Mitigating Risk, Improving Efficiency

Anatomy of a Fail

By Tim Keady, DTCC Chief Client Officer | Jun 24, 2020

Anatomy of a Fail

Trade fails happen. No matter how sophisticated your operations and processes, a portion of your transactions -- whether margin calls, equities or fixed income -- will likely fail to settle. Until now, many of these fails could be repaired and reprocessed with limited consequence. But that’s about to change. Under new rules that will cover nearly all European trading activity, firms will soon pay a heavy price – in the form of daily fines and buy-ins – for trades that fail.

As a first step, it is important to analyze your post-trade processes and procedures to look for weak points, and then formulate an action plan to reduce those vulnerabilities and optimize your settlement arrangements.

The Central Securities Depositories Regulation’s (CSDR’s) settlement discipline regime – which covers trading in securities that settle at any of the 41 European CSDs – takes effect in February 2021. Organizations need to take the time now to improve their settlement processes before the consequences of inaction start to bite.

Data Sets the Stage

Once you have assessed your post-trade processes, your analysis of failed settlements should look for processes that break down under pressure but perhaps only become apparent when you step back and look across an extended timeframe.

At the beginning of the post-trade chain is data -- who, when and where. That is, the identity of the parties involved in the trade, the date the trade will settle and the account settlement instructions. In the middle of the chain you should ask, will it settle? Reporting systems that generate exception reports as early warnings are essential to answering this question. Then, did it settle? This information must be communicated to both counterparties as soon as possible to resolve the fail and avoid fines.

If your fundamental data is incomplete or out of date, or your reporting systems are clunky and non-transparent, or your exception processing is still being conducted manually, the chance is high that trades will fail and that your resolution and exception processing may be costly once the settlement discipline is enforced.

Critical Steps in the Chain

Settlements fail for three primary reasons: standing settlement instructions (SSIs) are inaccurate or incomplete; securities have been sold but the party does not have them for delivery – or want to deliver them -- for various reasons; or the trade is not known (DK’d) or matched by the counterparty.

First, ask if your SSIs are inaccurate or missing data. Dig down to see if you’re using out-of-date standing settlement instructions or account information. Or perhaps you used the wrong SSI.

Second, if you’re matched with good instructions but the securities weren’t delivered, it is important to locate the securities and determine why.

And finally, if the settlement failed because the trade was not matched or known by your counterparty, find out if the trade was confirmed in a timely fashion. If not, why not?

Retool with Targeted Solutions

Once you’ve pinpointed the likely sources of fails and identified any shortcomings, you can address them by strengthening your post-trade processing chain with a variety of automation tools.

Automate matching and confirmation: Switching from manual to automated processes for matching and confirmation can be a firm’s single biggest game-changer in fails prevention.

Aside from adding efficiency and transparency, today’s automated solutions include features that improve data management, reinforce internal audit protocols and bolster risk management. DTCC’s Central Trade Manager (CTM™) is considered the industry leader in affirmation and confirmation for equities and fixed income trades, while DTCC’s Margin Transit Utility (MTU) automates margin settlements for products like OTC derivatives.

Lock in settlement instructions: Use of SSIs ensures that trade settlements, margin and payments are sent to the correct accounts. Because SSIs change frequently, make sure your firm has a way to ensure it utilizes up-to-date account instructions. Accurate SSIs can also facilitate timely confirmations. DTCC’s ALERT® database, the industry standard for SSIs, has helped automate nearly 2 million SSIs to date.

Fortify underlying data: Legal entity identifier utilities ensure that the data on trading parties is standardized. Processing systems with built-in reporting can identify failed settlements in as close to real time as you can get. DTCC’s solutions can also flag trade exceptions and help repair them. MTU, DTCC Exception Manager (DXM) and the GMEI® utility provide these capabilities.

The high trade volumes we experienced in March and April, as the Covid-19 pandemic spread, flashed a warning signal: during times of market volatility, we can expect trade fails to multiply. With the imminent launch of CSDR settlement discipline regime, the only way firms can get ahead of the trade-fail penalty curve is to upgrade their operations. The key to these upgrades is the automation of the various components of the post-trade lifecycle. The good news is, automation solutions are readily available and adaptable to a firm’s particular needs.

 

 

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