With the two-day settlement cycle on the horizon in the US, market players have their hands full, ensuring they have adapted their front, middle and back-office operations correctly before September 5. However, one major concern about the changeover has just been relieved.
The New York Stock Exchange and Nasdaq have eliminated September 5 as an ex-dividend date for corporate actions involving listed issuers. That decision promises to reduce the risk of time-consuming paperwork when there is a dispute about the party entitled to the corporate action payment in unsettled trades.
September 5 is when the US settlement cycle officially shrinks from three days to two days (T+2) after a trade is executed. It is also two days before the the so-called “witching day” on September 7, when previous trades settling on a three-day cycle and current trades now on T+2 settlement have to be processed on the same day. Given that September 5 will no longer be an ex-date, financial firms can breathe a sigh of relief that misunderstandings about who is entitled to receive a corporate action will be greatly reduced.
“Having September 5 as an ex-date would ordinarily not be a problem if it were not for the double settlement cycle on September 7,” says Steven Dapcic, director of corporate actions for Pershing in Jersey City, NJ. As BNY Mellon’s correspondent clearing subsidiary Pershing handles operational work for introducing brokers.
Corporate actions can comprise anything from a simple stock dividend to a complex corporate reorganization requiring investor approval. Those types of “voluntary” corporate actions have the highest potential for entitlement errors. The ex-date reflects the date before which an investor must purchase a security to be entitled to a cash or other payment from a corporate action. The purpose of the ex-date is to ensure that the correct party is registered as the shareholder of record when the entitlement is calculated and receives the benefit of the payment. Exchanges set the ex-date for their listed companies based on the current settlement cycle of T+3.
“Given the double settlement for trades executed on September 1 (T+3) and September 5 (T+2), the NYSE will not be quoting any security ex-distribution on September 5,” confirms a spokesperson for the exchange. “This situation is similar to trades executed around bank holidays such as Columbus and Veteran’s Day for which banks are closed. These days are deemed to be non-settlement days.” The spokesperson says that the exchange is already informing issuers what the ex-date will be if they set a record date of September 7 or later. September 4 is a US holiday.
Likewise, says Nasdaq in a memorandum to issuers: “Nasdaq and the other self-regulatory organizations have agreed with Depository Trust & Clearing Corp, which processes distributions for publicly traded securities that no securities will be ex-dividend on September 5, 2017 because otherwise there could be confusion about the proper settlement.” As the parent firm of the US national depository Depository Trust Company and clearinghouse National Securities Clearing Corp. (NSCCC), DTCC is one of several organizations spearheading the US’ move to a T+2 settlement cycle.
Nasdaq’s memorandum went on to warn issuers that the first record date to which the new ex-dividend date will be applied will be Thursday September 7. Securities with a record date of September 7 will have an ex-date of September 6 while securities with a record date of September 6 will have an ex-date of September 1. Securities with a record date of September 5 will have an ex-date of August 31.
While the US securities market has been working towards achieving T+2 for over a year, it wasn’t until March 2017 that the US Securities and Exchange Commission finally made the necessary rule change to effect the shorter settlement cycle. When it did so, it also required that as self-regulatory organizations the exchanges reduce the gap in time between the ex-date and the record date of a corporate action from three days to two days. That decision left the exchanges, DTCC, broker-dealers and transfer agents to consider what would occur if the ex-date fell on September 5.
“Creating an ex-date on September 5 would result in trades executed on September 1 and September 5 comingled in a single settling balance order for a double settlement cycle of September 7,” explains Dapcic. That means that the Continuous Net Settlement (CNS) system of NSCC would not be able to differentiate just who should receive the corporate action payment.
If that were to happen, there would ultimately lead to an increase in market claims, which typically occur for corporate action payments when a trade doesn’t settle on the intended settlement date. The failed settlement can result in the incorrect details of the beneficiary of the corporate action registered as the shareholder of record on the transfer agent or issuer’s books. Therefore. the broker-dealer of the investor entitled to receiving the corporate action would have to file a claim with the counterparty to receive the payment.
Although the exchanges may have alleviated one problem with handling corporate action payments, market players still aren’t entirely in the clear when it comes to addressing another critical aspect of corporate actions. That is a change to the cover/protect or guaranteed delivery timetable for some voluntary corporate actions, such as exchange offers and rights subscriptions. The purpose of the cover/protect or guaranteed delivery is to allow an investor to participate in a voluntary corporate action even if it doesn’t hold securities in its account at the time the corporate action expires. The securities might not have been delivered by another party or they might be out on loan.
The move to a T+2 settlement cycle will require the cover/protect period to lapse in two days, instead of three days, after the expiration date of the corporate action or the date when the investor must make a decision. Establishing a protect expiration date on a voluntary corporate action depends entirely on the issuer of the security, which establishes the term of the corporate action in the offering document.
Dapcic cautions that agent banks representing issuers need to provide them with guidance to ensure that they calculate the cover/protect period correctly. What happens if they don’t? If the protect expiration date is incorrectly extended, investors may buy securities after the expiration date for the corporate action and still try to vote on the corporate action.
Then what? “Lack of synchronization on the protect expiration date and T+2 settlement will create confusion among industry participants when filing ‘protects’ and generate liability notices that may not be honored,” explains Dapcic. Buyers of securities file “protect” requests when purchasing securities based on the agreements sellers deliver to them before the day the protect request expires. The broker for the party who must have securities on hand to participate in a corporate action will file a liability notice to another broker who fails to deliver them on time.
Any change in the ex-date of a security or change to the timetable for making a decision on the corporate action will likely need to be recorded in the fund manager, custodian bank or broker-dealer’s corporate actions system which typically downloads information from data vendors who have incorporated the timetables into their data feeds. “These applications currently have a setting to derive the ex-date as record date minus two business days,” explains Gerard Bermingham, director of business strategy for the Information Mosaic unit of data provider IHS Markit in New York. “This will need to change to record date minus one business day. Organizations that also offer dividend reinvestment programs will need to modify any systems that manage the DRIP process to again reflect the change in the number of days between the ex-date and the record date.” Information Mosaic offers software which handles all the steps of a corporate action from its announcement to its settlement.
The need for the industry to prepare for changes to the corporate actions lifecycle has been taken into account in DTCC’s industry-wide testing of adjustments to affected systems, which began in February. That testing includes corporate action events that require an ex-date or cover protect date such as stock-splits, spin-offs, rights distributions and mandatory exchanges. DTCC is now in the ninth of fourteen testing cycles with the last one set to conclude at the end of August.