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Headline: Twists and turns on the straight-through route Source: Euromoney Date: April 2001 Author: Jonathan Brown The markets’ goal of next-day settlement of equities and bonds will only be achieved if there’s full implementation of straight-through processing. The more volumes continue to increase, the more urgent this becomes. Yet two rival systems have not agreed on common standards and sceptics fear that implementing full STP and T+1 settlement will be a decade-long project for cross-border trading. Over the past year, straight-through processing (STP) has become something of a buzz phrase in the wholesale securities markets. Everyone talks of its importance, but progress toward the goal of 100% straight-through processing in trading has been slow and arduous, characterized by a lack of cooperation between the main technology players and foot-dragging on the part of many investment firms. Failure to cooperate between the industry leaders could hold the whole process back. STP is needed for straightforward reasons. In a world of rapidly increasing trade volumes, shorter settlement times and shrinking margins, STP offers greater operational efficiency, less exposure to market risk and – for the proficient – opportunities to win new sources of revenue. The push to shorten settlement from a three-day cycle (T+3) to next-day settlement (T+1) in the US has accelerated the need to develop widely-accepted STP solutions. Two key partnerships have emerged in the race to develop systems that will facilitate international STP. The Global Straight Through Processing Association (GSTPA) was established in 1998 as an industry association of securities firms, fund managers and custodians, with the aim of reducing the expense and difficulties inherent in cross-border trading. The GSTPA envisaged the development of a processing infrastructure based on multilateral inter-connectivity between custodians, broker-dealers and investment managers. It formed an operating company (GSTP AG) to oversee the process and, in June 2000, signed a business agreement with axion4, a consortium comprising SIS Segaintasettle AG, TKS-Teknosoft SA and Swift, to provide the technological solution. Separately, Thomson Financial ESG has allied with the US Depository Trust and Clearing Corporation (DTCC) to offer streamlined global trade management. This January, they announced that their proposed new global joint venture company, dedicated to transforming traditional trade processing into streamlined and efficient trade management, will be called Omgeo. The Omgeo platform will combine the existing Intelligent Trade Management system of Thomson with the DTCC’s TradeSuite utility to provide seamless processing of trade allocations. Some observers feel that these organizations must put aside political differences and cooperate to ensure the fully interoperable systems necessary for the success of the STP initiative. Stanley Young, partner in capital markets at the consultantcy Accenture, feels that the key issue in achieving STP is the relationship between these two groups. “The GSTPA and Omgeo initiatives will be the main drivers in this process,” he says. “If these two suppliers can work together and provide a fully interoperable system, then the industry will reap substantial benefits. If they continue to fight among themselves, then that will cause problems. We’d love them to talk to each other and reach an agreement soon on interoperability but I fear this might not happen.” Nigel Thomas, director of investment operations at Baring Asset Management and a vice-chairman of the International Securities Association for Institutional Trade Communication-International Operations Association (ISITC-IOA), is even less optimistic about the prospects for cooperation. “With the GSTPA/Omgeo situation, I fear that the industry may even go backwards,” he says. “The political aspects of all this need to be resolved before we can move to a highly efficient global marketplace. People’s personal political agendas need to be set aside so that we can achieve the goal of the highest possible level of STP.” Thomas is adamant that the two need to talk to each other as soon as possible to resolve the situation. “This is an opportunity for the industry to really sort itself out and it’s sad that the two main players can’t do this without pride and political agendas getting in the way,” he says. “I get the feeling that there is a lot of pride and money at stake here and it’s holding the process back. The industry practitioners should be working together to achieve the goal of trading and settling whatever, wherever on T+1 with minimum effort and maximum efficiency.” Whatever happens, Thomas feels it is vital that the systems are fully interoperable. If this doesn’t happen, any advantages will be outweighed by the problems, however efficient the rival services turn out to be. He worries that the GSTPA and Omgeo are going down two separate tracks when just one is required. Ultimately, the industry wants one pipe that all trades can be pushed down, and the confidence that they will settle on time. Until there is complete interoperability between the systems, this will not be achieved. Kevin Milne, executive managing director of Omgeo, the planned joint venture between Thomson Financial ESG and the DTCC, feels that the two partners have done as much as they can for now to get the GSTPA working towards compatibility. “It’s important to remember that we started to build our trade management system four years ago, two years before the GSTPA started their process. Nothing we have done has been in reaction to their activities. Back in August 1999, we were in a situation where we said to the GSTPA: ‘We would like to make our trade management solution available to you as its global straight- through processing solution.’ They decided not to do so. They wouldn’t speak to us as they felt sure that the industry would want to use their platform.” Christopher Stevenson Crosby, a managing director at KPMG and acting chief executive officer of GSTP AG, disputes this. “Omgeo has an initiative that is still in the process of being formed and there are some issues that they need to resolve while ours is moving forward. It’s important to remember that one of these initiatives is commercial in nature while the other, GSTP AG, is an industry utility, governed by the industry, led by the industry and aimed at reducing cost to the industry rather than returning economic benefit to its shareholders. We do need to talk about how our systems will connect and we look forward to discussing this with Omgeo at the appropriate time.” Unfortunately, Crosby also feels that the necessary connectivity may be difficult to achieve. “Interoperability is not as easy as people tend to make out,” he says. “We need to understand all the technological, legal and procedural implications.” Milne stresses that Omgeo doesn’t consider itself a rival to the GSTPA: “We are not in competition with the GSTPA. We never set ourselves up as a competitor to GSTPA though they seem to want to compete with us. We joined forces with the DTCC to deliver what we both felt was what the industry needed and wanted, and to deliver a global STP solution both more cheaply and more quickly than we could have done otherwise.” It is Milne’s belief that a common industry standard is essential. He emphasizes that Omgeo will still be pushing for full interoperability between the systems as this in the best interests of the industry. Omgeo has spent several months discussing interoperability with the US regulators and expects that the Securities & Exchange Commission’s order granting exemption from its registered clearing agency requirements will include some specific language on this topic. This may be a good starting point for negotiations with other service providers competing in this area. Omgeo says it is committed to interoperability with any provider that can reach the necessary standards as laid down by the SEC. Richard Genin, executive vice-president and head of worldwide securities operations at Bank of New York, thinks that the GSTPA and Omgeo will eventually overcome any difficulties: “There are issues that need to be addressed but the market’s main players will make it happen. These initiatives are right for the industry. Both will be supported by Bank of New York and other industry members.” Joseph Willing, managing director in charge of the institutional equities global middle office at JP Morgan Chase, has no worries about the relationship between the GSTPA and Omgeo. “We see them as competitors and this is a good thing,” he explains. “If, through competition, they can improve service and reliability then that is of great benefit to the entire industry. If both of these initiatives succeed then that helps everybody. We are deeply involved with both projects and will continue to be so.” The interoperability question does not bother Willing unduly either. He says: “I’m suspicious of how well interoperability will work in practice. From our perspective we will connect directly with whatever systems or messaging protocols our clients want to use. This will require us to support multiple interfaces, but that is not a problem.” Accenture’s Young is also far from convinced that full interoperability will be achieved: “It’s taken a long time but the industry is now moving towards standards. Both the GSTPA’s axion4 and Omgeo are using the ISO 7775 standard but will there be complete interoperability between the two? I suspect not.” He is concerned that rival systems should not develop incompatible protocols. “Our vision is that standard setting should be separated from service provision. This will allow free and open competition in this market, which can support a tremendous variety of service providers offering solutions to a tremendous variety of end users, all with different needs.” John Gubert, head of group securities services at HSBC Holdings, endorses this: “The market needs interoperability. The key is that the infrastructure, whether utility, for profit or joint venture, enables open competition and does not use its status as a monopoly to impede third-party entry to services.” In view of the impressive advances made in e-commerce over the past few years, it is perhaps surprising that STP has taken so long to come to the fore. Baring Asset Management’s Thomas certainly feels that the industry should have embarked