Sketching Out the Shape of Things to Come
Among the challenges on the “road to the year 2010” for all of those involved in investment processing are three that The Depository Trust and Clearing Corporation (DTCC) has already begun working with the industry to address, DTCC Chief Operating Officer Donald F. Donahue told delegates to the Securities Industry Association’s 32nd Annual Operations Conference and Exhibit in Florida in early May.
One is to integrate the activities of all parties to the trading process within the post-trade processing infrastructure. “This doesn’t happen today,” Donahue said. The second is to complete integrating today’s still-fragmented process itself within the asset servicing infrastructure. And the third, Donahue said, is to make sure all aspects of the industry’s infrastructure “support the way people actually trade today.”
Centralizing and standardizing account opening and maintenance is one way to bring trading parties into the process from the very beginning, Donahue noted. And to help do that, DTCC is working to define with the industry a possible service that would assist in new customer account screening and help industry members deal with their anti-money laundering requirements.
Combating Money Laundering
The potential service, according to Managing Director Susan Tysk, DTCC’s New Business Development, is currently under study by an industry working group formed to define and analyze business requirements.
Screening of new customer accounts is inconsistent, not only from firm to firm but often within firms, Tysk noted. “Localized screening at each firm does not lend itself to information sharing across the industry,” she said. Often, she added, the process is not automated either, and the information is not always retained and available to audit.
The proposed service would provide highly automated, consistent processes; a good platform for sharing data within privacy law limits; state-of-the-art information storage; security; retrieval and audit trails; and highly scalable systems. Tysk noted that, subject to a final decision by the working group, the system would be available for operation by the first quarter of 2006.
Bringing Buy-Side Into FICC
DTCC’s netting and risk management services have historically brought substantial benefits to the broker/dealer community but, for several reasons, they’re not as widely used in the fast-growing institutional side of the business, Tysk said.
In response, Tysk said, DTCC is attempting to make its services more accessible for buy-side firms, particularly in support of the industry objective to increase the levels of netting for institutional trades. DTCC, she said, brings two types of netting benefits to the industry – operational netting benefits and balance sheet relief. Operational netting relieves delivery-versus-payment volume on the Fedwire and at DTCC’s depository, and Tysk presented a model that would allow broker/dealers to settle at the block level and net this activity with their sell side activity. The model would also support the buy-side by providing flexible alternatives that include settlement on a trade-for-trade basis, netting by custodian, or netting at the account level.
The second type of netting, balance sheet netting, makes it easier for broker/dealers to cope with leverage constraints by offsetting certain sell-side and buy-side financing transactions against a central counterparty. To improve balance sheet netting, DTCC currently has taken a proposal to create “sponsored memberships” for buy-side firms. Tysk said the sponsor picks up some of the membership responsibilities for the buy-side member. In return, the sponsor can structure transactions so as to achieve favorable balance sheet treatment for both a reverse repo initiated by the buy-side and the repo itself with the street.
Following SEC approval, which is pending, Tysk told the conference, DTCC plans to implement sponsored membership initiative as soon as possible. “This initial implementation will support well capitalized banks as sponsors, along with registered investment companies and sponsored members. DTCC will seek to expand this proposal to other types of entities in the near future,” she said.
Post-Settlement Environment
Today’s trading across markets and new asset classes have introduced tremendous challenges to all post-settlement processing, said Janet Wynn, managing director of DTCC’s asset servicing and Deriv/SERV businesses.
“Faster than real-time algorithmic trading has upped the ante on the value of timeliness and accuracy,” she said. “Meanwhile, the widespread use of structured products has increased the complexity of payment calculations and trading across markets has necessitated a global perspective on corporate actions,” Wynn explained. “Structured trades and synthetic assets require new servicing models akin to an ‘asset servicing hub,’ where instructions can be received from many issuers, paying agents and individual counterparties.”
DTCC, for its part, she said, has already begun to deal with these changing markets. In the cash markets, DTCC now receives automated file input from over 90% of agents helping to boost the on-time rate for announcements and payments to 98.5%. “But three 9’s – 99.9% – remains our ultimate target,” Wynn noted. In the OTC derivatives markets, DTCC has introduced real-time payment reconciliation for credit default swaps, achieving a 94% match rate in support of bilateral netting. But this still leaves thousands of exceptions, she pointed out, which won’t be improved until the service actually extends to manage the payment settlement.
“Additionally,” she said, “some of our customers are actually calling for a ‘trade warehouse,’ where payments could be calculated centrally and the central clearing agent is, in effect, the paying agent.”
Risk Management
“The industry doesn’t do a good job of sharing information and coordinating margining and other risk management tools,” Jeff Ingber, managing director and general manager for DTCC’s Fixed Income Group, told the audience. “As a result, market participants end up having to post much more margin worldwide than they should. There are also lost trading opportunities and settlement inefficiencies, such as having to settle similar products in multiple locations.”
