Financial Journalist

FT Mandate 8 Nov 1999

Pressure from US authorities for T+1 to be implemented by 2002 is expected to have biggest global impact. Institutions unprepared for these changes are likely to become victims of consolidation. Gerry O’Kane reports

The achievement of straight-through processing (STP) and trade plus one day (T+1) in the global custody arena is equated in the minds of many with reduced costs, increased profits and greater competitiveness.

T+1 will increase broker and dealer transactions, boosting commission, while the fund manager enjoys lower charges and greater profitability and the investor more efficient trading. Others say T+1 is simply a way to reduce risk, which might have financial benefits.

“Having entered into a commitment, the sooner you discharge it and get on with the next one, the sooner you make money,” says Alan Jenkins, business development director for STP with Cap Gemini, an IT firm.

Jeffrey Tessler, general manager of Bank of New York (UK), agrees that it is a likely knock-on effect although difficult to correlate. “One point about T+1 is that settlement trade is getting busier due to pension reforms and the equity culture developing in Europe,” explains Mr. Tessler. “The fact is that the rules of the game are concentrating more on risk management and cutting that risk is important.”

With stock settlement, as with any system, the longer and more complex the processing of a transaction, the greater likelihood of problems occurring. For example should a stock be intra-day traded all the time? If each transaction takes trade plus five days to complete, it creates a complex paper trail to discover if someone has made a processing error or received the incorrect stock. It is also expensive. Any new system that cuts the complexity and time lowers the final cost of a mistake and reduces the chances of a mistake being made. This is the main reason argued for T+1.

According to a SWIFT study, the price to the global custody industry of repairing such failed deals and related problems amounts to $2bn in excess costs annually. As business increases, especially cross-border deals, the cost of mistakes will rise.

The US Securities Industry Association shows that US holdings of foreign securities rose 36% between 1995 to 1998, while foreign holdings in US securities rose by 62%. This was only in a part due to the buoyant market conditions.

“It’s a huge issue and every single conference has STP on its agenda,” agrees Michael Goering, Citibank’s director of product solutions. But Mr Goering adds that the issue of T+1 is not as clear-cut as many would claim. In some circumstances achieving T+1 is not a technology issue at all.

He points out that globally only 60% of transactions arrive at custodians in an electronic form. Two per cent of Citibank’s transactions still arrive from investment managers as faxes. Globally of those electronically formatted some 40% follow STP standards, while it rises to 80% into Citibank from European managers. Having said that, the US depository receives broker confirmations automatically.

This allows investment managers to affirm these trades directly on the depository’s system, enabling real-time electronic delivery of settlement instructions to their custodians, bypassing the traditional flow of settlement transactions through the investment manager’s back office before being delivered to the custodian.

“This means deals can be settled in T+0 but only a small percentage of trades are affirmed and settled this way. With such a low adoption in the US domestic market, it begs the question as to how the industry will achieve the same capability on cross-border deals,” says Mr Goering. So T+1 can be achieved without all the players using new computer systems.

Mr Jenkins points to another paradox. “Crest has a virtually real-time settlement, recent figures show 87.6% of the trades matched on trade date (T+0) and less than 1% of trades remained unmatched at close of business on T+1. In part one reason that T+1 is not demanded is that Granny still likes to hold the physical piece of scrip and that can take up to ten days to settle.”

However, Mr Jenkins warns that getting from T+5 to T+3 was often a matter of simply making the technology of batch-processing just work faster. Real STP, on the other hand, requires different computer systems.

While countries such as Taiwan already operate at T+1 with 100% matching driven by the regulatory authorities, it is the pressure from the authorities in the US for T+1 to be implemented by 2002 which is expected to have the biggest global impact.

“Those institutions that aren’t ready are likely to become another victim of consolidation as they frustrate their clients,” observes Mr Tessler. This is one reason why houses such as BoNY, Chase, Citibank and State Street are already heavily involved in STP.

The problem they all face is the cross-border application of T+1. A group of banks and interested institutions established the Global Straight- through Processing Association (GSTPA) to provide a way to do this. The compeition has down to four final bidders on a system called Transaction Flow Manager (TFM). This utility facilitates and controls the information flow from execution to settlement, establishing inter-operability between investment managers, broker/dealers and global custodians very early in the trade processing cycle, and a “just in time” enrichment of transaction data by each party as the trade progresses in its life cycle. In other words they all get information at the same time rather than in the more one-after-the-other method which is currently the norm.

“It’s important to realise that if GSTPA succeeds it is in the best interest of most of the players but the markets are not standing around waiting for it,” warns Goering. This is one reason why most of the big players already have systems following the STP model. He adds, “But there is no global standard on even how stocks are referred.”

Others point out that while the standard will make the system far more efficient, it excludes handling sub-custodians and securities depositories. Cynics might argue that a system may benefit the biggest players but will simply add more cost to those not in the consolidated league of custodians.

More importantly is how long this cross-border T+1 will take to implement. Goering says global implementation could take up to 10 years. The issues of increasing liquidity to the marketplace is also still in debate. Some observers moving to T+1 could have that as a knock-on effect. Others say it will allow capital adequacy ratios to be cut.

Some say it will not, since while the regulatory authorities have got to grips with front-end adequacy ratios they have little idea about how it relates to the underlying settlement business.

The issues of T+1 are more complex than players would initially confess.

trade plus one day, T+1, global custody, STP