STP. These three letters have been an immense headache to the financial services industry ever since they were first circulated in the early 1990s. The principle was ambitious: automatic, rapid settlement of trades from the front-to- back office of all participating organisations irrespective of location or national borders. This would enable banks to manage risk, reduce costs and remove manual intervention.
The sad truth is that the industry has been grinding only very slowly towards this goal. Many organisations claim to be achieving STP, but in reality they are simply automating just one section of the trade-settlement process. One area which has lacked automation is the entire post-trade pre-settlement stage of the process for cross-border securities trading.
This is still characterised by manual procedures, different service providers, incompatible databases and an absence of standards. Add to this the cost and failure rate of trades and it’s easy to see why the industry worldwide is crying out for a solution that solves these problems.
Two industry initiatives are set to address the challenge of processing cross-border trades: GSTPA, an industry association open to investment managers, brokers/dealers and global custodians; and Omgeo backed by the Tradesuite business of the Depository Trust and Clearing Corporation (DTCC) and Thomson Financial Settlements Group.
Both systems will eventually bring a dramatic improvement to STP enabling financial services organisations to centrally match securities transactions, bringing parties together in the post-trade pre-settlement environment. But there are subtle and important differences between the two.
Founded in 1998, GSTPA is based on a service that enables investment managers, brokers and dealers, and global custodians to automate the trade enrichment and matching process. The solution is underpinned by the ‘just-in-time’ philosophy that says that information required to add value to a trade is obtained from the party who owns it at the time when it is required.
At the heart of the GSPTA solution is its Transaction Flow Manager (TFM) which tracks, numbers, timestamps and routes cross-border trade information. Users will have the choice to connect with the TFM either directly or via a third-party concentrator – an organisation which has its own direct connectivity to TFM and which offers a connectivity service to its own customer base. These typically include a service bureau/vendor offering access to the TFM, a bank offering client access or a domestic TFM for participants in their own domestic market.
Although the go-live date of the GSTPA service has been put back to accommodate the pilot members of the consortium who wanted more time for user acceptance tests, recent months have seen steady and important progress. In July, for example, GSTPA and its parent organisation Axion4 announced the successful run of user acceptance testing and predicted that the solution would go live at the end of the year.
Omgeo, which has 6000 global clients, admits the similarities between its STP offering and that promised by GSTPA, but says that it offers more than matching software. As well as delivering an ‘intelligent central matching engine’, Omgeo will focus on other areas such as information management, performance benchmarking and building e-community services.
In April, the Securities and Exchange Commission (SEC) granted Omgeo permission to operate in the US by giving the company an ‘exemption from registration as a clearing agency’. Omgeo has also just announced a strategic partnership with Sun Microsystems which will be the organisation’s technology partner. In particular, Sun will provide Omgeo with servers for its intelligent trade management (ITM) workflow hub for directing transactions.
In August, Omgeo launched a beta version of its services. Firms who want to communicate with Omgeo’s Central Trade Manager will be able to do so by using Omgeo’s application programming interface (API).
All of these developments indicate that at some stage GSTPA and Omgeo will develop some kind of common interoperability. GSTPA – a non-profit industry organisation was originally concerned about the for-profit status of its rival. Now both parties are making encouraging noises about developing an interface. No one is pretending that it will be easy but both parties had preliminary discussions at this year’s Securities Industry Association (SIA) event in Orlando. The SIA itself has offered its intellectual capital to accelerate this work.
As for the industry – the potential customers of both Omgeo and GSTPA – interoperability is a prerequisite. Imagine a scenario between two parties to a trade where one organisation supports Omgeo and the other GSTPA – the industry simply won’t tolerate two entities who won’t talk to each other. As a result, financial organisations will probably need to link in to both systems – at least for the time being. But rather than perceiving this as a disadvantage, it’s worth remembering that they should benefit from the fact that there are two players in this space – which should increase competition and, hopefully, drive down prices.
So what are the implications for the different players in the trade settlement process? Fund managers probably have least to gain from either the GSTPA or the Omgeo offering. Although many have an interest in STP based on the good it will do the industry as a whole, as long as the trade is out of the door, and they have communicated it in a timely manner, many feel that it’s the end of their involvement in the transaction. At the same time, they usually lack the budgets required to invest in significant STP process reengineering projects and prefer to focus their attention on technical analysis and other front office trading technologies. As a result we are starting to see big global custodians – who have a much greater vested interest in the efficiency of the operational side of the business – looking to offer outsourcing services to fund managers to take the challenge of linking into these services off their hands.
bigger picture
For all the hype surrounding Omgeo and GSTPA, it’s important not to overlook some of the other technology and integration challenges facing the financial services industry today. Although the automation of the post-trade, pre-settlement phase of cross-border securities transactions will be of enormous benefit to the banking sector, integration with systems across other areas of the business – from trade confirmation to FX and cash management – is absolutely paramount. For example, electronic trade confirmation (ETC) technology such as Thomson’s Oasys system, will continue to serve financial organisations who deal within domestic marketplaces. For all the talk of cross-border trading, local matching won’t go away as a requirement.
