cycles 
would most likely increase the costs associated with such cross-border 
transactions.
---------------------------------------------------------------------------

    \306\ For further discussion regarding the potential benefits of 
harmonization of settlement cycles for market participants engaging 
in cross-border transactions, see infra Part III.A.4.
---------------------------------------------------------------------------

    The BCG Study estimated that the transition to a T+1 settlement 
cycle would cost the industry $1.77 billion in incremental investments 
(compared to $550 million for a T+2 settlement cycle), with an annual 
operational cost savings of $175 million per year and $35 million from 
clearing fund reductions (compared to $170 million and $25 million per 
year in a T+2 settlement cycle, respectively). Risk reduction benefits 
were estimated to be $410 million for a T+1 settlement cycle (compared 
to $200 million per year in a T+2 settlement cycle).\307\ Although the 
Commission preliminarily believes that these numbers cannot be fully 
accepted as cost estimates for the proposed amendment,\308\ the 
magnitude of the difference between the BCG Study's T+2 and T+1 cost 
and benefit estimates likely indicate additional larger structural 
changes necessary to transition to a T+1 settlement cycle.
---------------------------------------------------------------------------

    \307\ See BCG Study, supra note 107, at 41.
    \308\ See supra Part VI.C.5.a.
---------------------------------------------------------------------------

    In addition, the SIA T+1 Report estimated the initial investment 
costs of a shortened standard settlement cycle of T+1 to be $8 billion, 
with net annual benefits of $2.7 billion per year. The report estimated 
that broker-dealers would have an initial investment of $5.4 billion, 
with net annual benefits of $2.1 billion per year; asset managers would 
have an initial investment of $1.7 billion, with net annual benefits of 
$403 million per year; custodians would have an initial investment of 
$600 million, with net annual benefits of $307 million per year; and 
infrastructure service providers would have an initial investment of 
$237 million, with net annual loss of $81 million per year. Although 
these estimates have higher costs and benefits than the estimates in 
the BCG Study, the SIA estimates were made in 2000, and are much older 
than the BCG Study estimates, which were made in 2012. In the sixteen 
years since the publication of the SIA T+1 Report, significant 
technological and industry changes may have affected the costs and 
benefits of a T+1 standard settlement cycle, which may limit the 
usefulness of the report's estimates for assessing the costs and 
benefits of a T+1 standard settlement cycle today.\309\
---------------------------------------------------------------------------

    \309\ See SIA Business Case Report at 3.
---------------------------------------------------------------------------

2. Straight-Through Processing Requirement
    The Commission has also considered the consequences of mandating 
specific clearance and settlement practices, such as straight-through 
processing, in lieu of the proposed rules. STP involves the electronic 
entry of trade details during the settlement process, which avoids the 
manual entry and re-entry of trade details. By avoiding the manual 
entry of trade details, STP can speed up the settlement process as well 
as reduce error rates. However, the Commission preliminarily believes 
that although many of the costs and benefits of a T+2 standard 
settlement cycle could be achieved by mandating specific clearance and 
settlement practices, there are several reasons why mandating a shorter 
settlement cycle may substantively differ from a specific practice 
requirement.
    First, the Commission preliminarily believes that many of the 
proposed rule's benefits stem directly from the fact that the length of 
the settlement cycle has been shortened, and not from the particular 
practices used to comply with the proposed rule. As discussed above in 
Part VI.C., the Commission preliminarily believes that shortening the 
settlement cycle is likely to reduce a number of risks associated with 
securities settlement, including credit and market risks that stem from

