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94-18 Municipal Securities Rulemaking Board Preparing Way For T+3 Settlement Of Municipal Securities
Securities and Exchange Commission (SEC) Rule 15c6-l, effective June 1, 1995, establishes three business days as the standard settlement time frame for most securities transactions. Although municipal securities currently are exempt from the rule, the SEC has requested the Municipal Securities Rulemaking Board (MSRB) to develop a T+3 implementation plan for the municipal securities market.
In October 1993, the SEC approved Rule 15c6-l under the Securities Exchange Act of 1934. This rule requires the securities industry to compress the current five-business-day settlement time frame to three business days in June 1995. The rule does not cover municipal securities; however, the SEC has asked the MSRB to undertake a similar commitment for municipal securities. The MSRB is drafting a plan for presentation to the SEC, discussing how to handle the conversion to T+3 settlement for municipal securities.
Discussion Of Preparatory Actions
Shortening the settlement cycle requires improved use of automated clearance and settlement systems. In a T+3 environment, dealers, customers, and clearing agents all will have less time to deal with transactions that are not cleared automatically. Thus, it is crucial that all transactions, including transactions between dealers and with institutions, are processed efficiently within centralized automated clearance and settlement systems.
The MSRB recently strengthened its rules governing automated clearance and settlement systems. In 1993, it amended Rules G-12(f)(ii) and G-15(d)(iii) to require book-entry settlement for essentially all transactions between dealers and with institutions that involve depository-eligible municipal securities. In addition, all transactions between dealers are now subject to comparison in an automated comparison system under an amendment to Rule G-12(f)(i). Effective July 1, 1994, all transactions with institutional customers must be confirmed/affirmed in an automated confirmation/affirmation system (e.g., the Depository Trust Company's ID system) under an amendment to Rule G-15(d)(ii). These amendments remove several broad exemptions that previously existed in the rules, leaving exceptions only for special, narrowly defined types of transactions.
Improved performance by dealers, institutions, and clearing agents in the automated clearance system is critical if T+3 settlement is to occur without increasing the number of failed transactions. At the present time, the comparison rate for transactions between dealers is approximately 75 percent in the initial comparison cycle (i.e., by the close on trade date). Similarly, the affirmation rate for institutions is approximately 82 percent on T+3. Both of these rates must improve significantly to ensure that transactions in municipal securities will settle on time in a three-day settlement cycle. In the corporate securities market, the affirmation rate presently is 96 percent, and the corporate industry is working to increase this rate prior to the conversion to T+3. It is clear that, for the municipal securities market, it is even more important to address this area before T+3 is attempted.
The MSRB and NASD currently are working with clearing corporations, depositories, members, and industry associations to encourage educational efforts to improve the use of automated clearance systems for municipal securities transactions. Since participation in these systems by dealers is required under MSRB Rules G-12(g) and G-15(d), the NASD will increase its examination and surveillance focus on ensuring better member compliance with these MSRB rule requirements and improved performance in the systems. Members with poor comparison/affirmation rates must take immediate action to correct any deficiencies, and if an improvement is not made in a reasonable period of time, regulatory action by the NASD may become necessary. Through these efforts the MSRB and the NASD believe that it is possible to make great strides before the scheduled June 1995 date for conversion to T+3 settlement.
At this time, it appears the municipal securities industry can convert to T+3 along with other securities markets. Although the MSRB and the NASD believe there are unique problems on the institutional side of the municipal market, the solutions to these problems have been identified, and the remaining preparatory work, although considerable, can be done over the next several months if the industry makes the effort to do so. Persons having questions regarding this Notice may contact Brad Darfler, NASD Compliance Department, (202) 728-8946.