Last week, the House Financial Services Committee heard testimony from new SEC Chair Gary Gensler about January’s market volatility. Here’s an excerpt from his prepared remarks (also see this 18-page CII Research report from last week):
As we work to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation, I’d like to highlight seven factors that were at play in these volatile events:
1. Gamification and User Experience
2. Payment for Order Flow
3. Equity Market Structure
4. Short Selling and Market Transparency
5. Social Media
6. Market “Plumbing”: Clearance and Settlement
7. System-Wide Risks
We expect to publish a staff report assessing the market events over the summer. While I cannot comment on ongoing examination and enforcement matters, SEC staff is vigorously reviewing these events for any violations. I also have directed staff to consider whether expanded enforcement mechanisms are necessary.
Stonks’ Silver Lining: Same-Day Settlement?
In his remarks to the House Financial Services Committee, Chair Gensler said the two-day settlement cycle was partially to blame for the trading freeze-out that some investors experienced at the height of the “GameStonk” market frenzy. Here’s an excerpt about that:
The longer it takes for a trade to settle, the more risk our markets assume. The good news is, though it will take a lot of work by many parties, we now have the technology to further shorten the settlement cycles, not only to the settlement cycle we had a century ago, but even to same-day settlement (T-0 or “T-evening”).
I believe shortening the standard settlement cycle could reduce costs and risks in our markets. I’ve directed the SEC staff to put together a draft proposal for the Commission’s review on this topic.
Chair Gensler isn’t the first or only person to raise this possibility. CII’s Research & Education Fund suggested in a paper last week that slow settlement times were a potential contributor to the GameStop frenzy. And although it was only 4 years ago that the SEC said “hasta la vista” to T+3 settlement, former SEC Commissioner Michael Piwowar – who was an enthusiastic supporter of that 2017 rule change – also argued in a February WSJ op-ed that the 2-day settlement period is now past its prime.
DTCC then issued this 14-page whitepaper to identify steps necessary to move toward a T+1 settlement period – by 2023. DTCC says:
We believe the opportunity exists to accelerate the settlement cycle and optimize the process further, to T+1, T+1/2 or someday, even netted T+0, in which trades are netted and settled at the end of the same trading day.
DTCC goes on to say that real-time settlement is unlikely. It would put market makers in the very tricky position of having to see into the future and know what their net obligations will be at the end of each day, and have enough shares or dollars to meet those obligations. They’d basically have to change all of their processes and move to a transaction-by-transaction system. Last week, the Investment Company Institute (ICI), the Securities Industry and Financial Markets Association (SIFMA), and DTCC issued this follow-up FAQ to reiterate what needs to be done to accelerate the settlement cycle, and why T+0 isn’t feasible for all trades. But with Chair Gensler’s remarks, they could be taking a closer look at those obstacles.
In addition, DTC might be facing some competition. Paxos Trust Company announced that it’s already using blockchain technology to achieve same-day settlement for some equity trades. Paxos has also applied for full clearing-agency registration with the SEC and hopes to be approved sometime this year.
If and when a shorter settlement cycle arrives, it’ll have the most impact on broker-dealer obligations. The 2017 amendments didn’t change the settlement cycle for securities sold in most cash-only, firm commitment underwritten offerings – as explained in this Skadden memo at the time – and settlement on public offerings is still all over the place. While most deals are at T+3 or even T+4, some debt issuers want to push out settlement even further so that interest doesn’t start accruing.
Tomorrow’s Webcast: “Capital Markets 2021”
The capital markets have been a wild ride lately! Tune in tomorrow for our webcast: “Capital Markets 2021” – to hear Katherine Blair of Manatt, Phelps & Phillips, Sophia Hudson of Kirkland & Ellis and Jay Knight of Bass, Berry & Sims discuss what 2021 has in store for companies looking to access the capital markets, including discussion of financing alternatives. This webcast is available to members of TheCorporateCounsel.net as well as members of DealLawyers.com – you can tune in on either site!
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– Liz Dunshee