[[Page 69278]]

counterparty exposures. Moreover, the Commission preliminarily believes 
that intermediaries that manage these types of risk as a result of 
their role in the clearance and settlement system may share a portion 
of potential cost savings associated with reduced risks with financial 
market participants. While the Commission acknowledges that an 
alternative approach that primarily focuses on mandating STP may 
achieve some of the operational benefits associated with a shortened 
settlement cycles, such an approach may not reduce counterparty 
exposures and attendant risks.
    Furthermore, the Commission recognizes that STP may be a natural 
enabler for a shorter settlement cycle, but it may not be the most 
efficient enabler. The Commission preliminarily believes that market 
participants may have a variety of methods to comply with the proposed 
rule, and may prefer the least costly method of shortening the 
settlement cycle. By allowing market participants to choose how to 
comply with a shorter settlement cycle, rather than mandating a 
specific practice, the proposed rules may allow the market to realize 
the benefits of a shorter settlement cycle at the lowest cost to market 
participants.
    Additionally, mandating specific clearance and settlement practices 
instead of mandating a shortened settlement cycle may have adverse 
effects on competition in the market for back-office services. Back-
office service providers may have a variety of methods to help their 
clients comply with a shorter settlement cycle, and mandating specific 
clearance and settlement practices may adversely affect the number of 
providers that market participants might use, and a reduction in 
competition among back-office service providers that can comply with 
required practices may result in higher compliance costs for market 
participants.

E. Request for Comment

    The Commission seeks comment on the potential economic impact of 
the proposed amendment to Rule 15c6-1(a). In addition, the Commission 
seeks comment on related issues that may inform the Commission's views 
regarding the economic impact of the proposed amendment to Rule 15c6-
1(a), as well as alternatives to the proposed amendment. The Commission 
in particular seeks comment on the following:
    1. The Commission invites commenters to provide additional data on 
the time it takes to complete each step within the current clearance 
and settlement process. What are current constraints or impediments for 
each step within the clearance and settlement process that would limit 
the ability to shorten the settlement cycle from T+3 to T+2? Are there 
similar or additional limitations for shortening the settlement cycle 
beyond T+2? Do these constraints or impediments vary by market 
participant type?
    2. The Commission invites commenters to provide additional data on 
the current timing of trade matching. What portion of trades is 
affirmed on trade date? What portion of trades is currently matched 
such that they could already be settled on a T+2 settlement cycle? How 
does the timing of trade matching vary by the type of market 
participant?
    3. The Commission invites commenters to discuss the costs and 
benefits of the industry changes (e.g., technology changes and business 
practices) necessary to comply with a T+2 standard settlement cycle 
related to trade matching. What are the costs of implementing such 
changes? What cost-savings would these changes yield? What operational 
risks might these changes create?
    4. The Commission invites commenters to provide additional data on 
the expected collateral efficiency gains from a T+2 standard settlement 
cycle. How would clearing fund deposits change as a result of the 
proposed amendment? To what extent does this change fully represent the 
change to the level of risk associated with the settlement cycle for 
securities transactions?
    5. The Commission invites commenters to discuss the impact of a T+2 
settlement cycle on broker-dealers and their customers. What types of 
adaptations will be necessary to comply with a T+2 settlement cycle, 
and what are their relative costs and benefits?
    6. The Commission invites commenters to discuss the potential 
impact of a T+2 standard settlement cycle with respect to cross-border 
and cross-asset class transactions. What are the costs and benefits of 
harmonizing with certain markets' settlement cycles? Would a T+2 
standard settlement cycle make any cross-border or cross-asset 
transactions more or less difficult?
    7. The Commission invites commenters to discuss the anticipated 
market changes, if any, if the proposed amendment to Rule 15c6-1(a) 
were not adopted. Which activities necessary for compliance with a T+2 
standard settlement cycle would occur in the absence of the proposed 
rule amendment? Which market participants, if any, would move to a T+2 
settlement cycle in the absence of the proposed rule amendment?
    8. The Commission seeks comment on the alternative of shifting to a 
T+1 standard settlement cycle. Would such an alternative be appropriate 
and preferable to a T+2 standard settlement cycle? Why or why not? What 
are the costs and benefits of such an alternative relative to the 
baseline and the proposal?
    9. The Commission seeks comment on the alternative of mandating 
specific clearance and settlement practices, such as STP. Would such an 
alternative be appropriate and preferable to a T+2 standard settlement 
cycle? Why or why not? What are the costs and benefits of such an 
alternative relative to the baseline and the proposal?
    10. The Commission seeks comment on several topics related to the 
response of market participants to the shift to a T+2 settlement cycle 
in certain foreign markets. The Commission seeks comment on the 
following:
     Commenters are invited to discuss the impact that the 
shift to a T+2 settlement cycle in certain foreign markets (e.g., E.U. 
markets) has had on their clearance and settlement operations. Are 
there any responses to changes in the settlement cycle of these markets 
that may alter the costs or benefits of adopting a T+2 standard 
settlement cycle in the U.S.?
     Commenters are invited to discuss their preparations for 
upcoming migrations to a T+2 settlement cycle in foreign markets. Do 
these preparations alter the costs and benefits of adapting to a T+2 
standard settlement cycle in the U.S.?
     Has the experience of migrating to a T+2 settlement cycle 
in certain foreign markets allowed commenters to make any other 
observations relevant to the proposal to adopt a T+2 standard 
settlement cycle in the United States?

