On 28 May 2024, the settlement period for substantially all transactions in US markets will be reduced by one day, from two business days after the trade date (T+2) to one business day after the trade date (T+1).¹ While most of the burden and regulatory obligations associated with this transition rest on broker-dealers, investment advisers and other market participants will have to meet certain expectations from their broker-dealer counterparties regarding the confirmation, allocation, and affirmation process (the Confirmation Process). In addition, investment advisers will be required to create and retain new records relating to the Confirmation Process. Finally, the T+1 transition in the United States will create some complexities for investment advisers making foreign investments and investments in ETFs.

 In view of these new counterparty expectations, recordkeeping obligations, and market complexities, investment advisers should consider taking certain steps, outlined below, to ensure they are ready for the implementation of T+1 settlement.  In fact, the Securities and Exchange Commission (SEC) Division of Examination noted in its 2024 Examination Priorities that it will be assessing preparations associated with the shortening of the settlement cycle.²

SAME DAY CONFIRMATION, ALLOCATION, AND AFFIRMATION

The transition to T+1 is the result of rule amendments adopted by the SEC in February of 2023 (the T+1 Amendments).³ While the primary amendments adopted in this rulemaking were designed to require the settlement of transactions within one business day, the SEC also adopted amendments relating to the Confirmation Process. The SEC’s goal was to accelerate the Confirmation Process such that it will be completed as soon as technologically practical but no later than end of trade date in order to aid the transition to T+1 settlement, but critically, same-day completion of the Confirmation Process was designed to address a separate and longstanding industry goal.⁴ 

The T+1 Amendments seek to achieve this goal through two related regulatory actions: (i) new Rule 15c6-2 under the Securities Exchange Act of 1934, as amended, which imposes certain requirements on broker-dealers designed to promote same day completion of the Confirmation Process; and (ii) amendments to Rule 204-2 under the Investment Advisers Act of 1940, as amended, requiring advisers to make and keep records associated with their completion of the Confirmation Process. Together, these new requirements impose new burdens on investment advisers that likely warrant amendments to adviser policies, procedures, and both formal and informal practices.

Agreements or Policies and Procedures Promoting Same Day Completion of the Confirmation Process

While the Confirmation Process is driven not only by the broker-dealer but also by other parties to the transaction process, the SEC believed it was appropriate to impose obligations only on broker-dealers, relying on broker-dealers to modify the conduct of other relevant parties to the transaction (including investment advisers).⁵ As such, new Rule 15c6-2 requires broker-dealers to either (i) enter into written agreements with “relevant parties” to ensure completion of the Confirmation Process on trade date; or (ii) adopt policies and procedures reasonably designed to ensure completion of the Confirmation Process on trade date.⁷ 

Broker-dealers who opt to pursue written agreements will be required to negotiate the terms of those agreements with their investment adviser counterparties, so the resultant obligations will be clear to all parties. On the other hand, broker-dealers who opt to adopt policies and procedures may unilaterally impose requirements on the investment advisers who transact with them. 

The policies and procedures broker-dealers are required to adopt under new Rule 15c6-2 have specific elements intended to support completion of the Confirmation Process on trade date (listed on Exhibit A). Many of these elements will require broker-dealers to adjust their processes in ways that may impact their counterparties. For example, broker-dealers will be required to set target time frames for the completion of the Confirmation Process and implement procedures to support meeting those time frames, including new communication and escalation processes. In fact, the SEC suggested that broker-dealers should receive written assurances from the relevant parties to the transaction confirming that these parties understand their roles under the broker-dealers policies and procedures. As a result, investment advisers (and/or their custodians) should expect broker-dealers to be following up with them if their confirmations, allocations, or affirmations are not submitted to the broker-dealer within the targeted timeframes. In addition, these policies are required to establish processes for how a broker-dealer will identify and address delays caused by a custodian or investment adviser in the confirmation process. In addition, broker-dealers will be required to measure, monitor, and document the rates at which the Confirmation Process was completed on trade date. These documents will be available for review by the SEC and its staff as part of the examination process.

The result of these new amendments will be that broker-dealers will have new expectations of their investment adviser customers. As a result, even though investment advisers are not required to complete the Confirmation Process on trade date, they will effectively be required to do so because their broker-dealer counterparties will expect it, will have adopted policies and procedures supporting it, and will be measuring and monitoring performance with respect to it. 

Investment Adviser Recordkeeping

As a corollary to 15c6-2, investment advisers are subject to new recordkeeping requirements under Rule 204-2. While, as noted above, the SEC did not require investment advisers to complete the Confirmation Process on trade date, the SEC is requiring investment adviser to make and maintain records that the SEC and its staff may review to evaluate how often an investment adviser is completing the Confirmation Process on trade date. 

Under the amended rule, investment advisers are required to maintain, with respect to each purchase or sell order, “each confirmation received, and any allocation and each affirmation sent or received, with a date and time stamp for each allocation and affirmation that indicates when the allocation and affirmation was sent or received.” The SEC did not adopt prescriptive requirements with respect to the timestamp, but expressed approval of timestamps to the nearest minute. The goal of this new requirement is to help establish whether parties to a transaction are meeting their obligations under the written agreements or policies and procedures established by broker-dealers under new Rule 15c6-2.

The SEC noted in the T+1 Adopting Release that many investment advisers are already maintaining these records, but investment advisers should consider reviewing their processes to confirm that these new records will be maintained, especially with respect to timestamping confirmations, allocations, or affirmations received as well as sent. 

T+1 INVESTMENT CONSIDERATIONS

Timing Considerations

According to data cited by the SEC in the T+1 Adopting Release, only about 68% of trades currently complete the Confirmation Process on trade date. This suggests that investment advisers and/or their custodians may need to invest in development of processes and procedures to support same day completion of Confirmation Process, including how to staff their operations. In addition, from a timing perspective, end-of-day trading, transactions across multiple time zones, and variations in holiday schedules present additional challenges, especially for non-US trading desks. 

