Preparing for Change: What to Know About the Shift to T+1

On May 28th, U.S. markets are moving to a one-day settlement cycle, familiarly known as T+1. This move, which returns the settlement time frame back to a point at which it last stood a century ago, will have wide ranging impacts for firms, investors and regulators.

On this episode, we hear from James Barry, Director of Credit Regulation with FINRA's Office of Financial and Operational Risk Policy, Bobby Gomez, a Senior Director with Market Regulation and Transparency Services' Strategic Initiatives team, Mike MacPherson, a Senior Advisor in Member Supervision's Risk Monitoring group, and John Nachmann, Associate General Counsel with the Office of General Counsel's Regulatory Practice, to discuss what all market participants need to be thinking about and testing ahead of the transition.

Resources mentioned in this episode:

Episode 127: Understanding the Unique Risks of Every Firm

DTCC: The Key to T+1 Success Blog

Reg Notice 23-15: Regulation T and SEA Rule 15c3-3 Extension

Technical Notice: T+1 Settlement Testing

FINRA Margin Regulation

FINRA Investor Insight: Understanding Settlement Cycles

2024 Annual Regulatory Oversight Report

Listen and subscribe to our podcast on Apple Podcasts, Google Podcasts, Spotifyor wherever you listen to your podcasts. Below is a transcript of the episode. Transcripts are generated using a combination of speech recognition software and human editors and may contain errors. Please check the corresponding audio before quoting in print.

FULL TRANSCRIPT

00:00 - 00:26

Kaitlyn Kiernan: On May 28th, U.S. markets are moving to a one-day settlement cycle, familiarly known as T+1. This move, which returns the settlement time frame back to a point at which it last stood a century ago, will have wide ranging impacts for firms, investors and regulators. On this episode, we hear from four individuals across FINRA about what all market participants need to be thinking about and testing ahead of the transition.

00:26 - 00:35

Intro Music

00:35 - 01:19

Kaitlyn Kiernan: Welcome to FINRA Unscripted. I'm your host, Kaitlyn Kiernan. I'm pleased to welcome four guests to today's show to discuss the upcoming transition to a one-day settlement window known as T+1. The number of guests today represents the extent of the impact of this move. Joining me are James Barry, Director of Credit Regulation with FINRA's Office of Financial and Operational Risk Policy, Bobby Gomez, a Senior Director with Market Regulation and Transparency Services' Strategic Initiatives team, Mike MacPherson, a Senior Advisor in Member Supervision's Risk Monitoring group, and John Nachmann, Associate General Counsel with the Office of General Counsel's Regulatory Practice. John, Mike, Bobby and James, thanks for joining me.

01:19 - 01:20

John Nachmann: Thank you.

01:21 - 01:22

Mike MacPherson: Thank you, Kaitlyn. Pleasure to be here.

01:22 - 01:23

Bobby Gomez: Thank you for having us.

01:23 - 01:32

Kaitlyn Kiernan: Just to kick us off, can you each introduce yourselves and share your focus in the role of your team when it comes to T+1? James, do you want to kick things off alphabetically?

01:33 - 01:51

James Barry: Hi. Thank you. I'm Director of Credit Regulation here at FINRA. We primarily cover Rules 4210 and the margin rules and Regulation T. T+1 is going to primarily impact Regulation T compliance. And so, that's where we are going to offer our expertise today.

01:52 - 01:53

Kaitlyn Kiernan: Great. How about you, Bobby?

01:54 - 02:38

Bobby Gomez: Thanks for having me. I'm in the Department of Market Regulation and Transparency Services. The market regulation side of the department conducts oversight of the securities markets through automated surveillance, including areas that are affected by the change to T+1. The transparency services side of the department operates facilities that disseminate real time and historical market information for over-the-counter trading in the equity and fixed income markets, including as relevant for T+1, the Trade Reporting Facilities, or TRFs, the Over-the-counter Reporting Facility, or ORF, and the Alternative Display Facility or ADF. My group in particular, as well the Strategic Initiatives Group, is helping coordinate FINRA's preparations for T+1 across the organization.

