FINRA Requests Comment on Proposed Amendments to FINRA Rules to Support the Industry Initiative to Shorten the Settlement Cycle for Securities in the U.S. Secondary Market From T+3 to T+2

Shortening the Settlement Cycle for Securities to T+2

Comment Period Expires: April 4, 2016

Summary

Shortening the settlement cycle from trade date plus three business days (T+3) to trade date plus two business days (T+2) for U.S. secondary market transactions in equities, corporate and municipal bonds, unit investment trusts, and financial instruments composed of these products is an industry-led initiative. To support this industry-led initiative, FINRA seeks comment on proposed amendments to FINRA rules relating to the settlement cycle. FINRA proposes to adopt necessary rule changes in a manner and timeline that is consistent with the Securities and Exchange Commission (SEC) and other self-regulatory organizations (SROs) in an effort to provide the regulatory certainty necessary for an efficient transition.

The proposed rule text of the impacted rules is in Attachment A.

Questions concerning this Notice should be directed to:

Action Requested

FINRA encourages all interested parties to comment. Comments must be received by April 4, 2016.

Comments must be submitted through one of the following methods:

To help FINRA process comments more efficiently, persons should use only one method to comment.

Important Notes: All comments received in response to this Notice will be made available to the public on the FINRA website. In general, FINRA will post comments as they are received.¹

Before becoming effective, a proposed rule change must be authorized for filing with the Securities and Exchange Commission (SEC) by the FINRA Board of Governors, and then must be filed with the SEC pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA).²

Background & Discussion

In 1995, the standard U.S. trade settlement cycle for equities, municipal and corporate bonds, and unit investment trusts, and financial instruments composed of these products³ was shortened from five business days after the trade date to T+3.⁴ Since then, the SEC and the financial services industry have continued exploring the idea of shortening the settlement cycle even further.⁵

In April 2014, The Depository Trust & Clearing Corporation (DTCC) published its formal recommendation to shorten the standard U.S. trade settlement cycle to T+2 and announced that it would partner with market participants and industry organizations to devise the necessary approach and timelines to achieve T+2.⁶ In February 2015, the SEC's Investor Advisory Committee strongly endorsed DTCC's recommendation.⁷ Market participants believe a shorter settlement cycle will yield important benefits to the industry by promoting financial stability and significantly mitigating risks to the financial system.

In collaboration with the financial services industry, DTCC formed an Industry Steering Committee (ISC) and an Industry Working Group and sub-working groups to facilitate the move to T+2.⁸ In June 2015, the ISC published a white paper titled "Shortening the Settlement Cycle: The Move to T+2," which outlined the activities and proposed timeframes that would be required to move to T+2 in the U.S.⁹ The proposed timeframes included regulators and SROs finalizing their rule amendments by the second quarter of 2016, and developing and testing market infrastructure in 2017 with final implementation of T+2 by the third quarter of 2017.

Concurrently, in June 2015, the Securities Industry and Financial Markets Association (SIFMA) and the Investment Company Institute (ICI) jointly submitted a letter to SEC Chair Mary Jo White, expressing support of the efforts by the financial services industry to shorten the settlement cycle and identifying several SEC and SRO rule changes that they believed would require amendment for an effective transition to T+2.¹⁰ The ICI/SIFMA letter categorized the rule changes as follows: (1) rules that specifically establish or reference a T+3 settlement cycle (e.g., SEA Rule 15c6-1)¹¹; (2) rules that do not specifically reference T+3 as the standard settlement cycle, but establish timeframes based on the settlement date of a trade and require one or more parties to act prior to settlement taking place; and (3) rules that establish timeframes based on settlement date, but require action after settlement occurs (e.g., Regulation T, Regulation SHO, SEA Rule 15c3-3(m)).

In September 2015, SEC Chair White responded to the ICI/SIFMA letter expressing her strong support for industry efforts to shorten the trade settlement cycle to T+2 and urging the industry to continue to pursue the necessary steps towards achieving T+2 by the third quarter of 2017. SEC Chair White also indicated that she instructed SEC staff to develop a proposal to amend SEA Rule 15c6-1(a) to require settlement no later than T+2.¹²

Proposed Amendments

SEA Rule 15c6-1 currently establishes "regular way" settlement as occurring no later than T+3 for all securities, except for government securities and municipal securities, commercial paper, bankers' acceptances, or commercial bills.¹³ In anticipation of the SEC's changes to SEA Rule 15c6-1 to facilitate settlement no later than T+2 and to ensure that FINRA acts in concert and conformity with the impending rule changes by other SROs,¹⁴ FINRA is proposing definitional changes to its rules pertaining to securities settlement by, among other things, amending the definition of "regular way" settlement as occurring on T+2. The proposed technical changes would implement the anticipated rule changes of the SEC and the other SROs. Accordingly, FINRA believes that the proposed rule changes will not impose any burdens on the industry in addition to those necessary to implement the industry-wide initiative.

FINRA has preliminarily identified the following rules that establish or reference a T+3 settlement cycle that would need to be amended to reflect a T+2 settlement cycle:

The attachment to this Notice sets forth a list of the rules and the affected rule text that would be amended to comport with the industry-led initiative to move to T+2. As part of the ongoing initiative, FINRA will continue to review its rules to verify that impacted rules for securities settlement are identified and considered for amendment as appropriate.