Foreign Exchange

The conversion to T+1 also has some strategic investment implications, especially for investment strategies that invest in non-US investments. Specifically, the conversion to T+1 will create a settlement mismatch between securities settlement and the settlement of any foreign currency exchange (FX) transactions. Market participants often rely on FX trades executed in the “spot” markets in order to fund securities transactions in the US markets that settle in US dollars. As the settlement cycle for spot FX transactions will remain T+2, an FX transaction entered into on the trade date will not be settle in time to fund a transaction that settles in T+1. As a result, advisers will need to carefully consider how they intend to fund these transactions after the implementation of T+1 to avoid settlement failures. Advisers may need to consider securing dollars in reserve in advance of trades, arranging for a short-dated T+1 FX settlement or securing lines of credit rather than scrambling to find the cash in time. More broadly, other major global markets will remain on a T+2 settlement cycle, which may create other investment implications for transactions from a T+2 market and into a T+1 market (or vice versa).

ADRs/ETFs

The transition to T+1 settlement may also have implications for investments in ADRs and ETFs. ADRs are included in the scope of the T+1 Amendments so long as there are transfer facilities for the ADR in the United States. On the other hand, the ADR’s reference foreign security may continue to settle on a T+2 basis. As a result, investors who purchase foreign securities to create ADR shares may face a settlement mismatch between the delivery of the ADR shares and their purchased foreign securities. 

This same mismatch is potentially present with respect to the in kind creation/redemption process for ETFs that invest in foreign securities. Creating ETF shares in kind requires the authorized participant (AP) to deliver the underlying ETF investments represented in the ETF’s “creation basket” in exchange for ETF shares.⁶ Conversely, APs redeeming ETF shares deliver ETF shares and receive the underlying ETF investments represented in the ETF’s “redemption basket.”⁷ If foreign securities comprise some or all of the investments in the ETF’s creation basket, the AP will typically need to purchase those securities in the local market, which may have a settlement cycle longer than T+1. Since ETF shares are included in the scope of the T+1 Amendments, in such cases APs will experience a settlement mismatch.⁸

CONCLUSION

The effective date of the T+1 Amendments (and the transition to T+1) is fast approaching. Investment advisers and other market participants should review these new and amended rules to confirm they are prepared for the T+1 market. Specifically, investment advisers should, if they have not done so already, consider taking the following five steps: 

• Coordinating with broker-dealer counterparties to determine what the broker-dealers will expect of investment adviser clients under the broker-dealer’s 15c6-2 policies and procedures; 
• Reviewing their own policies, procedures, and business processes (including coordinating with their custodians and administrators, where relevant) to confirm that the they will be able to achieve same day completion of the Confirmation Process;
• Assess the potential investment impact of the T+1 conversion on their investment strategies (including FX, ADR/ETF transactions); 
• Consider any changes that may need to be made to technology systems, operations, and processes used to coordinate with broker-dealers, to allow completion of the allocation, confirmation, or affirmation process for the transaction; and
• Finally, review their processes and amend their recordkeeping procedures to comply with the new amendments to maintain the new timestamped records required under the amended Rule 204-2.

Exhibit A: Required Elements of Policies and Procedures From Rule 15c6-2(b):

1. Identify and describe any technology systems, operations, and processes that the broker or dealer uses to coordinate with other relevant parties, including investment advisers and custodians, to ensure completion of the allocation, confirmation, or affirmation process for the transaction;
2. Set target time frames on trade date for completing the allocation, confirmation, and affirmation for the transaction;
3. Describe the procedures that the broker or dealer will follow to ensure the prompt communication of trade information, investigate any discrepancies in trade information, and adjust trade information to help ensure that the allocation, confirmation, and affirmation can be completed by the target time frames on trade date;
4. Describe how the broker or dealer plans to identify and address delays if another party, including an investment adviser or a custodian, is not promptly completing the allocation or affirmation for the transaction, or if the broker or dealer experiences delays in promptly completing the confirmation; and
5. Measure, monitor, and document the rates of allocations, confirmations, and affirmations completed as soon as technologically practicable and no later than the end of the day on trade date.

¹ The shortened settlement period applies to transactions in equities, corporate bonds, unit investment trusts, mutual funds, exchange-traded funds (ETFs), American depository receipts (ADRs), among others.

² 2024 Examination Priorities at 19, available at: https://www.sec.gov/files/2024-exam-priorities.pdf 

³ Shortening the Securities Settlement Cycle, SEC Rel. No. 24-96930 (Feb. 15, 2023) (T+1 Adopting Release). [Adopting Release at https://www.sec.gov/rules/final/2023/34-96930.pdf., Fact Sheet at https://www.sec.gov/files/34-96930-fact-sheet_0.pdf; and Small Entity Compliance Guide at https://www.sec.gov/investment/settlement-cycle-small-entity-compliance-guide-15c6-1-15c6-2-204-2,] The effective date of the new rules is 5 May 2024 and the compliance date is 28 May 2023. 

⁴ See, e.g., T+1 Adopting Release at 282.

⁵ T+1 Adopting Release at 79.

⁶ In an ETF creation, APs are required to deliver a “creation basket” of securities, which is published daily by the ETF and may represent all of the holdings of the ETF, or a representative sample thereof. 

⁷ In a redemption, the APs will receive the “redemption basket,” which also may represent all or a representative sample of the ETF’s holdings.

⁸ APs will not experience the same settlement mismatch for ETFs that employ a cash creation/redemption process; instead the settlement mismatch could potentially create imbalanced exposures for the ETF itself.