 Lee Cutrone
Managing Director, Industry Relations
Often, the U.S. is credited with initiating much of the wide-reaching reform to the global securities industry over the past several years. Regulatory initiatives such as best execution have been adopted first in the U.S. and then by European and Asian markets and have been widely recognized as beneficial to the end investor. However, there have been other markets that have been vying to initiate global change as of late.
While the U.S. is still grappling with Sarbanes-Oxley and continues to gear up for Regulation National Markets System in the front office, the European Commission recently sought to regulate trading as well as clearing and settlement to facilitate market efficiencies. However, the EC recently opted to put in place a set of principals, or code of conduct, rather than formal regulation. But there is one region where back office regulation is firmly on the agenda: the Canadian securities industry.
When it comes to regulating a more efficient post-trade environment, the Canadian Securities Association has pioneered the latest efforts to reduce costly errors for the greater good of the industry. It has mandated that institutional trade matching, or as it is sometimes called “Same Day Affirmation, (SDA)” be adopted by investment managers in the Canadian financial market by the summer of 2008, via straight-through processing (STP). The regulation, known as National Instrument 24-101, has turned attention to the back office in an effort to shore up one of the most risk-laden spaces in the trade lifecycle.
In contrast, similar mandates around STP long-ago proposed in the U.S., (the T+1 initiative that dominated the post-trade space in the 1990s) have lost their urgency. Once driven by surging trade volumes and a deep desire to make the industry as efficient as possible, the motivation behind STP advancements in the U.S. today have changed. Industry-sweeping initiatives have been replaced with more tactical, enterprise level improvements that will bring tangible benefits to each participant rather than change the building blocks of the industry as a whole. While these types of achievements are no less valuable to the industry and the U.S. continues to be a leader in STP improvements, progress has plateaued somewhat, and it remains to be seen whether the automation curve will once again steep upwards absent of regulation.
The Canadian securities industry has recognized, on the other hand, that in order to drive change, best practices won’t do, and that regulation is necessary to meet (and perhaps exceed) efficiencies gained by U.S. markets. Indeed, the progress made in the U.S. post-trade environment is impressive: as it stands today, approximately 80 percent of trades are matched by the end of T+1 in the U.S., as compared to approximately 53 percent in Canada. National Instrument 24-101 aims to reduce firm-specific and systemic risk across the industry, bringing Canada to the forefront of global efficiency. In a mesh of the U.S.’s previous approach to STP and its new outlook, the industry-sweeping initiative will in fact bring those tactical, enterprise improvements to market participants. It is natural to wonder how the success or failure of the Canadian mandate will affect the U.S. market and beyond.
National Instrument 24-101, which essentially mandates that Canadian investment managers must match their trades with counterparties on trade date (T), will likely mark some of the biggest changes to operational infrastructure to hit the Canadian markets since the adoption of the fax machine in the 1970s. With inefficient securities settlement processes costing the industry US$140 million each year, STP for the Canadian market is a vital component of a capable, streamlined post-trade processing business model. Centrally matching trades through automated solutions has been shown to dramatically increase firms’ rates of same-day affirmation, the outcome when a buyer and seller capture and agree on trade details on trade date (T), independent of the settlement process. Higher rates of SDA mean operating costs and trade failures can be reduced dramatically, thus lowering systemic risk across the industry.
SDA provides enormous benefits over low levels of automation or those who still rely upon telephone, fax or email to confirm details of a trade. The high SDA rates afforded by automating the trade matching process, have been known to skyrocket to 80 percent and higher. Additionally, it has been demonstrated that operating costs and trade failures can both be reduced by up to 70 percent. Those who leverage automation are also better equipped to handle volume peaks than those who do not.
The rewards of regulating institutional trade matching will be felt not only within Canada, but potentially in every financial market in the world that chooses to more widely adopt STP. What remains to be seen is whether the efficiency gains anticipated in Canada will provide impetus for the U.S. and Europe to revisit similar mandates or other countries to join in Canada’s lead in efficiency. One thing is certain, though: National Instrument 24-101 will undoubtedly drive some much needed change to reduce risk.
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