Toward Best Settlement

Improving post-trade efficiency yields tangible benefits

While much has been made of the fragmentation of liquidity and trade execution venues, little has been said about the fragmentation of the post-trade environment—a large and overlooked opportunity for efficiency improvement. With trading technology evolving to address execution challenges, it’s time to look at the entire trade lifecycle with the goal of increasing efficiency and reducing operational risk in trade settlement. This document discusses the issue, identifies opportunities for improvement, and outlines some of the technology tools available to streamline the trading lifecycle from portfolio construction through settlement.

Thinking Beyond Execution

The fragmentation of the trading environment has been one of the investment industry’s hottest topics of the past decade. Spurred by unprecedented levels of assets pouring into the market and technology that compressed the cycle from idea to execution, myriad trading venues have sprung up, from new electronic exchanges to “non-displayed liquidity” sources better known as dark pools. A great deal of effort and energy has been expended on developing techniques and technology solutions to help traders cope with this more complex environment. The focus has been on managing ever-increasing trade volume and alternative destinations efficiently while meeting best execution commitments.

In its emphasis on execution, however, the industry has largely overlooked the issue of fragmentation in the post-trade environment—how to streamline the many steps that must be carried out between execution and settlement. Custodial and broker notification, DTCC confirmation and affirmation, and back office processing tend to be viewed as “housekeeping,” with little sense of urgency. Yet they are all critical to the overall operational efficiency of an investment firm. Whatever efficiency is gained in execution is compromised once the transaction enters the post-trade side of the cycle, where automation lags and operational risks are potentially costly.

At a time when firms are striving to regain and sustain profitability by scaling their business and improving efficiency, they can ill afford to ignore the potential gains in a more transparent and streamlined settlement process. What’s needed is a holistic view of the trade lifecycle that includes a commitment to “best settlement”—perhaps not in a regulatory sense, as with best execution, but certainly from a practical and philosophical standpoint. Firms need to be able to hold themselves and their trading counterparties to as high a standard of quality and efficiency in settlement as they do in execution.

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Ripe for Improvement

The trading process has evolved rapidly in recent years, with increased automation and integration streamlining the process from portfolio construction and modeling through decision implementation. The post-trade process, however, is still dependent to a large extent on offline communication. The opportunity exists to close the loop on the post-trade side and create true straight-through processing from idea generation to settlement. Three key areas of post-trade operations are all ripe for efficiency improvement:

1. Broker NotificationOrder management systems realized long ago that integrating broker communications such as allocations and electronic trade confirmations enables a trader to manage the entire lifecycle of a trade through a single platform. Advances in technology have led to a breadth of solutions, but the lack of standardization seems to be an Achilles heel.

Thomson pioneered the broker notification space in the 1990s, which then gave rise to Omgeo’s OASYS for US domestic trades and more recently Omgeo’s Central Trade Manager for cross-border trade communication. However, due to a heavier dependence during trading, the FIX Protocol has also emerged as a viable

solution for sending broker allocations. The flexibility and lightweight nature of the FIX Protocol has led to an increased demand from the buy-side in recent years.

While all solutions are viable, the buy-side may be required to support each one depending on the nature of their sell-side relationships. Order management systems will therefore be required to be method agnostic, but can add value by creating a seamless user experience.

By interfacing with order management systems such as Advent’s Moxy® OMS, these solutions allow for seamless trade allocations and broker confirmation, eliminating the manual exchange of data and resulting risks of error.

2. Custodial and Prime BrokerageNotificationInvestment firms need to inform their cus-todians and prime brokers of trade details. Today this is often done by email—and at many firms, surprisingly, on paper by fax. Besides creating a major efficiency gap in the straight-through loop, these outdated mechanisms have the added disadvantage of not being auditable. The process is especially complex as firms are dealing with multiple custodians with different back office systems and no real standard for streamlining. A typical cancel/rebill scenario must be phoned in to custodians.