VII. Small Business Regulatory Enforcement Fairness Act

    Under the Small Business Regulatory Enforcement Fairness Act of 
1996,\310\ a rule is ``major'' if it has resulted, or is likely to 
result in:
---------------------------------------------------------------------------

    \310\ Public Law 104-121, Title II, 110 Stat. 857 (1996).
---------------------------------------------------------------------------

     An annual effect on the economy of $100 million or more;
     A major increase in costs or prices for consumers or 
individual industries; or
     Significant adverse effects on competition, investment, or 
innovation.
    The Commission requests comment on whether the proposed amendment 
to Rule 15c6-1(a) would be a ``major'' rule

[[Page 69279]]

for purposes of the Small Business Regulatory Enforcement Fairness Act. 
In addition, the Commission solicits comment and empirical data on:
     The potential effect on the U.S. economy on annual basis;
     Any potential increase in costs or prices for consumer or 
individual industries; and
     Any potential effect on competition, investment, or 
innovation.

VIII. Initial Regulatory Flexibility Analysis

    The Regulatory Flexibility Act (``RFA'') requires the Commission, 
in promulgating rules, to consider the impact of those rules on small 
entities.\311\ Section 603(a) of the Administrative Procedure Act,\312\ 
as amended by the RFA, generally requires the Commission to prepare and 
make available for public comment an initial regulatory flexibility 
analysis of all proposed rules to determine the impact of such 
rulemaking on ``small entities.'' \313\ Section 605(b) of the RFA 
states that this requirement shall not apply to any proposed rule 
which, if adopted, would not have a significant economic impact on a 
substantial number of small entities.\314\
---------------------------------------------------------------------------

    \311\ See 5 U.S.C. 601 et seq.
    \312\ 5 U.S.C. 603(a).
    \313\ Section 601(b) of the RFA permits agencies to formulate 
their own definitions of ``small entities.'' See 5 U.S.C. 601(b). 
The Commission has adopted certain definitions for the terms ``small 
business'' and ``small organization'' for the purposes of rulemaking 
in accordance with the RFA. These definitions, as relevant to this 
proposed rulemaking, are set forth in Rule 0-10, 17 CFR 240.0-10.
    \314\ See 5 U.S.C. 605(b).
---------------------------------------------------------------------------

    The Commission has prepared the following initial regulatory 
flexibility analysis in accordance with Section 603(a) of the RFA in 
relation to the proposed amendment to Exchange Act Rule 15c6-1(a).

A. Reasons for, and Objectives of, the Proposed Action

    The Commission is proposing to amend Exchange Act Rule 15c6-1(a) to 
shorten the standard settlement cycle for securities transactions 
(other than those excluded by the rule) from T+3 to T+2. The Commission 
believes that proposing the amendment to Rule 15c6-1(a) to shorten the 
standard settlement cycle from three days to two days could potentially 
offer market participants significant benefits through the reduction of 
exposure to credit, market, and liquidity risk, as well as related 
reductions to systemic risk.

