executive director of Product Management,
With increased pressure for transparency and less tolerance for risk from regulators and investors alike, banks need to ensure that all of the information pertinent to completing their clientsâ trades is accurate at all times. One area where custodian banks are becoming increasingly involved in the trade process is around settlement and account instructions (SI). SIs are an integral part of ensuring that a trade settles on time, as it includes key reference data details such as place of settlement, account name and number, market, bank identification codes and more. If even one SI data point is incorrect, the trade becomes at risk of failure. Motivated by rising administrative and staff costs, the opportunity to delve more deeply into middle office outsourcing and the need for increased accuracy and efficiency, members of the global custodian community have been assuming more responsibility for the maintenance of settlement and account instructions on behalf of their underlying investment management clients.
Failed trades, large costs
Today, there are approximately $4.1 trillion in DTCC-eligible trades at risk on an annual basis (1). While there are several factors that cause trades to fail, inaccurate settlement instructions have always been a key reason. Additional reasons include the brokerâs inability to locate shares and errors in other security reference data.
According to a recent survey of the top global custodian banks conducted by Omgeo (2), approximately 10 per cent of custodian bank clientsâ trades fail or need amending after instructing. Of those failed trades, nearly 40 per cent of respondents indicated that 30 per cent were due to SI issues. In many cases, these types of issues were caused by inaccurate settlement and account data within the actual SI, as well as cases where the incorrect SI was appended to the trade.
Not surprisingly, SI data quality is crucial to the industry, as well as its ability to control the operations process and accelerate the SI enrichment process. By ensuring that all participants in a trade have clear and accurate SI, firms can process their trades with more accuracy and efficiency.
Over the past year, there has been a significant change in the capital markets community membersâ desire to standardise and automate the SI process, with custodian banks becoming increasingly more involved in the process as key owners of this crucial data. Today, each investment manager often maintains their own set of underlying custodian bank information, with each buy-side participant creating different custodian records. This method creates duplication, lacks standardisation and introduces errors. At the same time, much of the SI communication process between the buy side and custodians continues to be manual - with instructions being sent via email and faxes and entered by hand. As a result of these manual processes, the industry is overwhelmingly ready to make a change.
Overcoming challenges and the case for automation
However, there are a number of challenges to gaining a wide consensus on SI data management. For example, as mentioned, some firms in the industry do not have a seamless, automated way to manage the SI process. In the recent Omgeo survey (2), custodian banks confirmed that they primarily use manual procedures to communicate SIs to their buy side clients, with email identified as the most frequent method.
Although the industry, as a whole, has been actively working to ensure that SI data is accurate and up to date, there is still more that can be done by the global custodian community to maintain and improve SI information. One way to do so is via an automated, centralised process. Automation introduces greater control of data and compliance with industry standards. In the end, automation promotes an accelerated settlement and account instruction process, provides a greater level of transparency and facilitates greater control over operations.
Also found as a result of Omgeoâs recent study, more than 62 per cent of survey respondents believe that custodian banks should be more actively involved in the maintenance of SIs. A more active role helps banks to limit their work effort and risk, while containing costs. If SI data is incorrect, it means that the custodian does not have a good understanding of who they should be settling their trades with. It also means that the trade may need to be rebooked, which introduces additional overhead and costs. While some of these firms commented that they still believe that investment managers play a significant role in the settlement instruction process, most acknowledged that by taking a more active role, custodian banks could help reduce the risk of claims and compensation resulting from failed trades and also help the industry to achieve greater levels of straight through processing (STP).
Custodians take centre
According to the survey, nearly two-thirds of custodian banks are getting more actively involved in settlement instruction management today. Further, even more - 75 per cent - believe that custodian banksâ increased involvement in settlement instructions will be viewed favourably by the industry. Despite some concerns over taking on the additional task of managing this data on behalf of their clients, custodian banks see more and more of their clients asking for this service as they delve deeper into offering middle-office outsourcing.
As banks assume more responsibility for SI data and seek ways to increase their settlement instruction automation levels, there will be a very positive effect on trade failure rates. At a time where global regulators look to reduce risk throughout the trade lifecycle, and where Europe appears poised to move to a T+2 settlement cycle, firms will face increased pressure to ensure that all of their trade processes are as efficient and transparent as possible. Increased custodian bank involvement and enhanced SI automation levels will help to make the process more efficient, accurate and effective for all market participants while reducing systemic risk across the industry.
1. Omgeo whitepaper: âMitigating Operational Risk and Increasing Same Day Affirmationâ, October 2010
2. Omgeo bank survey