There seems to be general consensus amongst policymakers on both sides of the pond, that one of the most effective and efficient routes to reducing systemic risk is to tackle operational risk. According to Basel II, operational risk is the risk of direct or indirect loss resulting from inadequate or failed processes, people and systems or from external events.
With this emphasis on processes which this definition provides, its easy to see why policymakers have focused a large part of their efforts to date on improving post trade infrastructure as a means of mitigating operational risk. However, what has been most surprising is that efforts so far have focused almost primarily on the OTC derivatives space. Admittedly, the bespoke nature of OTC contracts makes them more susceptible to the threat of operational risk, but given the huge global volumes traded in cash equity, combined with the current stock market volatility, perhaps policymakers should turn their attentions to addressing operational inefficiencies in more ubiquitous asset classes.
A good measure of the level of operational efficiency being achieved in equities is the rate of Same Day Affirmation (SDA) being achieved. Simply put, it is the ability of the investment manager and broker-dealer to match details of a trade on the day the trade is executed.
Of course, in developed European markets, we would expect cash equity SDA rates to be pretty high, however, the low levels achieved in some European markets is disturbing. While in France and the UK, due to the relatively high levels of trade automation, SDA rates of 71% and 66% are achieved respectively; in other countries where manual processes are more prevalent, the SDA statistics are more alarming. Italy at 28% and Sweden at 22% represent the lower end of European SDA rates. This means that in these countries, more than 70% of equity trades are not affirmed on the day that they are executed, thus making it difficult for a financial institution to have an end of day snapshot of where its exposures lie.
Efficient post trade infrastructures can go a long way towards reducing systemic risk in the financial markets. While overhauling the financial system, it is important that policymakers do not make the assumption that it is only OTC markets that are suffering from high levels of operational risk and manual processes – it is prevalent elsewhere too.