It’s also important to remember just how many hurdles still lie between the global banking industry and the ideal scenario of T+1 settlement. Even within the US domestic market where the whole cross-border issue does not arise, T+1 is still some way away. And remember that in the UK, for all the hype we are still only at T+3 and the sheer expense of achieving the T+1 goal means that it won’t happen overnight – certainly not just thanks to GSTPA or Omgeo.
The drive to T+1 must also look beyond the realms of post-trade, pre-settlement – to encompass all steps involved in the transaction lifecycle from initial input of the trade through to final settlement. To this end, FIX and Swift have recently announced that they are working together to standardise trade instructions (the pre-trade part of the process). This is good news, especially now that the SwiftNet (IP) facility is enabling real-time settlements as well. The primary focus of SwiftNet is to complement FIX by providing a standard communication platform to support multiple financial communities whether they are organised around a many-to-one or few-to-few communication model.
But overall, banks are still coming to terms with the revolution promised by STP. Many are still focused on the past where different lines of business – such as securities, FX and payments – each bought their own message handling systems. The advent of STP has forced these organisations to re-examine their internal operations and dismantle the walls which exist between different business areas. Given that even the most basic of trades can lead to many reconciliation events across several different departments as a transaction progresses to settlement, organisations now realise that different departments can’t operate in isolation any more. For example, a cross-border trade will invariably produce parallel FX and payment transactions which also need to be reconciled and settled in the most timely and cost effective manner.
In parallel to the development of initiatives such as GSTPA and Omgeo for the cross-border securities market, the FX marketplace has seen the development of CLS (continuous linked settlement) – now due to go live in early 2002. The CLS initiative is designed to reduce the risks associated with the settlement of foreign exchange transactions by ensuring that both legs of an FX deal are settled simultaneously through this new settlement institution. Most people agree that CLS will help make cross-border foreign transactions safer, quicker and more efficient, delivering all the benefits of straight-through processing and eradicating the risk of failure of these transactions. The functionality and development of the core system have been completed and the technology is now undergoing thorough testing.
A long-term approach
Overall, the challenge is clear – get the commitment of all parties, externally, as well as internally to work together to ensure the eventual real-time flows of information among all participants, including buy-side, broker dealers, custodians and depositories – that way you can start to develop a strategy which accommodates all these parties and their individual interests.
You can also begin to answer the huge integration challenge precipitated by all these new financial services systems: GSTPA and Omgeo towards the end of this year, CLS in 2002, and Swift and FIX. Here, the most important thing is to steer clear of the temptation to quick fix in the short-term. Taking a piecemeal approach to the integration of all these different systems could be costly and even dangerous. The expense of integrating a new solution time and time again should be avoided, especially given the rapid pace of change within the financial services industry – where new trading solutions and standards will continue to arise.
Instead, banks should consider implementing a workflow middleware layer. This is a software wrapper for their business systems to which they can attach any new process or system with the appropriate API. It would support intelligent, data driven message processing interfaces and be capable of receiving and sending messages across a complete range of different media types and protocols.
As well as reconciling trades within all business lines, a central ‘control hub’ solution should also be able to handle exception management quickly and efficiently across them – helping to streamline operations and reduce risk across these diverse business areas.
Although cooperation between FIX and Swift to standardise trading instructions will go a long way towards eliminating the errors created when trades are jotted down on a form and literally thrown at the middle office, the sheer complexity and variety of the latest generation of cross-industry solutions means that the automatic resolution of exceptions is as critical as ever.
Automating the generation of investigations for any exceptions that occur within the multitude of business areas, will accelerate the discovery of their causes, and enable a high level of automated ‘message repair’. This will prevent any trades from falling outside the mainstream transaction flow for a lengthy period and effectively ensure the bulk of transactions are processed straight-through, without any manual intervention.
How would such an ambitious solution work? At least one technology vendor is close to launching a solution which achieves all these goals. SmartStream Technologies draws on its Transaction Lifecycle Management technology which integrates with other messaging solution modules to exploit STP from input to validation, matching, automatic generation of exception cases and correspondence transmission. It also includes an investigations module which uses intuitive workflow to resolve exceptions and reduce a firm’s exposure to costly interest penalties and operational risk.
But whatever the solution, financial organisations should always keep one thing in mind – the best laid STP plans of the industry are subject to constant delays, revisions and cancellations. Both Omgeo and GSPTA should both be live soon, for example, but who knows if the industry will support two similar offerings in the long term? Meanwhile other parts of the STP puzzle such as FIX and CLS are falling in to place. As STP evolves, the implementation of a control hub middleware platform will protect banks against unforeseen technology and industry developments. Nobody is saying that it will be easy – the best solutions never are – but the rewards will be wide reaching and stretch far into the future.