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The hidden barriers to achieving 100% STP

www.accuratesoftware.com

With the drive to T+1 financial institutions are striving to achieve 100% STP to reduce costs and eradicate their exposure to risk. The irony is that 100% STP will increase both costs and risk for those companies that actually manage to achieve it, argues Phil Hall, Joint Managing Director of securities technology specialists Accurate Software.

Business is booming in the securities industry, a fact the majority of financial institutions have discovered is also a double-edged sword. Growing volumes, buoyant trading on increasingly global stock markets and mergers of unprecedented size are creating a potent mix of opportunity and threat. Those players that can stand the pace are under mounting pressure to handle more trades in less time and provide more detailed, timely reporting of information to an increasingly demanding, globally dispersed client base.

The greater volume of trades and the demand for more rapid settlement has made it essential for companies to enhance their processing efficiency if they are to manage costs and minimise their exposure to risk. Reducing the trade-to-settlement times from three days (T+3) to just one (T+1) is widely agreed as the means to achieve this, and enable securities institutions to focus on delivering the rapid and responsive customer service that will secure their global competitiveness.

The economic justifications alone for T+1 are compelling, particularly when you look at how trade volumes are spiralling. Industry figures reveal that levels of electronic institutional equity trading, just 26% in 1998, are forecast to hit 44% by 2001. The daily numbers and size of cross border equity transactions have doubled - and values at risk have quadrupled - in the past three years.

W'th existing processes resulting in an average 15% failure rate for cross border transactions the cost of funding such failure is currently $1,250 million a year - but this will rise to $3,750 million in two years time as volumes continue to grow. For the US the stakes are even higher - a study commissioned by the Securities Industry Association has estimated that compressing the trade settlement cycle to T+1 will save the US securities sector $2.7 billion a year. No wonder, then, that the argument for T+1 has been well and truly won.

Reducing costs, minimising risks
It is generally acknowledged that the key to achieving T+1 is to automate the trade-to-settlement process so that the transfer of all data and messages in the securities trading value chain is performed electronically. The logic to the argument is that if you automatically process 100% of transactions you dramatically reduce the time it takes to confirm and settle trades, and eliminate the need for manual intervention. Shortened trading cycles and less opportunity for human error limit exposure to risk and, as the figures above demonstrate, dramatically reduce an institution's processing costs.

The logic is impeccable. Unfortunately the realities of securities' trading put two issues in the way of achieving 100% STP.

The first is distrust. Theoretically technology can deiiver 100% STP, but the majority of securities institutions believe that there will always be tasks that require decision-making and validation, tasks they are loathe to entrust to end-to-end automation technology no matter how good it is. Thats why if you look within the walls of most financial organisations you will find an enormous amount of manual checking and double-keying quietly going on behind the scenes. Industry analysts have identified that currently less than 40% of cross-border payments are processed without human interaction between initiation and settlement, with the figure for cross-border securities transactions less than 5%.

Ironically, however, the second obstacle to achieving a process aimed at reducing costs is that the sheer technology investment required to reach 100% STP will far outweigh the savings it will deliver in reduced processing time for the majority of financial organisations. 100% STP may be the industry's ideal but if individual institutions analyse the expenditure required against the benefits of achieving it for their particular organisation they may well discover that 100% STP won't cut costs or alleviate risk - instead, it will increase both.

Optimum STP
This doesn't mean that financial institutions shouldn't strive towards the ideal of 100% STP, but they do need to identify at what point the cost-to-benefit ratio is at its highest to determine the optimal STP level for their organisation. By evaluating their current trade volumes and the types of transactions they process, companies may well discover that the point at which the cost per transaction is at its lowest is nearer 90%, and that the closer they get to 100% STP the more steeply these costs rise.

87% STP, for example, may not roll off the tongue but it might be a far more achievable and desirable target for your own operations, not least because cost-effective solutions already exist that reduce the time spent on routine processing, and hence shorten the trading cycle, by up to 90%. These solutions achieve optimal STP by automatically reconciling many thousands of items per minute. They also provide a return on investment that can be measured in months, a welcome fact when you realise that the Securities Industry Association projected ROI on T+1 projects as three years.

Automated processing of a desirable majority of transactions is only half the story, however. Whether for cultural or economic reasons financial institutions need to accept that they may never be able to eradicate instances where human intervention is required. Instead they need to become smarter in how they manage the entire transaction life cycle, because it is how capably they deal with the percentage of transactions that fail that will determine how effectively they maintain and improve their processing efficiency and minimise their exposure to risk.

Cradle-to-grave transaction risk management requires advanced reconciliation and exception management systems that can identify, repair and highlight exceptions early enough within the overall process so that the majority of transactions - 90% and above - go on to be automatically reconciled. These end-to-end management solutions use rules based logic, customisable to the individual organisation and easily adaptable, to investigate and wherever possible automatically repair those transactions that cannot be reconciled. Where the technology itself cannot resolve the exception it provides a full history so that it is a swift and painless process for the user to source the relevant data needed to reconcile the transaction with its correct match.

Where transaction risk solutions come into their own is that, for those exceptions that cannot easily be resolved, they provide financial companies with fundamentally important visibility of the entire transactional flow plus cradle-to-grave auditing. This means that the underlying cause of the failure can be investigated, determined and irrevocably resolved without interrupting the automated processing of the majority of transactions. Such solutions also ensure that checks and flags are built into the workflow process, again customised to suit the individual organisation's own procedures and risk tolerance levels, so that no discrepancy goes unattended and hence can result in unacceptable exposure to risk.

This approach to exception management
succeeds in reducing the amount of insidious risk that is inherent within securities transaction processing by giving financial organisations greater intelligence on how transactions move through the life cycle and at what point they fail. The processing inefficiencies of external parties, for example, is a major cause of failed transactions, yet this often goes unnoticed when institutions cannot view nor analyse end-to-end transaction flow. Once the cause of the problem is discovered organisations can then find long-term solutions to prevent re-occurrence in the future.

The knock-on effect of this strategy is that financial institutions will find that they improve their overall transaction processing effciency and hence raise the optimal level of STP for their organisation. When institutions are able to identify and understand why transactions fail they are better equipped to resolve the underlying cause so that these exceptions can be automatically processed in the future. Not only that, they eliminate yet another exposure to potential risk.

Exception to the rule
At Accurate we have found that this pragmatic approach succeeds because it recognises that full automation of the trade-to-settlement cycle simply isn't practicable for all in the securities industry. Instead suppliers must work closely with financial institutions to help them identify how automated processing will impact the profitability of their individual business, and analyse how transactions flow within their operations. Only then can the right technology be deployed to enable these institutions to automate the optimal majority of their transactions, and better manage and eradicate the exceptions. When organisations and suppliers work together to get this right securities organisations will indeed be able to maximise reduction in costs and minimise exposure to risk - and the vision of T+1 will truly become reality.

Philip Hall
Joint Managing Director
Accurate Software

 

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financial services
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STP - seeing the light
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Not Easy!!
Hidden barriers
Thinking Panaceas
Less hype!
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