on integrated STP initiatives much sooner. He says: “At BAM we’ve been using systems to achieve STP since 1995. It’s amazing that it’s only in the last 18 months or so that STP has become an industry buzz word. Firms should have been looking seriously at implementing STP a long time ago. The Y2K preparations and the launch of the euro may have inevitably slowed things down but we have had the capability to improve STP rates for years.” Ageing populations in developed economies with more money than ever before to invest are driving volumes up on an unprecedented scale. This raises a need for greater operational efficiency. Until the beginning of 2001, global trading volumes had been increasing at a tremendous rate, with the strain on existing systems beginning to show. Young explains: “The escalation of volumes has meant large cost increases in terms of processing trades. There has been, historically, a direct correlation between the volume of transactions being made and the number of people needed in the industry to handle all this business. Moving to STP will help ease this problem.” Sorter settlement times have increased the pressure. The move from a T+5 to T+3 settlement cycle has been handled fairly well by the securities industry, but moving to an even shorter time scale presents much greater problems. “T+1 is pretty much the ideal environment,” continues Thomas. “There are two ways we can achieve this: either we throw more people at processing or we can put more trades through electronically.” Young prefers the second choice. “With T+10 and T+5 there was plenty of time to solve problems,” he says. “Even with T+3 there is still time to address difficulties. With T+1, the way transactions are processed has to change completely.” T+1 presents the industry with markets in which there simply isn’t time to carry out all the procedures necessary to get trades through in such a short time manually, let alone deal with the multitude of errors that can occur during the process. The system has to migrate to electronic platforms to achieve T+1. As Young says: “We have to completely redefine the protocols involved.” Reducing settlement risk Moving to T+1 is imperative if exposure to market risk is to be minimized. In a period of extreme market volatility, the risk of the market moving against an investor during the time it takes to process a transaction is greatly magnified. Genin of the Bank of New York says: “If we can shrink settlement times then we will automatically shrink exposure to risk. Under the current system, growth is being held back.” Young elaborates: “With T+3 we had market and settlement risk exposure for three days. If a trade failed during this time then this was potentially a big problem, particularly if the market moved against you. This is why there is market support for a move towards T+1 in markets around the world and the recent study of T+1 in the US. We estimate that it is possible to achieve a 67% reduction in settlement risk exposure by moving from T+3 to T+1. In money terms, this equates to around $750 billion worth of settlement risk in the US alone.” These are big figures indeed and food for thought for those still unconvinced of the need to introduce T+1 as soon as possible. But how much STP is realistically attainable?No matter how much of the procedure is migrated to electronic platforms, there will always be some possibility of error. Thomas feels that the aim of total STP from start to finish of all trades is unrealistic. “I don’t believe we will ever see 100% STP,” he says. “95 to 99% is certainly achievable but it really depends on the market in which you are operating. If you are trading just in London with London brokers then you’ll achieve a much higher level of STP than if you are dealing in other jurisdictions.” Put simply, some markets operate more efficiently than others. Young says: “If you look at certain domestic markets, where there is a great deal of STP already, then manual intervention can be virtually nil. Many firms are already achieving well over 90% STP.” And why do trades fail? The simplest and most prevalent reason is poor data. The old computer programmers’ adage of garbage in, garbage out is highly relevant to the financial services industry. Many inaccuracies occur at the execution stage of a trade and these have to be ironed out before the trade can settle. The onus is on the trader to input the correct data when the trade is first agreed, but too often the initial input of information contains mistakes that could be avoided. Justin Lowe, founder and vice president in business development of TradingLinx, a leading STP solutions provider, explains how human error is an important cause of failure: “Manual processes are the main cause of settlement failures, which can exceed 20% for cross-border institutional trades. Post-execution trade settlement processes employed at many financial institutions today involve excessive manual interventions, use of telephone calls and faxes, and duplication of efforts by all trade participants. According to a study by the SIA, 26% of equity allocations in the US are communicated verbally, and another 26% are still submitted via fax or other paper means. As such, it is not uncommon for all