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\
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    \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\
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    \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

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\
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    \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,

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), http://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), http://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), http://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

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

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).
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    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: http://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

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\
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    \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).
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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.
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    \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).
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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

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), http://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

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, http://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\

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), http://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), http://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.
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    \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).
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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.
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    \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\
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    \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

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.
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    \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

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), http://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), http://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

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), http://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), http://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), http://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''), http://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

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.
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    \247\ See, e.g., Omgeo, Mitigating Operational Risk and
Increasing Settlement Efficiency through Same Day Affirmation (SDA),
at 12 (Oct. 2010), http://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.

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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\
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    \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.
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    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.
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    \253\ See supra note 11 and Part VI.B.3, and infra Part VI.C.1.
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    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.
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    \254\ See DTCC Recommends Shortening the U.S. Trade Settlement
Cycle, supra note 76, at 2-3.
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    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\
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    \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), http://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.
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    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.
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    \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.
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    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.
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    \258\ See supra note 9 and Part VI.B.3.
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    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

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.
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    \259\ See supra Part II.A.3. for diagrams of retail and
institutional trade settlement flow.
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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.
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    \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).
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    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.
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    \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.
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    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\
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    \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.
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    However, broker-dealers that predominantly serve retail investors