02:39 - 02:41

Kaitlyn Kiernan: Thanks, Bobby. Mike, how about you?

02:41 - 03:18

Mike MacPherson: Yeah, thank you. As you mentioned, I'm a Senior Advisor in Member Supervision, supporting Risk Monitoring. Part of my function is working across all groups within Risk Monitoring on certain outreach functions that we do, T+1 being one of them, right? A major event that's happening in the industry. Hence, we in Risk Monitoring enact what we call our major events playbook and work in conjunction with Bobby Gomez with the overall FINRA working group. We ourselves formed a working group strictly on Risk Monitoring, reach out to firms discussing their readiness, their preparedness, any feedback that they may have regarding T+1. So, it's been interesting and I'm sure we'll get into the discussions.

03:19 - 03:23

Kaitlyn Kiernan: And last but not least, John, do you want to wrap us up?

03:23 - 03:34

John Nachmann: Sure. Hi, I'm John Nachmann from FINRA's Office of General Counsel. My team is responsible for amending FINRA's rules to align them with the SEC's adoption of the T+1 settlement cycle.

03:34 - 03:48

Kaitlyn Kiernan: Excellent. So, before we get into the nitty gritty of the actual implementation, let's just start by explaining what we're talking about. What is T+1 and to which securities does this amendment apply?

03:49 - 04:32

John Nachmann: To talk about T+1 we need to talk about two dates, the trade date which is the day and order to buy or sell securities executed, and the settlement date, which is the day the order is finalized and on which cash and securities are transferred between the buyers and sellers accounts. In a T+1 environment, a securities transaction will settle the next business day following the trade date. So, for example, if you sell a security on Monday, your trade would settle on Tuesday. T+1 applies to the same securities transactions covered by T+2. So, these include transactions for stocks, bonds, municipal securities, exchange traded funds, certain mutual funds and limited partnerships that trade on an exchange.

04:33 - 04:36

Kaitlyn Kiernan: And what does it mean from a rulemaking standpoint?

04:37 - 05:22

John Nachmann: In February 2023, the SEC adopted final rules on T+1. For purposes of this podcast, the most relevant of the rule changes are first, the SEC's amendments to Rule 15c6-1 to require a standard settlement cycle of T+1. And second, the SEC's adoption of new Rule 15c6-2 to improve the processing of institutional trades through new requirements related to same day affirmations. Once the SEC's rules were in place, FINRA then proceeded to amend its rules to conform them to the T+1 settlement cycle. FINRA's Rules become operative on May 28th of this year, which is the same compliance date the SEC has announced for Rules 15c6-1 and 15c6-2.

05:23 - 05:27

Kaitlyn Kiernan: And when's the last time settlement cycle shortened?

05:28 - 05:56

John Nachmann: Well, interestingly, in the 1920s, the settlement cycle for securities transactions was one day. Then over the subsequent decades, the length of the settlement cycle increased to five days until the SEC adopted Rule 15c6-1 in 1993 to shorten the settlement cycle to three days. A couple of decades later, in 2017, the settlement cycle was shortened to two days, and now, just a few years after the move to T+2, we're reverting back to a one-day settlement cycle.

05:57 - 06:00

Kaitlyn Kiernan: So, it took a century. But we've gone full circle here.

06:00 - 06:01

John Nachmann: Exactly.

06:02 - 06:05

Kaitlyn Kiernan: And why has it been shortening over the past few decades?

06:06 - 06:48

John Nachmann: Basically, due to improvements in technology that allow trades to settle more quickly. For example, with most trading and banking activities occurring online, extra days to physically deliver securities or funds are no longer needed. One of the main benefits of the shortening of the settlement cycle is the reduction of risk in the securities market. The shorter the time between the execution of a trade and its settlement, the less the chance that there will be an event that affects the transfer of cash or securities. This is especially relevant in times of increased market volume and volatility, such as following the outbreak of the COVID-19 pandemic in March 2020. The change also benefits investors because they're able to more quickly get access to their funds following a transaction.