participants in the transaction cycle to enter trade data manually and to re-key the same information into numerous, disparate systems.” Simple things like a digit in the wrong place can cost firms a lot of money. There’s an argument that the only way to eradicate failures is to have the dealer in control of the whole process from start to finish. If high levels of STP are to be achieved, then more care must be taken at the front end to get the data right at the start. The technology exists to save time and money through STP, but initial input of information has to be spot-on. Young explains further: “Generally, it is manual keying error, poor static data management and counterparty misunderstandings that cause transactions to fail. For cross-border trading especially, failure rates can be as high as 40%. There are often problems with static data. Investment banks are often very poor at managing this. Their legacy systems often mean that they have multiple copies of data that aren’t integrated. Updating data is also difficult. For example, a new security might be trading for two or three weeks before there is an ISO number allocated to it. There can also be disagreement between parties on the details of a trade. Often, this turns out to be a misunderstanding when the trade is originally set up.” Even when the data are correct at the front end, any manual re-inputting down the line can result in mistakes. If more efficient STP systems are put in place, removing the need for manual entry of data after a trade is made, the possibility of error is greatly reduced. Gubert at HSBC says: “The key problem is to ensure timely communication of the accurate data set in electronic form. Around 20% of institutional communication of transaction data remains via fax or alternative paper-based methods. There is no central reliable database of several key elements of a trade: the securities numbering, the BIC code, the client identifier (especially where the client is a fund manager), the standing settlement instructions and so on. Work is in progress here but it is painfully slow. There are also problems in gaining agreement on the detail of many standards: that is an issue of language and education. We should not underestimate the sterling work undertaken in this area by Swift, GSTPA and others. The reality is, though, that financial markets are Neanderthals in the e-world in this respect.” One problem with existing trade processes is that too often the information is flowing only one way. Problems often occur when, for example, custodian banks change the details of a trade without informing the executor. Such message repairs typically occur in between 8% and 12% of trades, resulting in those trades failing and contributing to less-efficient trading for all parties. Many brokers employ teams whose sole responsibility is to call custodians to check that all the details of a trade are agreed. What is needed is a trade management system that passes information in both directions so that, if the details are amended by any party, all other parties are informed automatically of the change. This would mean great savings in time and money for everyone. Application service providers, such as Arcordia and Omiris Networks, are regularly launching software packages that are able to conduct trading with a minimum of human intervention. Such systems offer have an important part to play in STP implementation. Crucial to this, though, is the standardization of messaging systems. Young says: “What we need is standard messaging protocols. This will enable software providers to provide applications based on agreed messaging standards which in turn should lead to greater interoperability among suppliers. So I think there is a great opportunity for these people to make money.” Achieving a global standard of STP systems could also facilitate cross-border trading, a major potential source of new revenue for dealers. These trades can present problems that an integrated STP process would remove, opening up markets, particularly for retail investors. Accenture’s Young says: “At the moment, only institutional investors are really trading cross-border. In the US, some 80% of trading is in the domestic market. With some foreign markets outperforming the US now, that ratio should probably be nearer 50-50.” Although many investors see foreign markets as an attractive destination for their cash, the present system acts as a barrier to retail investment cross-border. “For retail investors,” continues Young, “there’s no way that their appetite for international securities can be met. The cost of cross-border trading for retail investors is still too great. As STP grows and costs for cross-border trading fall, we will see a huge increase in such trades.” STP solutions such as Omiris Networks’ product are aimed specifically at facilitating cross-border trading. The Omiris system allows a firm in one jurisdiction to deal with other firms in other markets efficiently and with complete neutrality and flexibility. “For example, a German broker-dealer can deal in another country’s stock seamlessly and can also receive orders from those markets without modifying their domestic system,” explains Omiris chief executive officer, Charles