Are You Ready for T+1?
February 10, 2022
It seems like only yesterday that the settlement period for market transactions dropped from three to two days. Back in 2017, when I first blogged about this change, I said “The consensus … is that T+1 is a long ways off.”
I guess it depends on how you define “a long ways” but I may have to eat those words. In December, the Securities Industry and Financial Markets Association (SIFMA), the Investment Company Institute (ICI), and the Depository Trust & Clearing Corporation (DTCC) released a 43-page report to recommend a transition to a T+1 settlement cycle for market transactions. Yesterday, the SEC issued proposed rules to shorten the settlement cycle to T+1 (thanks to Andrew Schwarz of Computershare for bringing the SEC's proposal to my attention.)
[Maybe it is just a sign that I am old that five years doesn’t feel that long to me anymore. Still, it took over 20 years to go from T+3 to T+2; I think it was reasonable to assume we’d have a little more time to get to T+1.]
Not So Fast
Luckily, there is still a little time before you have to be ready for this. The report recommends implementing the T+1 settlement period in Q1 or Q2 of 2024. And there’s a lot that has to happen between now and then, including deciding on an actual date to make the changeover. (But, hey, the steering committee has a logo so at least the branding is well underway.)
Still, if you thought the last five years went by quickly, the next two years are going to fly by.
Why the Rush?
This is all about risk management. During the settlement period, there is risk that one of the parties to the transaction will back out (e.g., what if one of the brokers facilitating the transaction declared bankruptcy before the trade could settle). The longer the settlement period, the greater the risk.
Protecting market participants against that risk requires cash to be set aside, so that each party’s obligations can be guaranteed. This cash is provided by various market participants (such as brokerage firms).
Shortening the settlement cycle reduces the inherent risk, which in turn reduces the cash needed to guarantee settlement. This frees up cash that market participants can use for other, presumably better and more profitable, purposes.
In May of last year, SEC Chair Gensler attributed some of the issues involved in the meme-stock frenzy to the current two-day settlement cycle.
How Will 1-Day Settlement Work for Equity Awards?
That is a good question that I don’t know the answer to. Moving from T+3 to T+2 proved to not be that difficult, but T+1 seems like a whole different ballgame.
Here is an example of how the current settlement cycle works for equity award transactions that involve open market sales, such as same-day sale exercises or sell-to-cover transactions for RSUs:
- T: The trade occurs and is recorded in the company’s recordkeeping system. Once the market has closed, the stock plan administration team (in-house or third-party) begins processing the transactions.
- T+1: The share issuance request is sent to the transfer agent and the funds needed to cover the price of the shares and any tax withholding are communicated to the broker.
- T+2: The broker picks up the shares from the DTC and settles the trade.
It’s hard to figure out how this process can be condensed into one fewer day, especially for companies on the east coast (the markets close at 1:00 PM for those of us on the west coast, so we have a little more time to get the transactions processed on the trade date).
Yet Another Reason to Stop Granting Stock Options? (Or Consider Net Exercise?)
Of course, the easiest solution for stock plan transactions might be to avoid the matter altogether. The settlement period is only required for open-market transactions. It doesn’t apply to transactions between the company and employees, such as net exercises of stock options, SAR exercises (even if settled in stock), and share withholding on RSUs.
So maybe T+1 will be another nudge in the direction of full value awards or net exercises.