06:49 - 07:06

Kaitlyn Kiernan: We don't have time to get into it today, but for our listeners, if you have a chance, look into the paper crisis to learn why we went all the way to T+5. The paper crisis is one of my favorite pieces of market history. But what are the implications of this transition for firms?

07:07 - 08:34

Mike MacPherson: We've been speaking to a number of our member firms as part of our outreach across all our firm groupings, clearing firms, introducing firms to gauge impact. We don't want to just assume. We understand that a lot of firms out there are following the SIFMA playbook, which is great, but we wanted to hear straight from the firms what they're experiencing. And what we've actually heard is firms are well aware that this is coming. They understand the implications. They have formed governance groups, working groups. They are working with internal stakeholders, external stakeholders, all vendors really, that would have an impact on this, different clearing organizations. So, firms have been taking this very seriously and have been working with who they need to. What we've heard specifically from firms varies.

Some firms are requiring technology changes in order to accommodate and be in compliance with the rules. Some firms are basically also using human capital. They're hiring more people to get in line with what needs to be done with T+1. The affirmation process as John mentioned, the allocation process, everything speeds up. Now that doesn't just happen overnight. Firms need to train people. They need to understand not only internally but also external clients. So, there needs to be education. Firms have really run the gamut on this and it goes down from the SIFMA playbook, but each firm may have some individual needs that they need to address. And that's really what we've been hearing from firms. Technology advances, definitely employee education, client education and where need be, they are hiring additional staff in order to not have any hiccups come May 28th.

08:35 - 08:44

Kaitlyn Kiernan: Thanks, Mike. You mentioned educating clients. James, can you share a little bit about what the impact is for investors and the retail customers?

08:44 - 10:21

James Barry: For retail customers, this could have a significant impact to the way they normally would assume they pay for trades. For instance, if customers use ACHs, automated clearinghouse funds, to pay for a transaction, the transactions that are being settled on a T+1 basis may settle before the payment clears the automated clearinghouse. So, in those situations, customers could end up having debit balances in their cash accounts, for instance. So, when customers are placing orders online and they don't have, say, sufficient funds in their account to pay for the trades on settlement date, and they're assuming they will be able to do an ACH to pay for them by settlement, they should be very aware of the tightened timelines and how this may impact their ability to pay on time for their trades. The other thing that's happening here is we've talked about changing of the settlement cycle, but the payment cycle primarily comes from Regulation T. The requirement for a customer to pay for their trade isn't a settlement issue, that's a Regulation T issue. And the payment period in Regulation T is automatically linked to the settlement cycle under SEC regulations. So, from a customer perspective, Regulation T will automatically change. This will then impact the payment periods for margin accounts as well. There is a shift that's going to happen on the customer side of the equation that they will need to be aware of, that these settlement cycles are also going to impact the time that they get to wait to pay for their trade.

10:22 - 10:48

Kaitlyn Kiernan: Thanks, James. So, that seems like it feeds into that educational piece for customers that Mike just mentioned. So, it's good to have more detail there. And we mentioned that the implementation date is May 28th. So, that is sneaking up on us. Why is it important for firms to make sure they're prepared for this transition? And what are some of the risks of not being adequately prepared?

10:49 - 12:13

Mike MacPherson: There's multiple risks, but one of the main things that may happen if you're not adequately prepared is operational inefficiencies will come May 28th or come May 29th if you're not prepared for this and if you're not speaking to clients, or if you're not speaking to your clearing firms, if you're an introducing firm, you do run the risk of fails. You run the risk of possible possession or control issues with stock long recalls. You run the risk of not being prepared for mismatched settlements. A little different this time around with T+1-last time in 2017, most of the international markets were already on T+2. The domestic markets were the last of the party. This time around we are first and international settlements will follow. So, it is a little bit different here in terms of getting out there. So, you run that risk, that mismatched settlement risk.

We've highlighted this in our Reg Notice and several of our committee meetings. We've highlighted this potential mismatch of settlement risk. So, it is being prepared for that. Again, not every firm engages in these types of businesses but to the extent that you do, this is what we're asking you to be prepared for, along with that affirmation and allocation process. That is key. If you saw recently DTC put out an article as well saying they're looking for 90% affirmation to be done by 9:00 on T. As of December 2023, I believe there were only at 69 or 70%. So, they're really looking to get that percentage up. So, risk of not being prepared for that, risk of not affirming the trade is risk of the trade not settling timely.