B. Legal Basis

    The Commission is proposing an amendment to Rule 15c6-1(a) under 
the authority set forth in the Exchange Act, particularly under 
Sections 15(c)(6),\315\ 17A,\316\ and 23(a) \317\ of the Exchange Act.
---------------------------------------------------------------------------

    \315\ 15 U.S.C. 78o(c)(6).
    \316\ 15 U.S.C. 78q-1.
    \317\ 15 U.S.C. 78w(a).
---------------------------------------------------------------------------

C. Small Entities Subject to the Rule and Rule Amendment

    Paragraph (c) of Exchange Act Rule 0-10 provides that, for purposes 
of Commission rulemaking in accordance with the provisions of the RFA, 
when used with reference to a broker or dealer, the Commission has 
defined the term ``small entity'' to mean a broker or dealer: (1) With 
total capital (net worth plus subordinated liabilities) of less than 
$500,000 on the date in the prior fiscal year as of which its audited 
financial statements were prepared pursuant to Rule 17a-5(d) under the 
Exchange Act,\318\ or if not required to file such statements, a 
broker-dealer with total capital (net worth plus subordinated 
liabilities) of less than $500,000 on the last business day of the 
preceding fiscal year (or in the time that it has been in business, if 
shorter); and (2) is not affiliated with any person (other than a 
natural person) that is not a small business or small 
organization.\319\
---------------------------------------------------------------------------

    \318\ 17 CFR 240.17a-5(c).
    \319\ 17 CFR 240.0-10(d).
---------------------------------------------------------------------------

    The proposed amendment to Rule 15c6-1(a) would prohibit broker-
dealers, including those that are small entities, from effecting or 
entering into a contract for the purchase or sale of a security (other 
than an exempted security, government security, municipal security, 
commercial paper, bankers' acceptances, or commercial bills) that 
provides for payment of funds and delivery of securities no later than 
the second business day after the date of the contract unless otherwise 
expressly agreed to by the parties at the time of the transaction. 
Currently, based on FOCUS Report \320\ data, as of December 31, 2015, 
we estimate that there are 1,235 broker-dealers that may be considered 
small entities.
---------------------------------------------------------------------------

    \320\ See supra note 235.
---------------------------------------------------------------------------

D. Projected Reporting, Recordkeeping and Other Compliance Requirements

    The proposed amendment to Rule 15c6-1(a) would not impose any new 
reporting or recordkeeping requirements on broker-dealers that are 
small entities. However, the proposed amendment to Rule 15c6-1(a) may 
impact certain broker-dealers, including those that are small entities, 
to the extent that broker-dealers may need to make changes to their 
business operations and incur certain costs in order to operate in a 
T+2 environment.
    For example, conversion to a T+2 standard settlement cycle may 
require broker-dealers, including those that are small entities, to 
make changes to their business practices, as well as to their computer 
systems, and/or to deploy new technology solutions. Implementation of 
these changes may require broker-dealers to incur new or increased 
costs, which may vary based on the business model of individual broker-
dealers as well as other factors.
    Additionally, conversion to a T+2 standard settlement cycle may 
also result in an increase in costs to certain broker-dealers who 
finance the purchase of customer securities until the broker-dealer 
receives payment from its customers. To pay for securities purchases, 
many customers liquidate other securities or money fund balances held 
for them by their broker-dealers in consolidated accounts such as cash 
management accounts. However, some broker-dealers may elect to finance 
the purchase of customer securities until the broker-dealer receives 
payment from its customers for those customers that do not choose to 
liquidate other securities or have a sufficient money fund balance 
prior to trade execution to pay for securities purchases. Broker-
dealers that elect to finance the purchase of customer securities may 
incur an increase in costs in a T+2 environment resulting from 
settlement occurring one day earlier unless the broker-dealer can 
expedite customer payments.

E. Duplicative, Overlapping or Conflicting Federal Rules

    The Commission believes that there are no federal rules that 
duplicate, overlap or conflict with the proposed amendment to Rule 
15c6-1(a).

