Putting the 'means' before the 'end'

By Matthew Nelson, Executive Director, Strategy, Omgeo
By Soapbox

By Matthew Nelson, Executive Director, Strategy, Omgeo

It is no secret that there is a global shift towards shorter settlement cycles to reduce risk across markets. Recently, the European Commission (EC) brought shorter settlement cycles to the forefront by proposing that securities must settle no later than the second business day after a trade takes place – or what is commonly referred to as T+2 – by 2015. The proposed regulation would install a consistent clearing and settlement method across all 27 markets in the EU. And Europe is not alone. Asia has already accelerated their settlement cycles to T+2 in many countries, including Hong Kong, India and Taiwan.

In the US, which currently operates on T+3, the Depository Trust & Clearing Corporation (DTCC), in partnership with the Securities Industry and Financial Markets Association (SIFMA), has commissioned the Boston Consulting Group to study the costs and benefits of shortening US trade settlement cycles in response to Europes pending move.

This is not the first time the U.S. has looked at shortening the settlement cycle. It first started investigating the change back in 1999, but plans were shelved after the industrys focus shifted from settlement timeframes to other areas of risk post-September 11. In hindsight, the fact that the U.S. put these efforts on hold may not be a bad thing. Since then, the U.S. has implemented significant technology upgrades across the industry, including straight-through processing capabilities. These fundamental changes to the U.S. system will pave the way for an easier shift to shortened settlement cycles.

Automation and increased efficiency in the middle and back office are proven ways to decrease risk and improve a markets efficiency. Regulation has often been an important driver of this efficiency. However, not all markets achieve this efficiency in the same way. Some markets choose to focus on the end goal, such as Europe, where the focus is on achieving T+2 settlement.

Canada, for example, has taken a different approach. Back in 2007, the Canadian Securities Administrators (CSA) put forth regulatory rule NI 24-101 which currently requires 90% of institutional trades to be matched by noon one day after the trade is executed. The regulation prompted Canadian institutions to focus on their post-trade operations, and, according to a recent survey of Canadian investment management firms performed by Stratix Consulting, the industry has benefited from gains in efficiency. Of those surveyed, only 20% reported that they had not achieved the 90% trade matching requirement, but all expected to be fully compliant by year- end. The industry has made significant strides in achieving straight through processing as this is a major improvement over 2010 when only 53% of survey respondents met the 90% requirement.

Domestically, the Canadian market is increasingly automated, with 93% of investment managers using electronic trade matching solutions for equity trades and 80% for fixed income trades. For cross-border transactions, 80% are using trade matching for equities and 74% for fixed income.

As a result of its investment in its back office systems over the past five years, survey respondents said they are confident that if trade settlement in North America and Europe is moved to T+2, their systems and processes could accommodate the change. Since Canadian market participants have already made it a priority to achieve same day affirmation (SDA) – and SDA is closely tied to settlement efficiency – they are well poised to keep up. The affirmation/confirmation process is also known as the matching process. It is, therefore, not surprising that the EC proposed regulation also cites same-day trade confirmation (often referred to as SDA) as a best practice.

Without a high rate of adoption of functions such as electronic funds transfer or automated central matching, a move to reduce the settlement cycle could be challenging for many firms and may actually introduce more risk to the market – at least in the near-term. The key is to ensure the highest possible adoption of automated middle and back office processing within operations, including streamlining the confirmation and affirmation and process and moving towards central matching.

Firms globally must not just be focused on shortening settlement but improving their processes in the middle and back office to ensure they have the means in place to achieve the end objective. Bringing efficiency to the entire trade lifecycle is key to decreasing risk.