It is often said that there is nothing like a regulatory mandate to change market behaviour and the CSDR’s Settlement Discipline Regime (SDR), due for implementation in February 2022, is no exception. The threat of financial penalties for trades which fail to settle on T+2, as mandated by SDR, is spurring most market participants to address the sometimes overlooked issue of manual post trade processing. While this increased focus on post trade automation is certainly encouraging, there are still some firms that are resisting change. As firms get ready for the implementation deadline, we explore five common myths that can prevent the wider uptake of post trade automation.
Myth 1: The majority of post trade processing is automated.
While large strides have been made in addressing post trade inefficiencies, there are still instances where cash securities transactions are confirmed via fax. Unfortunately, while Article 6 of SDR endorses guidelines and best practices in post trade processing, it does not mandate the electronic confirmation and allocation of transactions. However, manual processing of transactions is error-prone and likely to delay the settlement of a trade, which can lead to a financial penalty, as mandated by SDR. Hence, firms should definitively agree on the terms of the trade in an automated and standardized fashion, before the trade flows further downstream for settlement.
Myth 2: The barriers to post trade automation are too high.
Firms often consider three barriers: technology, costs and behaviour. Technology can no longer be used as a barrier to automation. Connectivity options are broader than ever, with various entry solutions such as web, Secure File Transfer Protocol (SFTP) sites, Financial Information Exchange (FIX) and of course, Application Programming Interfaces (APIs). When considering costs, firms must consider whether increased operational risk exposure and potential penalties outweigh investment in post trade automation. This leaves behaviour – perhaps the most significant barrier to change. Some clients are using this as an opportunity to carefully assess client onboarding. An example would be where a broker takes into account the level of post trade automation a buy-side firm uses when on-boarding them to evaluate how much to charge to service the client. A fully automated buy-side firm would likely be charged less than a manual client.
Myth 3: Front office speed cannot be matched by the speed of the middle and back offices.
The front office is extremely focused on speed, including in execution and pricing. While speed and efficiency do exist in the back and middle office functions, there is insufficient focus on it, which seems misguided when we consider the number of steps required to get from post trade to settlement finality. A large number of firms still have multiple steps to their internal post trade processes, many of which are needed from a compliance perspective. This area can be sped up through automation, such as automatically enriching trades with standing settlement instructions (SSIs).
Myth 4: Accurate data is important but not vital to settlement success.
Accurate trade data is crucial to operational success. SSI inaccuracy is one of three primary reasons as to why trades typically fail. Some market participants match trades stipulating the place of settlement through SSIs as part of the confirmation and affirmation process, only to have them over-ridden by an internal system containing out-of-date or inaccurate data. As a result, the trade fails to settle. This type of outcome will be penalised by the SDR and is wholly avoidable. DTCC’s ALERT, the industry’s largest and most accurate SSI repository, has more than 10 million SSIs stored in it using golden source data and validated against Securities Market Practice Group (SMPG) rules. Furthermore, to create efficiency and reduce risk, the ALERT Global Custodian Direct (GC Direct) workflow automates the exchange of SSIs between a custodian's central repository and the ALERT host using dedicated ISO 20022 compliant messages.
Myth 5: Post trade automation has advanced but manual intervention is still required.
This is not actually the case, as a ‘no touch’ workflow from execution to settlement finality is already available. In this environment, reference data is centralized, and enrichment of key reference data occurs just-in-time from golden data sources. This facilitates downstream processes and eliminates the need for local data stores. Parties can agree on trade economics and SSIs on the trade date, resulting in an authoritative trade record. All parties (buy-side, sell-side, depositories) are notified with the same authoritative instruction and can track and resolve any exceptions to ensure settlement finality. Research we recently conducted amongst large global broker dealers, who typically spend $150-175 million on post trade services, showed that implementing a no touch processing workflow can reduce headcount, repair charges, technology expenses and claims and fees.
With ten months to go before SDR implementation, now is the time for market participants to dispel these common myths which create barriers to best practice adoption in post trade automation. The tools to achieve operational efficiency are available to market participants today and are a proven and effective way to achieve efficient settlement – a necessary goal to not only avoid SDR’s financial penalties, but also to mitigate operational risk and cost.
This article was first published in Global Custodian on 23 March 2020.