F. Significant Alternatives

    The RFA requires that the Commission include in its regulatory 
flexibility analysis a description of any significant alternatives to 
the proposed rule which would accomplish the stated objectives of 
applicable statutes and which would minimize any significant economic 
impact of the proposed rule on small entities.\321\ Pursuant to Section 
3(a) of the RFA, the Commission's initial regulatory flexibility 
analysis must consider certain types of alternatives, including: (a) 
The establishment of differing compliance or reporting requirements or 
timetables that take into account the resources

[[Page 69280]]

available to small entities; (b) the clarification, consolidation, or 
simplification of the compliance and reporting requirements under the 
rule for small entities; (c) the use of performance rather than design 
standards; and (d) an exemption from coverage of the rule, or any part 
of thereof, for such small entities.\322\
---------------------------------------------------------------------------

    \321\ 5 U.S.C. 603(c).
    \322\ Id.
---------------------------------------------------------------------------

    The Commission considered alternatives to the proposed rule 
amendment that would accomplish the stated objectives of the amendment 
without disproportionately burdening broker-dealers that are small 
entities, including: differing compliance requirements or timetables; 
clarifying, consolidating or simplifying the compliance requirements; 
using performance rather than design standards; or providing an 
exemption for certain or all broker-dealers that are small entities. 
The purpose of Rule 15c6-1(a) is to establish a standard settlement 
cycle for broker-dealer transactions. Alternatives, such as different 
compliance requirements or timetables, or exemptions, for Rule 15c6-
1(a), or any part thereof, for small entities would undermine the 
purpose of establishing a standard settlement cycle. For example, 
allowing small entities to settle at a time later than T+2 could create 
a two-tiered market that could work to the detriment of small entities 
whose order flow would not coincide with that of other firms operating 
on a T+2 settlement cycle. Additionally, the Commission believes that 
establishing a single timetable (i.e., compliance date) for all broker-
dealers, including small entities, to comply with the amendment is 
necessary to ensure that the transition to a T+2 standard settlement 
cycle takes place in an orderly manner that minimizes undue disruptions 
in the securities markets. With respect to using performance rather 
than design standards, the Commission used performance standards to the 
extent appropriate under the statute. For example, broker-dealers have 
the flexibility to settle transactions under a standard settlement 
cycle shorter than T+2. In addition, under the proposed rule amendment, 
broker-dealers have the flexibility to tailor their systems and 
processes, and generally to choose how, to comply with the rule.

G. Request for Comment

    The Commission encourages written comments on matters discussed in 
the initial RFA. In particular, the Commission seeks comment on the 
number of small entities that would be affected by the proposed 
amendment to Rule 15c6-1(a) and whether the effect(s) on small entities 
would be economically significant. Commenters are asked to describe the 
nature of any effect(s) the proposed amendment to Rule 15c6-1(a) may 
have on small entities, and to provide empirical data to support their 
views.

IX. Statutory Authority and Text of the Proposed Amendment to Rule 
15c6-1

    The Commission is proposing an amendment to Rule 15c6-1 under the 
Commission's rulemaking authority set forth in Sections 15(c)(6), 17A 
and 23(a) of the Exchange Act [15 U.S.C. 78o(c)(6), 78q-1, and 78w(a) 
respectively]. For the reasons stated in the preamble, Title 17, 
Chapter II of the Code of Federal Regulations is proposed to be amended 
as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1934

0
1. The general authority citation for part 240 continues to read as 
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f, 
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4, 
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20, 
80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et seq., and 
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; 
Pub. L. 111-203, 939A, 124 Stat. 1376 (2010); and Pub. L. 112-106, 
sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *
0
2. Amend Sec.  240.15c6-1 by revising paragraph (a) to read as follows:
    The proposed amendment reads as follows:


Sec.  240.15c6-1  Settlement Cycle.

    (a) Except as provided in paragraphs (b), (c), and (d) of this 
section, a broker or dealer shall not effect or enter into a contract 
for the purchase or sale of a security (other than an exempted 
security, government security, municipal security, commercial paper, 
bankers' acceptances, or commercial bills) that provides for payment of 
funds and delivery of securities later than the second business day 
after the date of the contract unless otherwise expressly agreed to by 
the parties at the time of the transaction.
* * * * *

    By the Commission.

     Dated: September 28, 2016.
Robert W. Errett,
Deputy Secretary.
[FR Doc. 2016-23890 Filed 10-4-16; 8:45 am]
BILLING CODE 8011-01-P