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STP - Stop Thinking Panaceas
The Global Securities Industry has for several years had to resist the temptation of becoming complacent when evaluating the modernisation of their business processes. Always in the background is the knowledge that one day an STP solution will be 'magically' provided. This solution will be 'off the shelf' and deliver everything that has been repeatedly heralded in a plethora of well-informed and well-meaning articles - when reading an industry publication you would be hard pressed not to find a relevant article.
However, what is being neglected is the improvement of existing in-house systems that needs to be undertaken in order to realise the full potential of straight through processing. It is all too easy to sit back in the belief that STP can be achieved effortlessly by implementing a 'plug and play' solution. Software companies already have 'off the shelf' packages ready and waiting. These both realise the opportunities, and nullify the threats that STP, and the directly related move to T+1, present.
can go wrong?
The 'Securities Transaction Police' in the form of one or other of the industry bodies will ensure that everyone complies with the standards. All solution providers are extolling their intimate relationships and devoted following of these industry initiatives. Check out the advertising literature. Anyone in Securities marketing today is compelled to keep up with their competitors, and omits any of the acronyms GSTPA, Omgeo, XML, ISO 15022, T+1 at their peril [I hope I did not forget one]! There is not even the need to be concerned any longer about the links between internal and external systems, Middleware can resolve that. Too simple? Of course it is. So what actions can be taken?
The new generation of software solutions will deliver far more than removing the need to re-key transaction information. They provide the structure for allowing trades to pass quickly through their life cycle and, equally importantly, highlight those that have got stuck. However, the solutions will only deliver where the fundamental issues have already been addressed. These are well known, but ask the people already involved in securities settlement on a daily basis what they are doing about STP. They will almost certainly refer to some high-level project team somewhere else in the organisation. Ask them though about which trades require the most manual intervention and they will be able to explain not only who the culprits are but also why the intervention is required.
The term STP is in danger of becoming too disassociated from reality. It has almost achieved the status of a 'big-bang' type solution that will supposedly get implemented overnight and trades will immediately start to be processed automatically. The primary hurdle the industry faces in achieving global STP is the lack of internal solutions, rather than inefficient post-trade processing between firms. Much of the latter problem has already been solved, so the money and time being spent on it should now be redirected to the automation and integration of internal systems and processes. The information necessary to complete a trade often has to be taken from different systems within an organisation. Emphasis should be on measuring operational efficiency, rather than idly waiting for a global panacea - businesses should get their own house in order.
In resolving how to get the best possible quality data it is probable that some of the Global initiatives such as Omgeo and GSTPA will be what every institution comes up with as an essential requirement. By not sitting back, and carrying out the exercise themselves, individual financial institutions will be ready to both use and provide the information in order to ensure that these excellent initiatives are a success.
There are a number of actions that can be taken to help ensure readiness for STP, which need to go beyond simply improving trading processes. The wider issues presented by overall trade management are what need to be addressed. These should tackle both the way information is stored and retrieved, as well as the handling of transaction details.
How well information is stored, retrieved and exchanged with counterparties will determine how well this challenge is met. Incomplete or inaccurate information is the main reason for trade failures. So, improving matching efficiency is impossible without first reorganising and standardising the way information is held. This process has already begun by agreeing with trading counterparties default or static data that will apply to the majority of trades. This can be stored in a database to be used when it is time to settle a trade. Some details rarely change. In fact the majority of data on any transaction can fit into a pre-agreed framework. The key is to try to reduce as far as possible the amount of variable information by intelligent interpretation of the trade criteria and enriching this with the relevant pre-defined static data. The fewer the number of variables the lower the risk of the trade failing.
The ability to detect these potential settlement problems becomes increasingly important as the number of trades being handled increases. According to the Securities Industry Association the number of trade exceptions in 2002 will exceed the total number of trades handled five years ago. The back office wants to be able to concentrate on the exceptions. To do this it needs automated, real-time reconciliation with its counterparties and custodians.
