A new research paper comparing the financial viability of central matching compared to the flexibility and return on investment of bilateral matching has been published by B.I.S.S. Research.
The paper, commissioned by post-trade technology solutions provider Salerio, supports the need for a comprehensive post-trade management system designed to automate the post-trade management process and offer a robust approach to confirmations settlement and tracking. It looks at the high costs and inefficiencies of the matching process in post-trade operations in both buy-side and sell-side financial services firms. It concludes that the current markets are inflicted with well-established operational matching processes and procedures that are impeding moves towards industry efficiencies and that enforce unnecessary cost burdens on all type of financial services and all products. The paper urges strongly that all firms undertake a review of their existing matching capabilities and question whether they might be better served with alternative matching service suppliers or greater investment in developing internal matching technology to rationalize and streamline their matching process and to reduce costs.
Gary Wright, C.E.O., B.I.S.S. Research and creator of the B.I.S.S. Accreditation and author of the discussion paper said: What is clear to me is that all types of financial institutions need to look very closely at their post-trade matching costs and operations and examine whether their capabilities will suffice for moves to T+2 or even shorter. Post-trade matching is a vitally important function in the market settlement process and there is a need for bilateral matching. Today a single transaction can be matched many times over and costs incurred at every stage, with some providers bundling the matching operation with associated services, so it is more complex than it needs to be. In the paper I layout the industry matching scene and provide a platform of issues and topics to be debated in the expectation that financial services firms will take up the challenge and introduce superior matching operations at a greatly reduced cost.
The paper focuses on high volume asset managers, hedge funds and brokers and questions the increased transaction costs and the volatile volumes that are currently at a decade low.
It charts the history of central matching including the creation of the industry user group that paved the way for the concept of electronic trade confirmation and the selection project to find suitable providers of matching systems by the industry, and included both the sell side and buy side. Today firms connect to multiple matching silos including Omgeo, Euroclear/ Crest, Clearstream and SWIFT, although some firms will have developed an in-house matching system that attempts to pre-match or integrate the matched transaction between external silos. Brokers and custodians systems have to be flexible to match through Omgeo or SWIFT or bespoke and include fax and email on certain occasions.
Omgeo and Swifts silos were developed to do different things and serve different people but, while both systems are more aligned, the market is still disparate and forced to use both, the report finds. This is a convoluted solution to a relatively simple market requirement, says B.I.S.S. The research finds that one of the ways to offset settlement failures is to reduce overheads, with the matching aspect of transactions being a clear target.
However, the market is made more complex by the fact that OTC products are soon to be centrally cleared, creating operational risks that existing post-trade operations will find it difficult to cope with. MiFID is likely to further complicated matters through the creation of multiple trading venues.
It is highly likely that the market is only at the beginning of another period of change that will further test all financial services firms, their systems and technology, says the report. With politicians and regulators under pressure to create more stable and efficient markets, the pace of change is going to be greater and more hectic, it says. Regulatory change has driven market developments over the last 25 years and the post trade arena is likely to include the following in years to come: shortening the settlement cycle, T2S, legal entity identifiers, clearing house consolidation, custodians becoming CCPs, SWIFT becoming more of a functionality provider, outsourcing, stock exchanges offering vertical clearing and settlement models and on-going regulatory change.
For the first time for a decade outsourcing is back on the agenda for tier two and three firms, says the report. Tier one firms are more likely to be the outsourcer and this is especially the case with custodians. Buy side firms, on the other hand will need to invest in building new relationships with outsourcing suppliers.
The market has worked best under a central matching structure, however that structure fails to support the market when there are a multitude of different entities involved that are all needed to settle transactions that are not centrally involved, says the report. Omgeo operates as a hub, but alongside Euroclear, Clearstream and all the other CCPs and CSDs.
“With so many buy-side firms and brokers utilizing an array of central matching silos with different financial products and markets all having their own matching requirements, financial institutions (FIs) have a huge challenge in maintaining all of these connections.”
Central matching suppliers will also find it hard to reduce costs and in fact the probability is that they may even increase over the next few years, says the report. “All firms need to re-examine their operational cost base and question if their existing operations are flexible enough to maintain profit margins within declining transaction volumes.”
With the FIs exposed to fluctuating volumes and turbulent economic environment they must evaluate their existing transaction costs structures and question if it would be better to established a new system, supporting architecture that gives them more control over their costs, the report concludes. By introducing new matching technology FIs could increase the throughput of their business and scope of financial products and markets. They could also rationalize their existing matching relationships and create a harmonious matching environment not only for STP but also for regulatory reporting. Interoperability between matching suppliers would provide an industry solution and much needed choice and competition to drive prices down and services up. FIs should create a bilateral matching capability within their own offices. This would have an ROI especially for high volume players. Low volume players would still gain a decent ROI, although over a longer period of time.
(JDC)