Straight Talk On Straight-through Processing Governance Starts With Shareholders
By: Thomas MacMillan
Why should you care about straight-through-processing (STP)? To start, inefficient securities transaction processing costs investors $140 million a year, according to a 2002 Cap Gemini Ernst and Young survey. Thomas MacMillan, chair of the Canadian Capital Markets Association, examines how STPcan help reduce the high operating costs for investment managers, broker/dealers, custodians, and others in the securities industry which ultimately result in lower investment returns.
When the markets are up, investors tend to ignore how many points processing inefficiencies can shave off their net income. But in today’s more challenging environment, this cannot be ignored. Plans to improve operational efficiency on an industry level began about four years ago, when markets were good. Even in today’s tough times, budgets for operational efficiency improvements haven’t been slashed. For those holding the purse strings, straight-through-processing (STP) is the answer to expense management and a way to improve client service and attract new clients.
What does STP mean?
Well, that depends. If you ask eight securities industry participants to define STP for securities transactions, you’ll get nine different answers. But each answer will have a common goal: seamlessly and quickly passing accurate financial information electronically – on a system-to-system basis – to all parties in the end-to-end securities transaction chain without manual handling or redundant processing.
Why is STP so important?
- Lower processing costs
- Eliminate errors and fails and minimize exception processing
- Minimize operational, market, settlement, payment, and systemic risks
- Provide faster, better service, and, ultimately, better prices for investors
- Improve the competitiveness of Canadian capital markets
- Promote improved cash management, compliance monitoring, and reporting
- Enable uniform and more timely notice of entitlements and other corporate actions and enhance securities lending operations
- Enable better integration with U.S. and international capital markets – the U.S. has also targeted achieving cross-industry STP
- Set the stage for the possible eventual move to a shortened settlement period such as T+1 (the day following trade date) or even T+0.
How can STP become a reality?
STP won’t just happen because it makes good business sense and it saves us hundreds of millions of dollars in the process. It will take a critical mass of securities industry participants saying “I’m fed up with the current process and I’m not going to take it any more” coupled with fear – “can we really compete against U.S. markets if we don’t do anything?”
It is for these reasons that the Canadian Capital Markets Association (CCMA) was created in 2000. The CCMA is a federally incorporated, not-for-profit organization comprised of firms and associations such as the Pension Investment Association of Canada, the Association of Canadian Pension Management, the Investment Counsel Association of Canada, the Investment Dealers Association of Canada, the Canadian Bankers Association, and the Security Transfer Association of Canada. It was launched to identify, analyze, and recommend ways to meet the challenges and opportunities facing Canadian and international capital markets. Its mission is to enhance the competitiveness of Canada’s capital markets through a forum of industry experts who provide leadership and direction to the investment community. Its core purpose today is to promote straight-through processing strategies. Made up of representatives from all parts of Canada’s capital markets, the CCMA will promote Canada’s evolution to STP across all industry segments.
CCMA participants have contributed more than 55,000 hours to STP cross-industry efforts to date. The following broad targets have been established: December 2003 – Industry standards and best practices to be published December 2004 – Legislative, regulatory, and rule changes to be enacted June 2005 – Industry-wide STP to be implemented. Furthermore, there are the following specific targets for the institutional market:
- December 2003 – Establish securities industry standards and best practices on who should do what by when in terms of data quality, message protocols, and timing and achieve industry-wide trade affirmation on T+1 for 80 per cent of all domestic trades
- March 2004 – Achieve a 60 per cent STP rate for domestic electronic trade delivery and enact legislative, regulatory, or rule changes needed (for example, trade matching on trade date) for industry-wide STP to take effect by June 2005
- June 2005 – Achieve: • 99 per cent STP rate for domestic electronic trade delivery • 100 per cent participant compliance with industry standards and best practices • 99 per cent industry-wide domestic trade matching on ‘T’ by promoting matching utility participation by investment managers, broker/dealers and custodians.
What can Canadian institutional investment managers expect to gain from STP?
There are a number of benefits STP can bring to the institutional investment manager, including:
- An 84 per cent drop in manual trade intervention: In a recent CCMA-commissioned study, it was forecast that investment managers would see an 84 per cent decline in the need to manually intervene in a trade instruction (See Exhibit 1).
- Fewer problems associated with business disruption: Participants with matched/confirmed trades on September 10, 2001, had fewer problems following the terrorist attacks on the U.S. on September 11, 2001. Those in the World Trade Center who relied on paper certificates, paper cheques, and paper forms spent considerably more time and money restoring those records than those operating on a same-day to realtime electronic basis.
- Reduced risk: Fewer errors and automated exception processing resulting from STP technology will lower operational, market, payment, and other associated risks. What will happen if the industry ignores STP?
- High fail rates and inefficient processing will impact client service and may come under regulatory scrutiny once STP becomes an industry standard. The Canadian Securities Administrators is expected to issue an STP readiness survey to securities industry participants in 2003. In addition, proposals from the Basle Committee on Banking Supervision are expected to force regulated entities to hold capital to cover operational risk.
- Higher execution, settlement, and safekeeping costs and/or lost business opportunities will directly or indirectly penalize participants not compliant with STP standards. Some U.S. firms no longer transact with counter-parties that cannot communicate with them electronically … and they don’t consider fax or phone to be electronic communication. Canadian participants report that they are starting to charge more if information is not received electronically.
- Securities lenders may demand higher returns from non-STP borrowers.
- Investment funds may become less competitive with other retail investment products if they bear a greater cost due to inefficiencies.
- Participants will not be ready if the securities settlement cycle is shortened to T+1.
Where are we on the road to implementing STP?
Industry participants, with the CCMA, are developing best practices, standards, and metrics to monitor progress towards achieving best practices and standards, with a draft paper to be released for public comment in June of 2003.
Over the next year, the CCMA will also be involved in a number of important industry initiatives, including:
- Virtual matching utilities – software models that allow for seamless, realtime matching of trade data throughout a trade’s lifecycle – from post-execution to settlement, from investment manager to broker/dealer to custodian to settlement body – are being developed, with key suppliers being U.S.-based Omgeo and Financial Models Company (FMC). The CCMA will be publishing a comparison of the Canadian and U.S. VMU models.
- Industry data on the timeliness and accuracy of information being passed among investment managers, brokers, and custodians is being collected and will be published to allow improvements to be tracked against a baseline.
These and more initiatives are expected to be in place within a year and be supported by any requested legal changes by December 2004. This will enable participants to implement STP on a cross-securities- industry basis for debt, equity, and fund trades by the target date of June 2005.
Canada is not grappling with these challenges alone. Recently issued reports by the Group of Thirty, the Committee on Payment and Settlement Systems/International Organization of Securities Commissions, and others include many recommendations that will bring markets around the world closer to STP domestically and globally.
STP for the Pension Fund Business?
As described above, STP benefits for pension and investment funds run from earning the best possible return on investment to reducing risks to improved corporate governance and due diligence. Pension and investment funds should be asking their managers and suppliers STP-related questions, for example:
- Tell me what you are doing to meet the securities industry’s STP goals?
- What are you doing to become more efficient and how will this impact me?
- May we have a copy of your response to the Canadian Securities Administrators’STP readiness survey (The survey is expected this spring. Then ask the question again next year when the survey is repeated)?
- What have you done to increase the efficiency of the flow of trade-related information and how will this benefit me?
It doesn’t matter that you’re not directly involved in the trade or investment decisionmaking process. What matters is that your fund is processed in the most efficient manner. This is why it’s important for you to challenge your suppliers and talk to your counter-parties.
Thomas MacMillan is chair of the Canadian Capital Markets Association.
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