Economic Impact Assessment

The industry-led effort to shorten settlement cycle to T+2 was based, in part, on an in-depth cost-benefit study commissioned by DTCC.¹⁵ The study identified several anticipated benefits. It concluded that a shorter settlement cycle would benefit market participants by mitigating operational and systemic risks by, among other things:¹⁶

As part of the ongoing initiative to move to T+2, FINRA is assessing the changes that will be required to those FINRA systems and applications that base calculations on T+3. In addition, moving to a shortened settlement cycle would impose costs across various other segments of the industry. These costs would include technological and infrastructure investments, as well as costs associated with implementing various operational changes required to achieve a shorter settlement cycle.

Some of these costs and benefits of the shortened settlement cycle may, directly or indirectly, impact the investing public. For example, public investors would likely benefit from reduced counter-party risk and reduced delays in settlement. Alternatively, costs associated with meeting the shortened settlement cycle may be passed on, in part or in whole, to investors. FINRA specifically seeks comment on any direct or indirect impacts that may accrue to investors.

FINRA notes that the potential economic impacts to the industry and investors discussed here are associated with the industry-wide move to T+2 and the SEC's anticipated amendments to SEA Rule 15c6-1(a), and FINRA believes that its proposed technical rule changes would not impose any additional burdens on the market participants.

Request for Comment

In addition to generally requesting comments, FINRA specifically requests comment on the questions below.

^1. FINRA will not edit personal identifying information, such as names or email addresses, from submissions. Persons should submit only information that they wish to make publicly available. See Notice to Members 03-73 (November 2003) (Online Availability of Comments) for more information.

^2.See SEA Section 19 and rules thereunder. After a proposed rule change is filed with the SEC, the proposed rule change generally is published for public comment in the Federal Register. Certain limited types of proposed rule changes take effect upon filing with the SEC. See SEA Section 19(b)(3) and SEA Rule 19b-4.

^3. Examples of such financial instruments include mutual funds, exchange-traded funds, exchange-traded products, American depositary receipts, options (exercise and assignment), rights, and warrants.

^4. Effective in 1995, SEA Rule 15c6-l(a) provides, in relevant part, that "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 third business day after the date of the contract unless otherwise expressly agreed to by the parties at the time of the transaction." Although not covered by SEA Rule 15c6-l, in 1995, the SEC approved the Municipal Securities Rulemaking Board's rule change requiring transactions in municipal securities to settle by T+3. See Securities Exchange Act Release No. 35427 (Feb. 28,1995), 60 FR 12798 (Mar. 8,1995) (File No. SR-MSRB-94-10).

^5.See e.g., Securities Industry Association (SIA), "SIA T+1 Business Case Final Report" (Jul. 2000); Concept Release: Securities Transactions Settlement, Securities Exchange Act Release No. 49405 (Mar. 11, 2004); and Depository Trust & Clearing Corporation, "Proposal to Launch a New Cost-Benefit Analysis on Shortening the Settlement Cycle" (Dec. 2011).

^6.See Depository Trust & Clearing Corporation, "DTCC Recommends Shortening the U.S. Trade Settlement Cycle" (Apr. 2014).

^7.See "Recommendation of the Investor Advisory Committee: Shortening the Trade Settlement Cycle in U.S. Financial Markets" (Feb. 12, 2015).

^8. The ISC includes, among other participants, DTCC, the Securities Industry and Financial Markets Association and the Investment Company Institute.

^9.See "Shortening the Settlement Cycle: The Move to T+2" (Jun. 18, 2015) (White Paper).

^10.See letter from ICI and SIFMA to Mary Jo White, Chair, SEC (Jun. 18, 2015) (ICI/SIFMA letter) at 5–8.

^11.See supra note 4.

^12.See letter from Mary Jo White, Chair, SEC, to Kenneth E. Bentsen, Jr., President and CEO, SIFMA, and Paul Schott Stevens, President and CEO, ICI (Sep. 16, 2015) at 2.

^13.See also FINRA Rule 11320(b) which provides, in relevant part, that "[i]n connection with a transaction 'regular way,' delivery shall be made at the office of the purchaser on, but not before, the third business day following the date of the transaction."

^14. On November 10, 2015, the MSRB issued MSRB Regulatory Notice 2015-22 seeking comment on draft amendments to MSRB Rule G-12 (Uniform Practice) and MSRB G-15 (Confirmation, Clearance, Settlement and Other Uniform Practice Requirements with Respect to Transactions with Customers) to facilitate shortening the settlement cycle for transactions in municipal securities. The comment period expired on December 10, 2015.

^15.See supra note 6. See also The Boston Consulting Group, "Cost benefit analysis of shortening the settlement cycle," (Oct. 2012) (examining and evaluating the necessary investments and resulting benefits associated with a shortened settlement cycle).

^16.Id.

ATTACHMENT A

Below is the text of the proposed rule changes.¹ Proposed new language is underlined; proposed deletions are in brackets.

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^1. In anticipation of the SEC's changes to SEA Rule 15c6-l to facilitate settlement no later than T+2, and to act in concert and conformity therewith, FINRA may change the rule text of its impacted rules to reference SEA Rule 15c6-l.