12:13 - 13:36

James Barry: For institutional DVP, customer transactions, delivery versus payment, that's when you simultaneously will deliver securities and receive the cash to pay for the securities. Very typical in institutional type of transactions. Also included in that business would be prime brokerage transactions as well. Of course, they will be settling on T+1, and the payment period in Regulation T is the same for those. And we are concerned from a Regulation T perspective, as Mike mentioned, that trades are not affirmed and they will be DK'd by the receiving firm on settlement date because they haven't got the instructions to match at TTCC. So, we have made a change to our extension of times for DVP transactions related to DKs, which is just jargon for 'don't know.' And that means whoever is accepting the trade doesn't have the instructions from their customer to match the trade, so they don't know the trade, so they will just send it back to delivering broker. Historically, we've only allowed two-day extensions and only one of each extension was allowed. We made a change to allow two extensions for DVP DKs. So, this will give firms more time to manage the DK and hopefully settle the trade.

13:37 - 13:45

Kaitlyn Kiernan: Great, thank you. And, Mike, what have you been hearing from firms in terms of how they're preparing? Are there any best practices you can share?

13:45 - 16:01

Mike MacPherson: Our outreach was done in the early fourth quarter of 2023. We also are conducting a second round of outreach. As we get closer, we are in the midst of that. So, feedback is pouring in. So, I don't have anything hot off the press in terms of second round but really from that first round of outreach, firms like I mentioned, putting those governance teams together, working in subgroups to handle all the various aspects of T+1-front office, middle office, back office, doing user acceptance testing within their systems, working hand-in-hand with the vendors. There's major vendors out there in terms of middle office. And some, we'll say back-office functions.

We've definitely heard that firms are partnering with them throughout this whole process. And it's been a great partnership. Engaging in any testing window that's out there and engaging with DTC, making sure that testing is going as planned with DTC. They put a lot of literature out there as well, so we definitely heard firms engaging with DTC as well as exploring other avenues, perhaps ACH payments. James mentioned earlier firms are exploring or educating clients on other ways to fund their account. Stock loan, prime brokerage, can't stress it enough-recalls, best practices. Everything's sped up, so it's on T, night of T. If you talk to people who've been talking to SIFMA, if you're looking in the SIFMA playbook, it's 11:59. Now that you know you want to issue those recalls on T, if you're looking at the affirmation, allocation process, it's getting word out there to your buy-side clients that we need those trade allocations. The affirmations have to happen T by 9:00. This is something that's been publicized, been talked about, and it's really something that everybody is looking to accomplish. So, we've heard that.

I mentioned earlier, some firms have hired more people to deal with this. They're trying for technology to speed up this process. So, firms are definitely taking control of the situation and making sure that they are doing everything possible before May 28th. And just from a funding and liquidity perspective, there actually could be liquidity benefits here in terms of clearing or requirements may come down because there's less duration risk. So, we've heard a lot about what firms are preparing to do in terms of okay, let's make sure everything's all right. Let's make sure there's no operational issues. But we also want to talk about all the benefits of T+1 as well. Yes, some liquidity gains being one of them.

16:02 - 16:34

James Barry: We did publish Reg Notice 23-15 on the extension process and the testing. We did make a change to that. We've expanded the testing through to May 28th. So, right up until go live date, we will allow firms to test for T+1 with the extension system. If people need more information on finding stuff out about extensions and margin in general, go to finra.org/margin and that'll take you to everything you ever wanted to know about extensions and margin.

16:35 - 17:05

Kaitlyn Kiernan: We will link to that Reg Notice and some of the other resources, like the SIFMA playbook in our show notes, so listeners can find easy access links there. Testing doesn't sound like my ideal Memorial Day weekend, so hopefully folks get started sooner than that. So, I assume that the implementation varies quite a bit based on the type of firm as well. So, Mike, is there anything you've heard about the prep that's more firm type specific that you'd want to mention?

