For those who thought straight through processing went out with the “Macarena,” think again. Financial messaging cooperative SWIFT wants STP off the shelf where it lingers as a quaint notion. “All the building blocks for a new post-trade process are there,” concludes SWIFT in a new white paper. “What’s needed is community-level commitment to build it.” What is also needed before a big commitment, though, is for the industry to honestly assess why it fell short of the dream of STP.
The “T+Whatever” pushes lost steam and were overshadowed by Y2K fever, which turned out to be an expensive yawn. The subsequent dotcom bust, followed by 9/11 and the Great Recession pushed STP down on many firms’ lists. Yet the nagging problems that STP was supposed to eradicate have stubbornly remained chiefly with small-to-medium-sized buy-side firms.
The white paper actually touches on some specifics such as same-day affirmation rates, which Omgeo in September 2010 found to be deficient with more than 30% of cash equity and fixed income trades in US markets “affirmed after trade date.” Again citing Omgeo, SWIFT says the answer can be traced to the fact that many small- to medium-sized investment management firms rely on manual processes and also rely on their broker/dealer counterparties to clean up any messes these systems create. By contrast, large firms have STP rates of 90% for equities, 70% for fixed income and they use more than 25 brokerage firms and more than 10 custodians.
“Since 80% of transactions are concentrated in just 25% of institutions, this leaves a long tail of small- to mid-sized firms who do not use transaction automation at all,” according to the white paper. “The smaller firms argue that for them, the fax machine, or the email, or the spreadsheet distributed via the (file transfer protocol) FTP make sense. If rekeying has to happen at the broker end, and if this takes place out of hours and is a little error-prone, so be it. Any error caused by the broker will be covered by the broker if it goes wrong, so there is little or no operational risk falling on the investment manager.”
Thus 70% of small- to medium-sized securities firms still use faxes, emails and firm-specific spreadsheets for post-trade processing. They never came close to fully realizing STP.
SWIFT via the white paper proposes to solve this problem by urging “concerted action” from large brokerage firms and/or regulators to remove manual processes and for small-to-medium sized firms to rally around an “obviously-compelling alternative mechanism” that make automation a no-brainer.
In addition, SWIFT is pushing for:
- Standards implementation, which in this case means support for XML and ISO20022
- Market Practice Guidance, particularly “several market practice guides which define the implementation rules of a given set of standards, for a given set of transactions” developed by SWIFT and the Securities Market Practice Group (SMPG).
- And (not surprisingly) its own Simulation Testing and Qualification Service (STaQS) for checking the compliance of IT systems against published standards and market practices.
Setting aside the use of SWIFT’s services for a moment, the cooperative does have a point about the greater usage of XML, which is already very popular. While most shun the thought of another government initiative, the regulators or a consortium of industry bodies may have to step in and strongly urge the widest possible usage of XML for STP because a common language is now essential. Let we forget, STP has to cover, in order of priority according to consultancy CityIQ, over-the-counter (OTC) derivative instruments, corporate actions, exchange-traded derivatives, allocations/confirmations, settlements/reconciliations, contracts for difference (CFDs) and associated give-ups, commodities, repurchase agreements and stock lending and borrowing.
If small-to-medium sized firms would embrace a common language, much of the manual processing would fall away. This would be a huge step toward alleviating many operational risk headaches, which still burden many firms large and small. (Corporates should also get on the XML bus, but that’s another story.)
A recent survey of buy-side firms this past summer by CityIQ reveals that cutting down on operational risk remains a high priority for buy- and sell-side firms because op/risk has become a greater concern for all. In fact, the top worry for operations managers is an urgent need to better exploit standard communications via broker/dealers and custodians. This is a running theme for firms whether they outsource key groups or keep their back-office operations in-house.
“Operational Risk has also changed; for many years, it was a virtual bucket containing forms of risk not directly associated with commercial gain, and parked in a corner of an office usually occupied by temporary financial analysts, auditors and Basel II consultants,” according to the SWIFT white paper. “Lately, it has become the single highest priority of operations heads, as they plan new ways of handling the expected further growth in volume, type and value of transactions, in the context of a systemically-safe and intrusively-regulated industry landscape.”
Thus a new consistency for STP communications is needed to extend the steps of STP automation to “counterparties and settlement agencies that do not yet use them at all,” according to the SWIFT white paper, which adds that until there is consistency, the “high and rising rates of settlement failures in domestic US settlement systems” will continue.
To see the white paper for yourself, please click here.
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