SWIFT, the Society for Worldwide Interbank Financial Telecommunication, provides the best model for increasing efficiency and reducing risks in this area. By standardizing and automating workflows for settlement and reconciliation, SWIFT supports straight-through processing for its member organizations, enabling them to operate more efficiently and securely. SWIFT has been the industry standard in Europe for custodial communication, but is also gaining traction in the US domestic market. Wider adoption of SWIFT standards would be a giant step toward reducing inefficiencies in the interest of the industry’s long-term growth.

3. Back Office ProcessingImproving communication with counter-parties requires a high level of collabora-tion and agreement among different play-ers on standards and practices. The one area where investment firms can exercise the most control, however, is in their own back offices.

While traders and trading operations are focused on execution, firms must recognize that transactions do not end there. They may not even realize the extent of manual processing taking place or the opportunity to streamline it. Firms need to evaluate their critical data repositories and systems for portfolio accounting and trade order management to determine whether they

Firms need to be able to hold themselves and their trading counter-parties to as high a standard of quality and efficiency in settlement as they do in execution.

2 | Toward Best Settlement

are deriving maximum efficiency from portfolio construction through post-trade processing.

The need for greater post-trade efficiency strengthens the case for selecting systems that can be integrated easily and that speak the same “language.” Integration and interoperability may, in fact, be more important criteria than pure functionality. Especially critical is the connection between trade order management and portfolio management. The OMS should be able to communicate trade details to the portfolio management system seamlessly, so that portfolios are updated accurately and in a timely manner.

Standardization and Consolidation

The issue of post-trade fragmentation is not specific to any one segment of the industry, nor is it confined geographically. It cuts across both the traditional and alternative investment marketplaces, domestically and globally. And it affects all firms that are interested in cutting their back office costs and operational risks, regardless of trading volume.

There are indications, though, that the industry is starting to come to grips with the issue. Quality of settlement

is becoming more of a factor in how investment managers evaluate brokers. Today, firms can run reports that enable them to grade and compare brokers on settlement efficiency. As brokers are increasingly judged and selected based on best settlement in addition to best execution, industry standards and best practices will become more and more defined.

Protecting Clients— and Profitability

As the trading environment has become more complex and fragmented, technology has managed to keep pace, enabling traders to make informed decisions and execute trades efficiently in the face of escalating volume. Now, however, it’s time to look beyond execution and see the whole picture. Post-trade processing represents the next big opportunity for efficiency improvement.

Technology now exists for navigating the entire trade lifecycle, from portfolio modeling through execution to clearing and settlement. Firms that take the holistic long view stand to reap efficiency gains now and put themselves in a strong position for the future as best settlement standards and practices take hold.

Traders and portfolio managers have a vested interested in improving their firms’ profitability—and in keeping clients satisfied. Clients expect their managers to be acting in their best interests, including the timely and accurate settlement of trades. The concept of best settlement is, in some ways, an extension of the belief that what’s best for the client is best for the firm. By optimizing post-trade efficiency, everyone benefits.

Advent Technology: Closing the Loop

Advent’s Moxy® trade order management system provides investment firms with a centralized trading hub. Working in combination with Advent’s suite of straight-through processing counterparty interfaces, Moxy enables traders to manage the entire lifecycle of a trade through a single platform—from portfolio modeling, construction and rebalancing through trade execution and allocations, all the way to settlement and reconciliation. Integration with an Advent portfolio management solution adds another level of efficiency by allowing real-time communication of trade data and updating of client portfolios.

Post-trade processing represents the next big opportunity for efficiency improvement.

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The Next Frontier for Efficiency Gains

The post-trade environment is the next frontier for improving standards of efficiency and accuracy in the investment process via technology. As the investment industry emerges from a period of extraordinary volatility, it’s a good time for firms to examine their systems and processes to see if they are maximizing efficiency throughout the trading process, including post-trade.

Technology exists today to enable true straight-through processing from portfolio construction to final settlement. Firms that take a holistic view of trading, and take advantage of technology to support it, stand to realize increases in efficiency that strengthen the bottom line. As the industry moves toward standards and defines best practices in the post-trade arena, firms that embrace the concept of best settlement will enjoy a marked competitive advantage.

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