Giessen. “So they can process a German trade just as if they were dealing with another German institution just next door, when in fact they would be dealing with a US or other European firm. They can receive orders over the application and send them with complete flexibility. All the required translations, mapping and such happens within the application. The infrastructure to do this, like telephone lines and browsers, is all provided by us.” Omgeo’s Milne feels that levels of STP are already pretty impressive. “The problem of applying technology to cope with shortened settlement times has been solved. We have to shoot for as near to 100% STP as possible but even now, many firms are achieving upwards of 90% STP. We are chasing after the final 10%.” It is his opinion that the battle to achieve STP has been largely won, and that people are now looking at STP and operational efficiency from a different perspective. The main issue is no longer making operational savings and improving risk management. STP is, of course, a vital component in maximizing efficiency – essential in today’s markets where margins are shrinking and firms need to radically increase their volumes of business just to keep up. But the more forward-looking brokers are using that improved operational efficiency as a value proposition to gain more business. A great way to win new business Milne says: “When these brokers are pitching to fund managers they are saying: ‘Use us because we are very efficient which makes your life as a fund manager easier.’ It reduces most of the hidden costs of dealing. In recent years the top 10% of operationally-efficient brokers have had volume growth of about 27%. The bottom 50% are only growing at about 7% or 8%. The moral is that operationally-efficient brokers are taking on business at four times the rate of standard brokers. These numbers are very important as they are useful in gaining market share. So the real driver behind STP now is not cost reduction. It is improving efficiency to increase value to clients and take on new business.” Lowe at TradingLinx agrees that the potential for increasing revenues is significant. “Firms that recognize this will win,” he says. “Brokers with STP will be able to attract a lot more order flow. Asset managers with STP will attract new plan sponsors. That is undeniable. This is also a huge opportunity for vendors. For example, Tower Group estimates that the industry will spend $19 billion on STP between 2001 and 2004.” Thomas agrees that the more efficient markets and nations are implementing high levels of STP but points out that other markets are lagging well behind. “The vanilla equities markets are pretty efficient, but if you’re trading in local emerging markets, for example, I’d be surprised if you were achieving more than 50% to 60% STP,” he says. “The fixed income markets are now catching up with the equities markets. This is surprising as you could argue that STP is actually more relevant to fixed income markets, considering the size of the transactions that people are dealing with.” Estimates of when an efficient global STP network will finally be established vary. Crosby is confident that the GSTPA’s solution will be online in the very near future. The system is in its final stages of development, with the pilot scheme due to start in June and be fully up and running by the end of the year. But Lowe at TradingLinx foresees a longer haul. “It is going to be very long indeed. Most of the world uses faxes and some countries even use telex a lot,” he explains. “Our strategy is to move those fax and telex users to a web interface as soon as possible because 99.9% of them have some type of internet connection and we can hook them up to our ETC network instantaneously.” Thomas is even more pessimistic. “Realistically, I think we’re talking about 10 to 12 years. T+1 and STP are readily attainable in domestic markets, but I don’t believe that T+1 will happen cross-border globally, certainly not before I retire. We’re looking at T+2 at best. I don’t believe that we can ever have 100% straight-through processing worldwide across all markets.” It is essential that all players in the industry are fully behind the drive for STP, aware of the benefits and prepared to make the necessary investments, if the vision of global STP is ever to become reality. Willing believes that this is generally the case, though there is need for encouragement. “From a broker-dealer perspective, sentiment is fully behind the initiative,” he says. But from the clients’ perspective, more persuasion is needed. “When we visit our clients we always take time to convince them of the need for STP. The bigger clients definitely understand the benefits.” Convincing smaller clients is tougher, however, mainly because of the level of investment required. Kevin Smith, senior vice-president and group manager for global custody operations at the Bank of New York, recognizes that smaller players might struggle. “All the initiatives require big investment in systems, so many of the smaller players are not so keen,” he says. “But this is going to happen so people will eventually have to put everything they can into it.” |
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