The problem, Ingber suggested, is that the various industries that make up the “financial markets” haven’t recognized the synergies to be achieved from links and better information flow among the markets. The clearing structure, he noted, does not match market structures, and a lot of trading activity is left out of the structure entirely.
“We should move to a common settlement structure,” he said. “It would mean less risk, better efficiency, lower costs – and an opportunity to introduce other products.”
U.S. and foreign markets also act in an insular fashion, Ingber added, with clearing and settlement structures focused on the notion that U.S. dealers trade U.S. products and European dealers trade European products. Instead, he said, the industry should be trying to facilitate cross-border trading of U.S. and European debt products.
One example of how expanded central counterparty services can improve market operation is in mortgage-backed securities, Ingber said. DTCC’s introduction of a central counterparty for this market will provide guaranteed settlement and pool netting, which in turn will reduce risk and increase operational efficiencies. Ingber said the new service would also facilitate balance-sheet offset, generate increased liquidity by getting margin returned earlier, and establish a blind-brokered repo market.
Making Account Transfers Easy
DTCC’s Automated Customer Account Transfer Service (ACATS) and Cost Basis Reporting Service (CBRS) have been updated and expanded into new areas, Edlyn Meringolo, vice president, DTCC Product Development and Marketing, told the conference. She said that the services are:
- Currently pilot testing a standard way to automate the transfer of account information on insurance investments – initially annuities – with production implementation scheduled for June 6.
- Providing cost-basis reporting for a growing number of firms;
- Increasingly used by banks interested in the capabilities to re-register annuity and mutual fund products and provide tax-lot information.
Volume moving through the cost-basis reporting service is rising rapidly, she reported, and in May, DTCC made it possible for firms using the service to submit cost basis and tax data via the Internet.
BCP Backup and Testing Costs
In a separate conference session focused on business continuity planning (BCP) priorities, DTCC Managing Director for Business Continuity George Perretti talked about the impact that BCP has had on the company’s operations.
He outlined the increased costs DTCC has faced in establishing its various redundant facilities elsewhere in the country, including leasing space and equipment, hiring or relocating staff, and testing and site certification. Additional costs companies need to keep in mind for BCP initiatives, he noted, include command team activations, the maintenance of crisis-management sites, “tabletop” exercises, building evacuations and safety training.
While data replication for back-up data centers in the New York City region is synchronous, Perretti said, sending data to centers outside the region relies on asynchronous technology that has a possible lag time, and therefore a potential for data loss. “DTCC is working with a vendor on a new data replication process for extended distances,” he said, “and we estimate we can cut the lag time to a few minutes.” DTCC also plans to talk through with participants in the next few months the implications of this potential loss of data and steps participants can implement to provide safeguards in such an event.
Breakpoint Boogie
Although DTCC has long had a non-trade-related information service in place between mutual funds and firms to help them comply with regulatory requirements, according to Ann Bergin, managing director of Mutual Fund Services, only in the last year has the industry really begun to make full use of it.
“The report by the Joint NASD/Industry Task Force on Breakpoints, which noted that our Mutual Fund Profile Service provides a database that can be used to deal with breakpoint problems, changed industry perceptions,” Bergin said. “In the last year, we’ve made a number of important enhancements to the database to accommodate more breakpoint information, such as including full breakpoint schedules and money market fund assets in breakpoint calculations.”
Work now in progress on the Profile Service includes creating new fields to support the new SEC rule on voluntary redemption fees, she said. “We’re excited about the potential for our Profile service to help the industry in other ways,” Bergin added, “such as creating an alert service for data discrepancies and supporting ‘point-of-sale’ requirements.”
Liability Notifications
A pilot program begun last November to channel and automate corporate action liability notifications through DTCC’s Web-Based SMART/Track system has proven highly successful, Tom McCarthy told convention delegates.
In fact, added McCarthy, DTCC managing director for product develop-ment, the pilot, which began with 19 participants, grew to 46 and resulted in DTCC and the SIA meeting with the New York Stock Exchange in April to suggest that the exchange mandate SMART/Track as the way to transmit liability notifications involving NYSE securities. The exchange has agreed to consider a petition to modify its rules and require SMART/Track for transmitting liability notifications.
Reengineering Project
DTCC’s multi-year re-engineering project aimed at the consolidation of underwriting, reorganization and dividend processing within a single operating platform is at the point where it’s “getting legs,” Lori Trezza, DTCC Operations vice president, said.
“We held a series of customer focus group meeting earlier in the year,” she said, “and, based on the feedback we received, we’re finalizing the business requirement documents and developing the project plan for the next phase.”
Several of the new features customers are looking forward to, she added, are Web browser access with better reporting and export functionality, and a “dashboard” feature that “pushes” critical information to the forefront so that customers can see it in time to take action. @