The New Catalyst – Institutional Trade-Date Matching
By: Linda Bernard
More than five years ago, I wrote an article for Benefits and Pensions Monitor that talked about the Canadian capital markets’ efforts to shorten the trade settlement cycle to T+1 (trade-date plus one day), along with the U.S. (see ‘SEC Mandates T+1: It’s Coming’ – June 2000).
At the time, many in the industry thought that the move to T+1 would be the catalyst to implement STP (straightthrough processing) strategies. Fast forward to today, the industry is still focused on STP, but it now has a new driver.
The industry is now focused on shortening the institutional trade-matching cycle to T (trade execution date), as opposed to shortening the trade settlement cycle to T+1.
What’s the difference? The settlement cycle refers to the period of time between the transaction execution date and the transaction settlement date when securities are paid for. That period of time is normally three business days, or T+3. The trade-matching cycle refers to the period of time it takes the buyer and the seller of securities to agree to the details of the trade, such as the price per share and net settlement amount. Today, the trade-matching cycle can vary from T up to T+3, and sometimes can go beyond T+3 when processing delays occur.
Trade-matching delays occur for a number of reasons, such as the lack of standard data elements on the trade notification, infrequent electronic trade downloads throughout the day, ineffective trade allocation practices for block trades, and the need for a single-source database to store crossreference information such as counterparty account numbers.
Another contributing factor to the industry’s trade-matching challenges is that the Canadian Depository for Securities’ (CDS) settlement system links just three trading parties: the broker/dealer, custodian, and depository. Not linked is the investment manager. In the U.S., the Depository Trust and Clearing Corporation’s settlement system links all four trading parties. This difference was highlighted in a study commissioned by the Canadian Capital Markets Association (CCMA), which indicated that approximately 80 per cent of the trades executed in the U.S. are matched by the end of T+1 compared to 51 per cent on T+1 in Canada. The same study also reported that Canada’s STP readiness was ahead of the U.S. in certain areas like securities dematerialization and processing retail payments. However, Canada lags behind the U.S. by approximately 14 months in terms of its overall STP readiness. The gap was mainly attributed to the way in which the Canadian securities marketplace matches institutional trades, specifically from a technological, behavioural/process, and regulatory perspective.
Another challenge faced by the Canadian securities industry is that the New York Stock Exchange (NYSE) has Rule 387 that mandates how and when trades are to be matched. The Toronto Stock Exchange has Rule 5-105, which is similar to the NYSE Rule, but it is not widely acknowledged and is not enforced within the industry.
Based on the study’s key findings, the CCMA decided to realign its efforts, resources, and priorities and focus its efforts on institutional trade-matching. The CCMA believes that this is the area of greatest risk and of greatest benefit to the competitiveness of Canada’s capital markets. The decision to reprioritize efforts was also influenced by the Canadian Securities Administrators, (CSA) proposed National Instrument 24-101 Post-Trade-Matching and Settlement (trade-matching rule).
Proposed in 2004, the CSA trade matching rule mandates that once the trade is executed, no later than the close of business on T, dealers and advisors must take the necessary steps to match a trade as soon as practicable. If errors or discrepancies are detected, dealers and advisors have up to T+1 to reach an agreement and match the details of the trade.
The CSA commented that the tradematching rule offers many benefits for Canada’s capital markets, including the reduction of both processing costs and operational risks due to the development of STP systems, the protection of Canadian market liquidity, a reduction in settlement risk, and the overall mitigation of systemic risk.
The CSA recognizes that the implementation of the trade-matching rule will result in additional costs that will be borne by Canada’s capital market participants. However, the CSA views these costs as justified because the expenses incurred will reduce both the processing risks and processing costs, which will improve the global competitiveness of Canada’s capital markets.
After publication, a total of 26 capital market participants commented on the regulator’s proposed trade-matching rule. The majority of the commenters supported the concept of the trade-matching rule and suggested that the CSA implement a phased-in approach, starting with a T+1 timeframe and progressively work towards T.
The CCMA also supported a phased-in approach to trade-matching and identified a series of industry-wide target dates and milestones to achieve 100 per cent institutional trade matching on T. The following high-level goals were validated and deemed reasonable by a number of Canada’s capital market participants:
- By July 2006 – 100 per cent of all institutional trades will be reported to CDS by 7:30 p.m. on T+1 and 75 per cent of those trades will be in a matched status on T+1 with CDS, awaiting trade settlement
- By December 2006 – 100 per cent of all institutional trades will be reported to CDS by 7:30 p.m. on T and 95 per cent of those trades will be in a matched status by noon on T+1 with CDS, awaiting trade settlement
- By July 2007 – 100 per cent of all institutional trades will be reported to CDS by 7:30 p.m. on T and 100 per cent of those trades will be in a matched status by 7:30 p.m. on T with CDS, awaiting settlement
Accomplishing 100 per cent institutional trade-date matching will be challenging. Implementing industry-wide best practices and market standards may not be enough; which is why many participants are exploring the feasibility of using a matching utility to facilitate and control the information flow from trade execution to trade settlement.
It is not known if the CSA’s tradematching rule will materially change or if it will compare favourably with the CCMA’s goals. What we do know is that the CSA intends to publish the rule in January 2006. So, once again, hang on everyone, it looks like we’re in for an interesting time.
Linda Bernard is director, product management, at CIBC Mellon Global Securities Services Company and chair of the CCMA communications and education working group.
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