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Straight Through Processing
The arrival of our new millennium coincides with the global securities industry surfing a tidal-wave of radical change. The combination of globalisation, increasing regulatory interest in each market, greater competition, price transparency, margins coming under relentless pressure and greater customer sophistication are causing firms to redefine their strategic responses.
Securities intermediaries can respond by pioneering new products, improving their productivity, constraining their costs, integrating their systems, paying attention to controls and benchmarking, developing new risk management capabilities, and taking advantage of opportunities to merge with or acquire other corporations. From an IT perspective, technology will be an enabler but also, a battleground between firms trying to secure first mover advantages. Securities intermediaries could deliver strategic responses via a full-spectrum offering featuring web-enabled technologies such as vertical portals, data warehousing, rapid time-to-market, data (and risk) analysis, process improvement, a compliance culture, and above all, enterprise-wide application integration to enable straight-through processing (STP) to occur.
Why the need for STP? The reason is because end-investors, be they corporates, private funds, pension funds or mutual funds, will demand and win greater transparency. The challenges of spiralling transaction volumes and falling settlement cycles means that fund managers will discover that their operational cost burden will impede efforts to improve productivity and develop new services aimed at improving performance. They will need to increase efficiencies by reducing costs, mitigating risks to market participants, and opening up capacity to allow business to grow. They will also need to modify processes, cultures and behaviours to support the above. The big dependency is whether fund managers are equipped with flexible systems and information interpretation capabilities which are able to distil order out of chaos in real-time.
Custodian banks are ideally positioned to help fund managers relinquish the delivery cycle. This is because fund managers, who are clearly in the fee-earning performance business, resent maintaining multiple databases to support the delivery side of business. Taking on new third-party business or entering new markets spells further headaches for operations staff already overworked attending to greater errors, valuations, reconciliations, statements and the like. In order to get there, a revolutionary approach, inclusive of all market participants and constituencies, was needed.
The formation of the GSTPA in the late summer of 1998 was timely in this regard. The Association now features a 18-person Executive Committee with novel governance drawn from fund managers, broker/dealers and custodian banks. To date, the GSTPA has drawn nearly 90 member entities under its avowed mission - to reduce the complexity, cost, and risk associated with cross-border trade processing and to promote the more efficient flow of information to all parties involved in cross-border trading. In streamlining the information flows between cross-border players, this would make it possible to present domestic markets with electronic settlement instructions before their opening of business on T+1. This in turn would reduce the number of failed cross-border trades, and enable interconnectivity among participants involved in securities processing.
Implicit in GSTPA's model were a series of new concepts which are not as yet part of the post-trade, pre-settlement marketspace in today's world. Firstly, intended interoperability between broker/dealers and investment managers but including global custodians in the loop. Secondly, the early involvement of the latter party receiving enriched information on the trade process 'just in time', an approach based on prevalent models in the airline reservation, freight and many retail businesses. Thirdly, the promise of open architecture and the participation of multiple 'best-of-breed' vendors behind the operation of a highly secure, robust, industrial-strength Transaction Flow Manager (TFM) service entity which would direct trade message assembly, matching, enrichment and routing from post-execution through to settlement. Last but not least, the promise of industry-standard protocols coupled with industry codes of practice, ensuring congruence of common standards and the way they are utilised in practice.
The fund manager clients of custodian banks will benefit in a variety of ways, not least of which would be sustainable capacity and release from the delivery cycle. The most important impact of STP will be on fund managers' accounting and reconciliation activities. Andersen Consulting estimated that up to 40% of back office costs in fund management firms is related to reconciliations, with the matching of books and records not only time-consuming but also a source of contention between fund managers and custodians. Were standards to be applied to the trading data (with trade support desks enjoying a single standardised delivery pipeline for all trades compatible with their front-office systems), then much of this reconciliation activity would be reduced.
Custodian banks will benefit to an even greater extent. Custodians and clearers would benefit from earlier involvement, streamlined trade processing and reduced fail administration and easier reconciliation in their own right. They would be ideally placed to develop prime asset servicing businesses making better use of credit and securities lending capabilities, while developing new capabilities such as trusted third party services and quality-based pricing to satisfy clients. In effectively outsourcing settlement delivery and reconciliation to custodian banks, fund managers would raise their game and concentrate on maintaining productivity, managing performance and delivering better reporting to their clients. This is because the TFM could provide the appropriate metrics to justify service level agreements (SLAs) or to augment cash or securities availability across international markets.
Following a highly-intensive RFP process, the Association identified a preferred vendor alliance comprising DTCC, IBM, SIS Intersettle, SWIFT and TKS Technosoft with which it is proceeding to final contractual negotiations. The Association also directed the alliance to discuss migration with vendor providers critical to transition in the spirit of inclusiveness and collaboration. It is therefore likely that several of the other bidders will find that they have not lost out because they will have the advantage of detailed insight in terms of adding value, particularly at the customer sites.
With many markets such as the US and Japan already contemplating settlement on a T+1 basis within three years in order to mitigate escalating risks, the transition from 'easy' settlement to 'fast' domestic settlement will not be trivial. With so much at risk, the clients of custodian banks may find their custodians more than responsive should they enquire of STP-incentivised or risk-based pricing. Firms should capitalise on the opportunity to achieve 'STP-outside' as well as inside, and custodian banks should enjoy the opportunity to influence the pace proactively.
Anthony W Kirby
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