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An investment management perspective
The global securities industry is undergoing a period of dramatic change driven by increasing customer expectations. Centred on Internet-based business models and new regulations requiring T+1 securities processing, both these expectations share a common solution, End-to-End Straight Through Processing. End-to-End STP (also known as Global STP) allows transactions to move seamlessly through the processing cycle without manual intervention or redundant handling, thus resulting in substantial cost savings and a reduction in failed transactions.
This requires the automation of nearly every process along the way, as well as application-to-application connectivity to allow integrated information flows. In addition to these, complete linkage with industry utilities, networks, business partners and industry standards is necessary in order to allow instantaneous communication. It is therefore apparent that although End-to-End STP offers enormous benefits to the entire financial services industry, achieving it represents an equally enormous challenge.
Two solutions have emerged in response to this challenge, GSTPA and Omgeo. GSTPA (the Global Straight Through Processing Association, an industry association for investment managers, broker/dealers and global custodians) represents the industry led initiative. Omgeo, formed out of the merger of DTCC and Thomson Financial, represents the for-profit alternative. Largely erroneously, GSTPA has been seen as the primarily European, crossborder initiative while Omgeo has been perceived as the US domestic alternative; but in practice either solution has the functionality to handle either/both roles.
Both solutions have their pros and cons. Many investment managers, particularly in the UK and Europe, clearly felt uneasy about the lack of clear information that was available about Omgeo and also believed that it would prove expensive; perhaps exorbitantly so; if it achieves market dominance. (This lack of information was understandable due to the recent formation of Omgeo.) On the other hand, courtesy of the widespread use of Thomson's OASYS solution, Omgeo already has a strong base of market penetration upon which to build. GSTPA, despite having the benefit of being designed from scratch rather than formed by merger, still has to work from the ground up in achieving market adoption.
This report is based upon a survey conducted by TCA Consulting in winter 2001 of twenty-six respondents drawn from major investment management firms in the UK.The survey was designed to learn more about the plans of investment management companies to participate in End-to-End STP in global securities, the anticipated efficiencies and issues, and their likely choice of system. The take-up of STP by investment managers is key as they will drive the volumes. A further objective of the research was therefore to understand the perception of GSTPA and Omgeo in the marketplace to assess the levels of take up, and learn when, and by which initiative, critical mass might first be achieved.
Sitting on the fence
Investment managers do not presently perceive any significant first mover advantage from rushing to adopt one or other solution before their peers, since they feel that any benefit at this stage is likely to be peripheral at best. Tracker funds are an obvious exception to this as management fees are far lower and the incremental advantage of lower processing costs will have a much higher proportional impact on overall performance.
However, sitting on the fence will not be an option for very much longer; particularly for investment managers active in US markets.T+1 is a very real deadline, and STP is necessary to even contemplate the move towards it. Since the US market will be working on the T+1 model (albeit in a T+3 timeframe) from mid 2004, the deadline for practical purposes is shorter than many appreciate.The squeeze on specialist resources that usually takes place as such deadlines approach (e.g. first phase Euro and Y2K) makes it likely that delaying implementation much beyond the end of 2001 may, in the long run, prove a costly strategy.
Admittedly, not all managers are necessarily under the same time pressure. Apart from those with absolutely no US exposure, another group that can perhaps afford a slightly more leisurely approach are those who intend using one of the concentration services. Since these will circumvent the need for managers to connect directly into Omgeo or GSTPA, the scale of the implementation task for those using them will be appreciably smaller.
Custodians have a clear incentive to change this. Apart from all the usual STP benefits, it is logistically not in their interests to have a mass of clients all switching over to Omgeo or GSTPA at the last possible moment. Furthermore, a few early high profile client implementations should provide the sort of tangible evidence of benefit that might lure the rest down from their perch on the fence. As yet, this doesn't seem to be happening; less than 25% of interviewees reported that they were under any sort of pressure to participate and of these none said pressure was coming from their global custodian. Perhaps a suitable case for a spot of judicious soft dollaring on the part of the custodial community?
Both solutions appear to have something of a perception problem to overcome. Despite the composition of its board (which has six industry and four Thomson/DTCC members) several managers expressed concerns that Omgeo's pricing could prove problematic if it established market leadership. Given that Omgeo, courtesy of Thomson's six thousand or so OASYS users, already has something of a head start, such concerns are perhaps not unreasonable. (More than 90% of survey interviewees also stated that they used existing DTCC or Thomson products.
Rather ironically, Omgeo's head start also causes a perception problem for GSTPA, with some managers expressing concerns that as a result GSTPA may never achieve the necessary critical mass, further fuelling fears of an Omgeo monopoly. However, the guarantee of interoperability with other similar industry initiatives that Omgeo was obliged to give to the SEC when it was formed should provide a measure of comfort, and prevent exclusivity.