17:06 - 18:00

Mike MacPherson: We've done a couple rounds of outreach. This round of outreach really focused more on us and the introducing firms and making sure of their preparedness with 15c6-2 as John mentioned earlier, the new aspect to the rule and making sure that they understand the relationship with the clearing firm who's doing what, who's responsibility is it from the affirmation process? Are they speaking with their clearing firms on what does it mean if I don't affirm, what does it mean if I don't have funds in the account, if I can't settle timely? Just making sure that they are asking these questions. Again, they most likely definitely are. But we just don't want to assume anything. So, just different aspects that you're hearing more from the operational side aspect on the clearing firms and more I'll say on the upfront aspect on the introducing firms, that's the kind of difference that we're hearing, but we're just getting the word out there. The first time around, I think we were clinical in how we sent out information this time around, we're really trying to partner with the industry.

18:02 - 18:09

Kaitlyn Kiernan: Great. Thanks. And in your outreach, what have you heard regarding what firms are most concerned about?

18:10 - 18:42

Mike MacPherson: I think you've heard it several times here already. Affirmation process is absolutely number one. You've probably heard us all mention it. I'll say angst really, instead of concern. It's not totally in their control. It is that client education, right? It is getting it out there to any kind of party that they're involved in. It's by far topic one, maybe followed by that international piece where the settlements, domestically, will be on T+1, while most international settlements will be on T+2. I'll say that's a distant second in terms of angst, but really that affirmation allocation process.

18:43 - 19:06

Kaitlyn Kiernan: Great. And I'll also point out FINRA has on its website a investor focused education piece about the transition to T+1. So, if firms wanted to use that with their clients, we'll also link to that in the show notes. And were there any lessons learned from the T+2 transition in 2017 that FINRA is applying this time around?

19:07 - 19:58

Mike MacPherson: This time around, we have really ramped it up in terms of the form of outreach that we are conducting right now. As I mentioned, we implemented our major events playbook, and what that means is everything's documented and everything's centralized. That's the best part about this. The feedback loop is tight. So, in other words, if we're hearing something from firms, it's all centralized in one place. People can analyze it. I can talk to the overall working group. I can talk to Bobby Gomez and let him know if he's talking to the SEC to make sure they're aware of it. I can talk to James Barry on anything, anything in the rules I could talk to John on. So, everything here that we're doing right now is our best practice for the industry, we'll say. And Reg Notice, you can tell by the tone and how we've approached it this time around. It is much more, we'll say, user friendly in terms of getting the education out there. It's not just telling you, well, here are the rules that are updated. And that's not the only information that we're putting out there.

19:58 - 20:08

Kaitlyn Kiernan: And of course, the move to T+1 doesn't just impact firms, it also impacts FINRA. So, Bobby, what has FINRA been doing to prepare for this move to T+1?

20:09 - 21:23

Bobby Gomez: Mike covered the outreach that we've done to firms, and both Mike and James were talking about the different areas that are implicated by the change to T+1. It really does impact compliance with numerous rules and regulations, including Regulation SHO, SEC financial responsibility rules, a payment period for purchases under Regulation T, recordkeeping requirements are impacted as well. And given this broad impact, really within two weeks or so of the SEC's adoption of the rule changes to move to the T+1 settlement cycle here at FINRA, we started to form a cross-departmental working group to ensure that the organization is taking a holistic approach to assessing the impact of the rule changes, ensuring coverage across all impacted areas of the organization, as well as sharing information with all the relevant stakeholders. Our working group includes staff from our Office of General Counsel, from our Departments of Member Supervision, Market Regulation and Transparency Services, Finance and Technology, and really the benefit of the working group is it's provided a forum for the different FINRA departments and groups to discuss their plans for preparing for the move to T+1, as well as to identify and elevate issues for broader discussion, so that information does not stay siloed within one single area of FINRA.

21:24 - 21:41

Kaitlyn Kiernan: A lot of those departments from the working group represented here on the podcast today as well. We've also mentioned a couple times that FINRA has made a number of testing environments available. Why is it so important to take advantage of and run tests under these different scenarios?

