Matthew Johnson, DTCC Associate Director, ITP Product Management
Communication, automation and the division of labour are key to outsourcers and clients maintaining a good working relationship, writes DTCC’s Matthew Johnson.
With the potential implementation of the Settlement Discipline Regime (SDR) just over six months away, outsourcers are weighing potential business opportunities and threats. On the one hand, SDR may create a commercial opportunity to provide new services but on the other hand, some buy-side clients may take a view that those added services should be provided at no extra cost.
As asset managers are increasingly focused on cost reduction, outsourcing of back- and middle-office functions has risen, as it enables them to focus on investment strategies rather than post-execution services such as trade matching, settlement and corporate actions. That said, the level of outsourced activities varies greatly with some asset management firms outsourcing their entire operations while others prefer to retain certain functions in house to ensure greater control and oversight.
The implementation of SDR could lead some outsourcers to evolve their offerings and alter how they manage relationships with their clients. The regulation’s settlement penalty regime could prove to be a particularly challenging aspect, as it mandates charges against each transaction which fails to settle under a specified timeframe. The issue for outsourcers is that if the trade is late for settlement as a result of their actions, this cost cannot be passed along to the buy-side. In cases where the buy-side client is responsible for a trade which fails to settle on time, the outsourcer will then need to decide whether the penalty should be passed onto the client, and if so, how much should they pass on? These types of decisions will affect outsourcers’ relationships with their clients and so they require careful consideration as well as meticulous planning.
Another potential issue is SDR’s buy-in regime, which mandates firms to source a replacement trade via a buy-in agent, should the original trade fail to settle after a specific set time frame, in order to fulfil trade settlement. The buy-in rule will create an issue around the speed of communication from the asset management firm to the outsourcer on trades which have been executed for buy-ins. Efficient communication will be particularly important for liquid securities, which may require same day settlement. Once a buy-in trade has been executed, the outsourcer must have access to all relevant data pertaining to that trade to ensure timely settlement. It will be essential for the asset manager to provide the outsourcer with the necessary data on the buy-in, in as close to real time as possible.
Automation holds the key to outsourcers’ ability to treat SDR as a commercial opportunity rather than a threat. By ensuring their post-trade processing offering, particularly the trade confirmation and allocation process, is as automated as possible, outsourcers will be more efficient and in a better position to correct errors. Manual processing is more prone to errors, and so if there are discrepancies between market participants at the trade confirmation stage, it could delay the settlement of the trade which will then incur the financial penalty.
Working towards a proposed deadline of February 2021, outsourcers and their clients should be well on the way to agreeing what the division of labour will be when it comes to post trade processes relating to SDR. Yes, SDR presents an opportunity for outsourcers to take on more tasks on behalf of their clients, however, outsourcers must ensure they have the requisite post-trade automation in place in order to offer these additional services efficiently. Otherwise, SDR could prove costly in terms of resources and client relationships.
This article was originally published in Global Custodian.