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Page last updated
February 15, 2003




A Quantum leap in Post-execution Trade Processing - The Virtual Match Utility


Over the past two years, the Securities industry has experienced a surge in interest in regard to straight through processing. In large part, STP and T+1 have become synonymous. The Investment Management, Brokerage, and Custodial communities have made great advances in terms of tying together disparate applications in a seamless fashion. Up until this point, STP has been for the most part a technological revolution. While technology advancements are key, the introduction of Institutional Trade Processing (ITP) models is about to force the industry to examine the business processes being employed.

The key to many of the emerging ITP models is the Virtual Match Utility, or VMU. The Security Industry Association (SIA) defines a VMU as "a software model that allows for seamless, real-time matching of trade data throughout a trade's lifecycle. The VMU treats the trade cycle as a unit from post-execution to settlement rather than as a group of loosely related messages and processes". A VMU represents a quantum leap in post-execution trade processing. Gone are the days of local matching where parties set their own tolerances independent of each other, and then matched trades in house. While local match engines served their purpose at the time, there was a complete lack of transparency in the process. VMU's offer centralised matching and the ability for all parties involved in a transaction to monitor a trade through its entire life cycle.

The complexities that the industry now face involve inter-operability. ISO 7775 standards moved the settlement world towards standards. 15022 has taken the industry a step further with STP rates now around 95% when used to their full advantage. FIX standardised the IOI through execution phases, and the convergence of FIXml and SWIFTml may provide the harmonisation required to ensure the complete life cycle is standardised. Standards have allowed the industry to communicate effectively across time zones, and across language barriers. Unfortunately, standards will not solve the inter-operability challenges faced between VMU's. The crux of the problem lies with different matching models. Some match NOE's against Block Order Notifications, and then release allocations and wait for confirms to be returned by the Broker for a second match. Others match on the Block level and then release the underlying allocations to the broker without the need for a second match on the allocation level. Some employ a complicated tolerance check to determine which side to accept when matching fields fall within tolerance, while others look only to the Manager to determine tolerances. There is also the issue of generating automatic corrections back to the Managers portfolio management or trade order system to ensure exact matches when matching fields fall within tolerance levels. Commission enrichment and step-out methodologies make inter-operability seem even more unlikely.

In addition to handling different matching models, VMU's must also have the ability to access multiple Standing Settlement Instruction (SSI) databases. It is now accepted that the industry will not support a single central SSI database. This has led to the development of the distributed database model, or "Just-in-time" processing model. The Just-in-time approach calls for a VMU to access different SSI databases depending on the customer preference. The ability to query multiple databases ensures that settlement instructions do not have to be maintained across multiple databases. The challenge in executing this model lies in how instructions are retrieved. Obviously, certain elements of a trade are key e.g. the Broker and Custodian, settlement location, settlement date, instrument type. The discussion now revolves around the use of customer identification information. It is agreed that client accounts must be linked in a manner that allows Managers, Brokers, and Custodians to cross-reference an account with their own internal ID. Without this ability, STP fails. Concerns have been expressed about maintaining client information within an SSI database. Some SSI databases include client account information as part of the settlement instructions, while others maintain only settlement instructions. Again, different models require solutions based on inter-operability capabilities.

All of this has left many firms sitting on the fence trying to determine which VMU to subscribe to. Local domestic markets can only operate effectively in a T+1 environment if a VMU is employed. This may introduce more VMU's and different matching models, although standing settlement instructions are usually not seen as a major challenge when all parties involved in the transaction are within a local market. It is natural to assume that cross-border models will differ from local matching models. There are peculiarities in local markets that will be accommodated through those local matching models. The question now becomes who do you move forward with, and when. Those that wait for VMU inter-operability may find themselves scrambling to accommodate many at the last moment. Those that start interfacing with two or more may find they have expended a tremendous amount of time and effort if inter-operability is achieved. One must also question the priority the VMU suppliers place on inter-operability. As industry groups continue to put forward new models and ask for further efficiencies from the technology available, VMU suppliers will be stretched to provide all things for all people, not to mention inter-operability. The requirements of a free market economy do not always satisfy the emotional arguments of the industry.

For any VMU to be successful, and for any market to operate efficiently, critical mass is a must. While large buy-side players can afford the costs of utilising a VMU, can the same be said of small players who employ invest and hold strategies? It is not only the cost of using a VMU that presents the problem, but also the costs of interfacing with it. On the sell-side, will boutiques be able to interface with multiple VMU's economically? Most middleware providers would readily admit that their solutions are geared to mid to large sized firms. All of these factors have given rise to STP Partners, Service Bureaus, and Concentrators. This form of outsourcing allows for economies of scale to provide services that would otherwise only be available to large firms. Multiple interfaces can be accommodated through a single pipeline, while the challenges of standards maintenance, communications, and network management are removed. This is a solution that many mid to large sized firms are now looking at as they concentrate on their core competencies. While software vendors typically provided these services in the past, Custodians are now gearing up to take advantage of what is seen to be an untapped but lucrative market. Recent studies and surveys indicate that revenue streams measuring in the billions of dollars are at stake between now and 2006. What remains in question is how serious the Custodian community is about outsourcing, and what areas are going to be targeted. How many of these initiatives are defensive in nature rather than being based on sound business models?

The Investment Management niche is highly specialised. Questions about conflicts of interest arise when a Manager employs multiple Custodians. Even more important is the ability to integrate business processes into an outsourcing arrangement. The re-engineering of business practices to accommodate STP and T+1 processing involves moving responsibility to where they best belong. Matching is no longer a function at the end of the process, but rather something that occurs throughout the trade life cycle. The responsibilities of front, mid, and back offices will blur even further to ensure efficiencies are gained. If a Manager and Executing Broker are responsible for ensuring a match, shouldn't the trading desk review the results of matching? If a firm utilises a VMU to receive execution or allocation details rather than forwarding the messages through to an order management system, it is key that trading staff has access to the VMU. Outsourcing key areas of responsibility may not as easy as they seem at first glance. Market practice guidelines are calling for final cumulative NOE's to be reported within 30 minutes, and allocations to be reported back to the broker within the same timeframe. Error resolution should follow those same timeframes. This becomes extremely difficult if the Trader who executed the trade is four phone calls away from the person who receives the notice of an unmatched transaction. If a VMU treats the trade cycle as a unit from post-execution through to settlement, then business processes should not fragment those benefits. It seems likely that most outsourcing arrangements in the Investment Management field will continue to revolve around technology, rather that the responsibility for business processes. Bringing the proper technology closer to the people that are required to use is the only way to ensure that changes in business processes result in efficiency gains.

The next year will most likely see firms making choices in regards to the strategic direction they wish to pursue in regards to VMU's, outsourcing, and other key STP initiatives. Once these decisions are made, the challenge of changing internal business and determining areas of responsibility can be tackled.

Bob Shaw
Director of Product Management

Bob Shaw, Director of Product Management for FMCNet, joined Financial Models Company Inc (FMC) six years ago after spending over fifteen years in operational positions with some of Canada's largest financial institutions. He currently sits on the Canadian T+1 Institutional Trade and Technology Group, and other international T+1 committees. Established in 1976, Financial Models is a leading provider of comprehensive Investment Management systems and services. FMC is a public company whose shares are traded on the Toronto Stock Exchange (Symbol: FMC).




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