An area that Omgeo and GSTPA both need to address is the widespread misconception about their geographical coverage. Managers' comments made it clear that many saw Omgeo as the US domestic option, while GSTPA was the obvious choice for Europe and cross border transactions. This is perhaps understandable given that one of the Omgeo partners is the US domestic depository and that GSTPA has awarded the build and run of the TFM to a European Consortium; Axion 4; who also include the Swiss Depository SIS. However, both solutions have the necessary functionality to cover both roles. For example, Omgeo may not specifically cover cross border transactions, but Thomson OASYS (which is a major ingredient in Omgeo) is already frequently used in that role.
Fund managers' lead
Though custodians and other service providers can supply both incentives and dual coverage, it is investment managers who will ultimately determine the actual take up of GSTPA and Omgeo. Despite UK investment managers' concerns over lack of information, their 'wait and see' attitude isn't due to a dearth of preparation or a lack of broader awareness. For example, 80% of those interviewed stated that their ISO15022 projects were already underway and more than half of them cited T+1 and shorter settlement cycles as the major issues for the industry over the next three years.
Those shorter settlement cycles may at least partially account for investment managers' current reluctance to descend from the fence. The SIA estimates that by next year more than 16% of institutional trades will not be affirmed by noon on T+2. Given that, it's perhaps understandable that there are probably more than a few managers who currently regard T+1 as a bridge too far.
Awareness among UK investment managers of GSTPA and Omgeo is high, with 96% of interviewees reporting themselves as 'au fait' with both models. In the case of GSTPA, some managers are already actively participating in the pilot, while others are members of the Association, or have attended conferences, or received extensive information about it. There were some concerns expressed about GSTPA's rate of progress. A similar situation prevails with regard to Omgeo, with some organisations already involved in working parties, and several reporting themselves dissatisfied with the amount of real information available.
GSTPA is perceived as the global, European initiative, while Omgeo is seen as very much the US-centric, American model, though in functional terms this is not necessarily accurate. Some of the comments indicated that managers were making these assumptions because Thomson and DTCC were US entities, while the GSTPA had put more research and effort into Europe.
A majority (60%) of the managers interviewed intended to participate in one or other initiative, and 24% said they would eventually connect to both. At present these are little more than intentions, few (if any) managers appeared to have made any definitive decision as yet. The overwhelming preference is to sit on the sidelines and see how others get on, which rather begs the question as to which managers will actually trial the systems! In addition to GSTPA and Omgeo, with T+1 effectively going live in mid 2004, this approach will not be viable for much longer.
Though their broker/dealers' and custodians' choice may influence some managers' decisions (with some actually looking to them for outright direction) most managers expect to dictate their preferred solution. This was partially the reasoning behind the expectation that service providers should support both solutions. The general consensus was that clients dictate the remit of these providers and so it was necessary for them to conform. Certainly, most managers felt under no pressure to participate and saw themselves as the primary drivers.
Where fund managers did report coming under pressure to participate, there was no clear trend as to sources of this pressure; with broker/dealers, GSTPA, Omgeo, and others all bringing influence to bear. (Though interestingly no custodians.)
Interviewees' comments seemed to suggest that GSTPA would be the cheaper of the two solutions by virtue of having scaled down prices to broker/dealers. On the other hand, Omgeo found favour because of the initial momentum it enjoys (courtesy of the existing Thomson client base) and its ability to supply SSI enrichment.
Some managers expect to connect to both systems, and indeed a few are already connected to both, although supporting both Omgeo and GSTPA is not seen as the optimal solution. Those planning to connect to both models intend connecting to Thomson first, but the decision will also be strongly influenced by their custodian's choice of system.
The benefits of
GSTPA and Omgeo
The key benefits are seen as:
n Reduced cost.
n Increased STP.
n Reduced involvement in the settlement process.
n Ability to meet T+1.
n Less manual intervention thereby reducing risk.
n Faster settlement processing.
n The ability to handle heavy volumes.
n Greater efficiency and accuracy through automation.
n Reduction of DTCC as a monopoly.
The benefits of Omgeo were perceived to be much the same, but there was less certainty due to the relative lack of concrete information about the system.
Some managers expressed confusion about the benefits of Global STP. They felt that while it might reduce risk between the settlement and trade dates (which is of marginal benefit when the counterparty is well known), this does not balance the higher short term risk with pressure to participate possibly driving them into choosing the wrong solution.
Lack of information
about the solutions available
In terms of their requirement for additional information, most fund managers would like GSTPA to continue to keep them fully informed of the latest developments and updated on progress. While Omgeo has only recently obtained regulatory approval, it is clear that the market lacks up to date, detailed information about Omgeo, particularly relating to pricing and the impacts of required changes. Omgeo are however, currently taking steps to address this issue.
No real business
driver, and issues with the investment and commitment required to
implementation and the ability of suppliers to provide good support
Not all managers have made their final decision on this as yet, with most still investigating the various options, and some considering the purchase of a third party vendor package. In-house development was not generally favoured.
In addition to these, the following were also raised as issues:
n Two different (potentially non-standard) solutions.
n Conflict in the financial services sector over the different requirements of broker/dealers and fund managers.
n The ability to deliver a solution that fulfiled the requirements of investment managers and provided the promised benefits.
n The timeframe.
n Budgetary restrictions.
n Resourcing restrictions.
n Rivalry between GSTPA and Omgeo. Specifically Omgeo
In addition to these addressed above, there were a few key issues raised that related specifically to Omgeo; namely that it was:
n A US centric solution.
n Expensive, with the potential to become more so once it achieved critical mass.
n Lacking in connectivity and integration; despite the SEC guarantee.