The danger with the concept of STP is that the emphasis is on increasing the percentage of trades that do not require human intervention. However, today's ETC process is already highly automated, so improving the automation of the remaining tasks will yield ever-diminishing returns. There will always be trades that require some form of human intervention, for example where special settlement instructions are requested. It has been estimated that on average 20% of trades account for 80% of operational expenses. A trade is simply a collection of data. The efficient management of this data by improving internal systems is the key to achieving better exception processing. In the case of the above and other examples, user-definable criteria needs to be applied to each processing step in the operational cycle. These criteria should be initially rigid so that more trades are proposed for user intervention. With experience the rules can be refined and relaxed so that an increasing number of trades achieve STP.
But why limit automation to just the trading lifecycle? There are now products that allow businesses to apply this to their whole operation. These solutions, known as Workflow, provide automated control of a process or series of activities managed, but not necessarily carried out by a computer. The essential prerequisite for designing a workflow solution is the ability to provide a clear definition of the process from start to finish including information, activities and participants and the relationships between them. Once this is achieved then the potential for automated workflow to enhance exception handling could be truly automated not only internally but also externally using the new facilities and industry initiatives. Current manual and fragmented processes could thus be integrated into the business and help make more seamless the divide between disparate systems in an institution and the human interactions that link them.
Apart from helping to unify an institution's existing legacy systems, automated workflow will provide three major benefits:
A. Reduced risk by ensuring that settlement problems are addressed within ever-shortening settlement cycles.
B. Improved customer service by automating tasks and hence allowing staff more time to devote to both existing and new services.
C. Efficiency by allocating tasks automatically
These are challenges that, if not already underway, can be addressed right now, especially as the main processing steps in a Treasury Back Office Operation have basically remained unchanged for some time.
Back offices have a reputation for having a high number of staff, extremely manual processes and a variety of systems rather on the periphery of the department's business objectives. As data is rationalised and processes streamlined, why not also break down the organisational barriers. If data is standardised efficiently, multi-instrument systems can be implemented. The back-office could be similarly re-organised away from pure product lines. The challenge is to build in enough flexibility to handle both the standard equity and fixed income instruments, as well as accommodate new derivative types. The move towards cross-product systems has rather taken a second place to STP recently, but with the move to regional hubs and the ever-increasing drive for greater economies of scale, it should really be seen as a complementary initiative for improving all-round efficiency. Fewer systems will also mean that if requirements change, amendments only have to be made in one place.
Fragmentation is also a hurdle to improving connectivity. Institutions have been building effective connections between small numbers of applications for years. This has historically been done by one-to-one connections. So the challenge is how to replace a vast number of point-to-point connections with a more efficient technology. One way of doing this is to use Middleware. However, this means buying and purchasing a new application. Suitable solutions are often expensive and difficult to install so may not come about if included simply to improve connectivity and operational efficiency.
Connectivity solutions should also be considered for the benefits they provide to other applications such as confirmation and payment verification. Where only paper confirmations are available there are now excellent products available using intelligent scanning technology to enable the conversion of printed documents into standard message formats. These provide the possibility to install an automated reconciliation tool. As volumes increase and settlement cycles decrease, however, electronic solutions are becoming virtually mandatory to avoid the delays and risks associated with manual processing. The vast distribution of, for example, the SWIFT communication network amongst financial institutions facilitates electronic confirmation reconciliation. Even where volumes do not justify large solutions there are services becoming available such as message concentrators or closed user groups, that provide even the smallest business with the ability to exchange transaction information in electronic format.
Every institution should already be tackling some or all of the challenges of STP outlined above. The effectiveness of any measures undertaken does of course need to be accurately assessed. The performance of operation management should be evaluated in the same way as investment management is today. By tracking settlement progress throughout the lifecycle of the trade it will be possible to highlight what steps have been successful and what have not. Conclusions can then be made as to which counterparties are the most efficient. Fund Managers, for example, would be able to use this information to favour particular brokers. Accurate benchmarking will be another of the benefits of the drive for improving STP.
The challenges are well known and have been addressed by the industry at each and every opportunity. The debate will continue, and rightly so. However, the fundamental issues will not change. It is no longer sufficient to simply target more efficient trade processing. This will only help reduce risk and operating costs. In order to remain competitive, businesses will need to address the wider picture of trade management. The winners will be those who act now to prepare for the opportunities, rather than wait to contend with the threats.
Providers of trade matching, account reconciliation and exception management systems to the Treasury, Securities and Derivatives Markets.
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