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Page last updated
February 15, 2003





Changing times in the Securities Industry


The financial industry faces many issues as it meets emerging deregulation, globalisation and technology trends. The traditional business model - enterprises working together within a limited geographical area - is disappearing. Financial institutions are increasingly positioning themselves in the worldwide marketplace.

For the securities industry, never has the need to review its position been more critical. A complex business with many participants, it is struggling to catch up with its contemporaries, as it strives to compete on a global basis.

There are many reasons why this is the case. Traditionally, the securities industry have used manual processes for many of their operational activities. However, market trends are pushing the industry to review the way that they now operate. Manual processes are labour intensive, at a time when companies are looking to reduce their cost base, rather than increase it. Clearly, such companies will be viewing technology as one way to reduce overheads and increase efficiency.

A second factor is that historically settlement in three to five days has been acceptable. Now, the drive to settle in less that three days is forcing the industry to consider automating the majority of their core processes.

Thirdly, global and cross border trading means that participants in the securities industry - fund managers, custodians and investment bankers - also need to standardise on message formats to communicate effectively. Indeed, there are many initiatives being formed in the industry to agree standardised and secure financial messaging.

Finally technology itself is forcing the pace of change. The internet opens up new opportunities for the industry, as a fast cost-effective message delivery mechanism. But clearly it is not without its own issues - security and reliability are key considerations for the financial services. Where a financial services organisation operates a global intranet this is clearly not an issue. However, for smaller brokers and fund managers wanting to communicate with other parties across the web, the risks of non-secure messages are high.

A Concern For All Parties
The securities business is very aware that time is marching on and all parties - brokers, fund managers, custodians - need to address all of these issues. However, with so many participants in any securities transaction, adopting common systems that can automate and speed up the process is not easy.

Brokers and fund managers have typically dealt over the phone - for years many have simply operated a paper-based and somewhat random confirmation system. If the price was good, the fund manager did not care how that settlement was constructed or confirmed - a scrap of faxed paper was acceptable. So, unlike cash reconciliations there has not been that historic automation or electronic communication.

Similarly, custodians have tended to have their own practices, which makes automating the reconciliation processes complicated. In many instances there is criticism that there is significant duplication of effort when it comes to reconciliations of records, production of reports and service performance monitoring. Such manual processes are labour intensive, costly and error prone. Given the large sums involved in any one transaction, mistakes can also be expensive.

While these manual methods are not very efficient, they have nevertheless met with clients needs. Because of this approach, and a reasonably satisfied market, up until recently the securities industry has not really needed to adopt technology in a big way.

However, with increasing competition in the marketplace, clients are becoming more sensitive to charges, and it is increasingly important that brokers and fund managers keep costs down. Clients are more aware of service charges, and are willing to choose the most competitive service. Brokers and fund managers cannot afford the luxury of high operational costs, as they cannot now pass them onto the client.

The Drive to T+1
Other factors are also forcing the need to change ways of doing business. With the increasing volume of securities business being handled, and the need to settle faster, processes and methods of transactions with organisations need to be reviewed.

When the drive to move settlement dates from five days after a trade to three days was initiated, the change could be made by hiring more staff and working longer hours. Now T+1 means that the process has to be changed, and that means looking at automation as the answer. Naturally this also means a review of existing technology to automate standard securities transactions and to handle exception processing. Changing the process to identify exceptions or aberrant transactions enables greater volumes of business to be handled faster.

Many customers of the large clearing houses also believe that they can shorten the time between trade date and settlement day with a substantial reduction in risk for all participants.

But to reach T+1 is not simple - it requires a redesign of the communications process. Such restructure requires real time flows of information among all the participants, including the buy side, broker dealers, custodians and depositories. An extensive amount of technology must be redesigned and new systems put into place to move into an era of T+1.

Trades have to be done on a same-day process, where the transaction is executed and the allocation done on a real-time basis. That allocation has to be sent out to an interim agency or broker directly. Discussions at SIBOS last September indicated that this flow has to be more dynamic with allocations expected within 20 minutes for a true T+1 solution. The information then has to go to a custodian. Clearly a sophisticated system is needed to keep all parties informed and to smooth the flow of information.

Reducing Operational Costs
There is no doubt, that this growth in the volume of securities trading, and faster trading and settlement cycles has led to increased pressure on existing manual reconciliation processes. Traditionally, increasing business volumes within a manual environment has often meant employing more people, and expanding into more offices - resulting in increased costs which can spiral out of control.

Managing the cost base is considered by some to be more critical than the settlement life cycle. The fact that a transaction can be settled after one day instead of three days from an industry point of view is important, but itŐs not as critical as the fact that it may cost 10 dollars to do a trade that a competitor can do for just 5 dollars.