When mentioning the cost issue, several managers also expressed reservations about Omgeo because of Thomson Financial's global stronghold over the trading and settlement process.
However, since the Omgeo system is based on existing products, it is generally expected to reach critical mass first because of its established client base in the UK and Europe. All investment managers actively considering the Omgeo system were also existing users of one or more of Thomson/DTCC's suite of products. (Mostly OASYS/OASYS Global, Alert, Market- match and Tradesuite.)
In order that we might also gain a perspective of the 'bigger' picture, the survey participants were asked a series of questions on the larger subject of cross border trading. These included issues currently being faced, and their view on actions which can be taken to improve the process.
The key issues at present are T+1, shortened trade and settlement timeframes and resulting new technology.These arise because the existing interface and process with brokers and custodians is largely brokers and custodians is largely manual and inefficient.
Other specific areas of concern include:
n Failed trades.
n Lack of automation across the industry.
n Operating across international time zones.
n Non-standard international settlement requirements.
n International compliance.
n Increasing volumes.
n Timely broker confirmation.
n Inaccurate settlement details or delivery instructions.
n Trading stock in non-automated markets.
n Whole stream processing.
n FX and finance obligations.
n Risk management.
Compliance with the
new SWIFT ISO 15022 standards
Fund managers are of the view that standardisation, technology and end-to-end automated processing are the main factors over the next three years that will make the cross border settlement cycle more efficient and reduce settlement times. There is also a perceived need for a centralised exchange for clearing and settlement.
SWIFT introduced ISO15022 standard messages to the securities industry in November 2001, and the ISO7775 securities messages which were used will become obsolete in November 2002. It was this deadline which prompted the need for insight into the perceptions of investment management organisations on these messaging standards. GSTPA and Omgeo will also use the ISO15022 message standard.
The vast majority (80%) of investment management organisations use SWIFT for clearing and settlement. Compliance with the new SWIFT ISO15022 standards is an objective UK fund managers are striving towards.
Most fund managers will be achieving compliance by using a middleware package, or buying a vendor package. Only a few will be building a system in house or modifying an existing in house system. Where known, preferred suppliers of middleware and vendor packages are primarily Mercator, One Ten and Heliograph.
There are two approaches that can be taken to ISO15022.The first is pure compliance, where the existing ISO7775 messages are mapped onto the new messages. The alternative is to undertake a strategic approach, the benefits of which are to:
n Enhance STP in all areas including order matching, settlement, event announcement and distribution, corporate actions entitlement processing and reconciliation, transaction reporting, etc.
n Improve fails management; the correct use of the settlement party chain along with the capability of intraday fails reporting will help just-in-time pre-settlement matching and ensures all parties to the trade are contactable for resolving issues.
n Improve intraday securities and cash management bringing new revenue opportunities.
n Reduce operational costs by eliminating existing fax- based manual processes for collateral management.
n Bring considerable benefits in corporate actions processing in the areas of event capture and distribution, entitlement and payment reconciliation, and voluntary response tracking and execution.
nl Ease access to industry initiatives, including GSTPA and Omgeo.
But there is confusion amongst fund managers regarding the level of compliance being implemented within their organisation and the alternative strategies available.
Well over half (65%) of the investment management organisations covered by the survey were not planning on achieving compliance with the new SWIFT ISO15022 standards by 17th November 2001. Compliance during 2002 is likely to be a more achievable goal. This is in contrast with the global custodian community, and to a lesser extent, the broker/dealers, who were aiming for, as a minimum, compliance in November 2001.
From the managers' perspective,'wait and see' is also a strategy with a shorter shelf life than perhaps many really appreciate. For those with US exposure, to all practical intents and purposes, the deadline for T+1 compliance is mid 2004. While it is of course technically possible to implement Omgeo or GSTPA for just US funds, for UK managers (who are also likely to have funds in other markets) it would be strategically pointless. If either GSTPA or Omgeo are to be implemented anyway to meet T+1, it makes little sense to have to go through the whole process again for other funds/markets at a later date.
Further delay in choosing between GSTPA and Omgeo will only risk a mad scramble at the last minute. This is particularly important as UK investment managers still have much preparatory work to do in other closely related areas. For example, while it is laudable that 80% of the managers interviewed claimed to have started work on their ISO15022 projects, it is a sobering thought that 65% of them nevertheless also admitted that they would fail to meet the first go live date for the standard in November 2001.
It is clear that the priority of End-to-End projects needs to be raised within the investment management community to ensure that industry initiatives such as T+1 are effectively implemented and the cost benefits are realised, giving those who take a lead a real opportunity to shape the future of the industry.
TCA Consulting is a wholly owned subsidiary of The Terence Chapman Group plc. They architect, integrate and implement technology solutions in the financial services sector, enabling their clients to respond to market challenges and achieve vital business goals.
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