21:42 - 22:20

Bobby Gomez: The reason it's important for firms to take advantage and test under these scenarios is so that they can ensure that from an operational standpoint and from a technological standpoint that their systems are working the way they should. What no one wants is for the compliance date to come, and it's May 28th, and firms don't know what they're doing, and they have issues in terms of how they're adapting and complying with all the various issues that are related to this move to T+1. It's important for firms to understand what they need to do from an operational standpoint, and the testing enables them to work out some of the kinks that they might otherwise experience if they were to simply not test.

22:21 - 22:37

Kaitlyn Kiernan: Just to wrap up, we've talked about a lot of important information about this transition, but just for us all to wax poetic a little bit at the end, what are your thoughts on T+0? What does everyone think? Is that where we're going next?

22:38 - 22:58

Mike MacPherson: Everything is moving faster. Just look at certain spaces that aren't in our jurisdiction. I'll say, just look at the crypto space. Everybody loves the convenience of it. The quickness. I think we're headed there. I don't know when, but I can't imagine a world in which we're not moving forward and thinking in that direction. I think we're a long way off, to be honest, but I don't see how we don't progress to T+0.

22:58 - 24:20

James Barry: You know, I think there is a challenge for the buy-side to move along here. As Mike mentioned earlier, the affirmation rate is critical and moving to effectively, real time affirmations where firms right now are unable to in general get the affirmations in on T0. This is going to be a huge change for the industry. There's also advantages to investors for settlement on T+1-stock loan is a big piece of the puzzle here. That's clearly an advantage for investors, being able to borrow stock and return it. Having real time returns of borrows or near real time returns of borrows is another challenge I think the industry would have to face. There's a lot of things that have been working well with having more time to settle a trade, so it's not like everything is a positive, but getting all your stuff lined up, your financing, international settlements. One thing I don't think we mentioned particularly was normal settlements around spot FX. Spot FX settlements, I think is another problem. Are we going to be able to manage customers paying for their trades from abroad, funding US dollars and converting from their foreign currency into US dollars all in near real time? There's more challenges than I think would be limited to just the United States alone.

24:20 - 24:32

Mike MacPherson: Yeah, I'm not saying John won't be busy rewriting some rules, but...That's definitely a major part in moving to T0.

24:33 - 25:16

John Nachmann: I agree with Mike that going to T0 is definitely a possibility, but it will be some time in the far future. It definitely seems like the SEC would like to move in that direction, and it noted in its proposing release for T+1 that it's actively assessing a T+0 settlement cycle and asked for public comment on it. While the SEC determined not to move to T+0 this time due to the operational and technical challenges, the SEC did say that it will be working with industry leaders, public interest advocates, investors and other regulators to assess the future feasibility of T+0 and identify ways to overcome the challenges associated with the move.

25:16 - 25:19

Kaitlyn Kiernan: Good to know. Bobby. Any final words?

25:20 - 25:54

Bobby Gomez: I think eventually we will move to T+0. I think in my mind the question is really how long it takes. From a purely technical standpoint, I understand that it's not overly complicated and it's somewhat relatively straightforward, but moving to T+0 would require numerous, complex market structure changes really across multiple financial markets as well. So, in that sense, it wouldn't be easy. Having said that, I think when it does happen, I think it's going to be relatively swift where one market is probably going to take the plunge and everyone's going to have to quickly follow to get in line. So, that would be my prediction as to how it'll play out.

25:55 - 26:26

Kaitlyn Kiernan: Great. Well, that's it for today's episode of FINRA Unscripted. Bobby, James, John and Mike, thank you for joining me to discuss the wide-ranging impacts of the move to T+1. Listeners, definitely check out the show notes for links to the various resources we mentioned throughout the episode. And if you don't already, you can subscribe to FINRA Unscripted wherever you listen to podcasts. Today's episode was produced by me, Kaitlyn Kiernan, edited and engineered by John Williams and coordinated by Hannah Krobock. Until next time.

26:26 - 26:32

Outro Music

26:32 - 26:59

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