settlement
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Corfinancial Senior Executive Asks, Where Does The Settlement Process Really End?

(Paul Bowen, Senior Executive at corfinancial)
Written for the Fintech Times by Paul Bowen (Senior Executive, corfinancial)
It’s an uncomfortable fact for both the buy- and sell-sides that, despite great leaps forward in trade processing technology (clearing and settlement infrastructures) over the last ten years, a significant proportion of trades still fail to settle on time. Some estimate the value of equity transactions at risk of trade failure could be north of USD$970 billion, and the value of fixed income transactions at risk could be over USD$300 billion. As a consequence, the cost of stock borrowing to avert the risk of trade failure on this scale could be as much as USD$4 billion. In fact, some estimates suggest that more than a quarter of institutions on Wall Street have a fail rate higher than one in five. It’s a big problem and an area of the trading world that has traditionally been very weak.
 
Following the common settlement cycle for securities of T+2, in between trade date and settlement date two days later, there are a number of reasons why a trade might fail on settlement date. The seller might not have the stock; stock might be out on loan; or the settlement instructions may be incorrect. For example, the fund manager could have instructed the custodian to settle the trade in one location, such as Euroclear, while the broker might be trying to settle the trade in DTC, so effective delivery vs payment cannot occur.
A key focus for the industry should be acknowledging the need to more effectively manage the point in the trade lifecycle where the settlement process really ends. Is it enough for the custodian to simply report to the asset manager that a trade has failed to settle and financial losses will be incurred by someone?
Today, there are some industry reporting utilities for investment managers, but there are more effective ways of communicating settlement status intra-day by utilising existing messages offered by SWIFT to better mitigate against the risk of settlement failure.

Many trade confirmation and matching systems end their process chain at the point where they send an instruction to a custodian bank to settle a trade in the market. I believe that there should always be continual checks in the trade processing lifecycle, so that when an instruction is sent to a custodian to settle a trade, the custodian is able to respond with messages highlighting the changing status of that trade until it settles.

Settlement tracking software maintained by an asset manager enables the agent of the custodian to send multiple notifications via the global custodian back to the asset manager providing intra-day updates on the status of that trade. Once the settlement date has passed and a transaction has failed to settle, interested parties can still continue to get these updates until such time as the trade does settle. Given the immense cost of failed trades, it is not enough to simply issue a report that informs the buyer or seller that something has gone awry with a transaction.
For many firms this type of operation is quite a step forward in the communication of useful and relevant information around transaction settlement. Ultimately, this approach results in less failed trades because there are multiple notifications being generated about that trade intra-day. Whilst the communications are not real-time (due to the fact that there remains a dependency on the custodian bank that is generating the SWIFT messages to respond promptly), it is nevertheless creating an environment whereby interested parties can receive as many notifications intra-day as the custodian can issue.

If asset managers wish to significantly reduce the risk of trades failing to settle, then I believe that there is more to do to ensure that trades are effectively monitored if firms want to avoid settlement failure and not pay for it. The management of failing trades should certainly be more automated, and one has to question how many asset managers are really in safe hands. Moreover, in terms of the inexorable industry move to T+1, this issue of settlement tracking will soon shift from important to mission critical.

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