Industry commentators suggest that securities houses and banks are starting to appreciate the benefits of automated reconciliation as a key way to manage and reduce costs. Indeed, some of the existing software solutions on the market, already have an integrated transaction management solution for the settlement part of the securities reconciliation life-cycle. The module provides settlement and reconciliation messages from the settlement instruction through pending, confirmation and settlement.

An Ideal Model For Automation
A complete automated system could take this one step further - back to the start of the process - to the relationship between the broker and fund manager. The ideal model could start when the transaction is a possible trade, matching it right through the process to the custodian, and then closing the loop by confirming back electronically. Only if exceptions are encountered would this be highlighted.This makes it easier for a trade to be tracked from order initiation through to settlement and reconciliation.

Such an ideal model is based on a companysŐ existing software solution, which has at its centre a single database. This performs as a matching engine for transactions, which can operate 24 hours a day. It is designed to trigger on individual matches, real time, or in pseudo batch mode, waiting until a certain number of items have been received.

Of course, despite achieving high match rates on good quality data, with an automated system there would always be the exceptions in the process. For example, a fund manager who places an order with a broker in Tokyo where the order could only be partly met. An ideal intelligent system, (such as that presented by Geac SmartStream) enables the user to set up the system to handle partial confirmations. A confirmation can also be completed for just part of the deal, as well as standing instructions to the broker as to how to proceed.

Another example might be a reconciliation of an Australian statement. The statement could be received, matched against the ledger, and exception raised and a note sent to the agent in Australia, advising of the exception before the reconciler has logged onto the system in the morning. Again, such an exception management work-flow is based on the same event-driven approach to matching and is integrated into the central hub or heart. This could also be achieved in real time, 24 hours a day.

In the scenario of an international securities house, the system must interface easily with existing systems within an organisation. Any reconciliation system must be based on an open architecture so that it works with existing internal applications. Users may want to reconcile statements from their own branches as well as externally. The goal is a global network, working off a single settlement hub, which would send constantly updated positions to all of the banks systems around the clock.

Industry Initiatives Encourage Co-operation
The communication processes could also be streamlined with more efficient transfer of information between the parties and standardised message formats. Another main reason why securities is behind payments in the reconciliation stakes is clearly because of the lack of an industry recognised standard for messaging. In fact, only recently have many securities houses got access to the SWIFT network. Today SWIFT is evolving in response to the needs of banks and securities houses. In addition, industry initiatives such as ISITC have brought the various participants in the securities transaction process into closer contact in a co-operative context.

Since September 1998 when the Global Straight Through Processing Association (GSTPA) was launched, the initiative to construct a new model for handling the information flow in securities trades has captured the imagination of many companies. The GSTPA aims are to streamline cross-border information flows to facilitate the settlement of cross border trades in a T+1 environment. At the core of the project is a transaction flow monitor which will be responsible for passing information through to all relevant parties at each stage of the transaction process.

Unlike several previous industry initiatives aimed at addressing shortcomings along the securities transaction chain, GSTPA has managed to bring on board participants in other existing initiatives such as FIX and ISITC. FIX has focused on the early stages in the transaction chain, primarily involving brokers and investment managers. While incorporating electronic trade confirmation in the form of the Industry User Group, ISITC has been concerned to improve message flows between fund managers and custodians. ISITC 's task is to promote standard message types and work closely with SWIFT to improve dialog between investment managers and custodians and it has been pretty successful.

Of course, a project as ambitious as global straight through processing has to be attentive to the delicate balance between meeting the concerns of a broad range of participants while forging ahead with innovation. The GSTPA is an important industry iniative which will be closely monitored and discussed over this year. It will be interesting to see if any alternatives emerge.

If you are a big banker with a fund management arm, you may have all of the infrastructure to support SWIFT from day one. While some fund management companies can also be very small independent organisations - albeit with billion dollar portfolios - and may not want to invest a large amount of capital in technology.

Clearly this situation has to be managed well, in order that all parties co-operate to achieve a common aim. To force certain messaging standards, that require a considerable capital investment, upon a community where not all parties are committed to invest will almost certainly end up in failure.

Embracing The Internet
As well as the big secure systems like SWIFT there also has to be smaller systems that enable the use of the internet. A message standard that can support the internet means that the costs of sending something in a secure message over the internet is less than sending a SWIFT message. If a broker or fund manager is using an encrypted private key it should be secure - indeed, many people already send bank details across the internet. A small fund manager may choose to use the internet to connect to brokers. They may not have the time or funds to invest in an infrastructure to support SWIFT, and so would view an alternative, secure messaging system over the internet as a viable alternative.

Looking To The Future
ItŐs clear that the pace of change in securities reconciliation is set to accelerate rapidly. There are opportunities and proven solutions available already to increase settlement times and centralise them through one central system. With the initiatives currently under way and technology forcing the pace of change, the securities industry is set to enter a new era.

Mark Cappell
Geac Ltd


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