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 Lee Cutrone
Managing Director, Industry Relations
September 10, 2009
It seems “risk mitigation” is all the rage nowadays, and while it has been something we’ve advocated for since Omgeo’s inception, it has never been more important to consider a cost-effective, efficient means of doing so. This is where same-day affirmation (SDA), the practice of affirming trade details on the same day the trade is executed, can put a firm leaps and bounds ahead of where it might be today when it comes to ensuring effective risk management.
SDA can curtail the number of failed trades, reduce operational costs and provide transparency for investors. Automatically affirming trades on the trade date ensures that trades travel seamlessly and instantaneously. With manual processes, there can be time lags and delays, given the sequential nature of the steps in trade processing. Moreover, if an investment manager is not automated, there may be no affirmation at all in practice; rather, some trade details are sent without explicit affirmation by the investment manager. While it might be safe to assume that this practice is unacceptable, particularly considering what can happen overnight in today’s global economy, 70% of traders today leave the office at the end of the day not knowing if their counterparty has confirmed their trades.
With both Lehman and Bear Stearns, rumors about their stability circulated for a couple of weeks. On a Thursday evening greater transparency was provided about their tenuous situations and by the following Monday they were either acquired (Bear) or bankrupt (Lehman). Firms must be able to respond to counterparty viability promptly; SDA is one way to assure that regardless of what happens tomorrow, trade details from trades executed today are locked-in today. In response to this problem, The Treasury Market Practices Group (TMPG) has even proposed that firms should pay a fine for failed trades. With today’s trading volumes, failed trades are more than just an inconvenience for the back-office. The excessive costs of failed trades are accumulated by traders, but passed on to investors. Adhering to SDA ensures that details of a transaction are agreed upon immediately by the counterparties, lowering the operational and settlement risk.
Several months ago, Omgeo commissioned a study by Oxera Research on the prevalence of same-day affirmation in Europe, which determined a direct correlation between SDA and reduced trade fails, as well as mitigation of costs associated with rectifying these fails. Extraordinary costs mount from the various functions necessary to resolve failed trades, such as record-keeping, reconciliations of settlement instructions, corporate actions, claims handling and others. Automation also enables a larger volume of trades to be processed without the need to increase staff in the middle-office. When SDA is introduced, processing costs are reduced, and savings can be passed on to investors.
Current market conditions and the exposure of several fraud cases have also pushed investors to be much savvier. A recent survey by Ernst & Young, Investors on Risk, found that, “sixty-one percent of respondents said they had avoided investing in companies, and 48% had de-invested in companies where risk management was considered inadequate.” It is evident that performance is no longer the only requirement to measure success. Furthermore, “82% of respondents agreed that good risk management was worth a premium on the share price.” In order to stay competitive, firms must value the client’s demand for stability and protection.
When climbing a mountain you are only as fast as the slowest climber, and the same is true of automation. The overall processing of any firm is as much a function of the efficiency of its trading counterparty as it is its own processing efficiency. The weaknesses of even a few significantly reduce the overall processing effectiveness of the rest of the industry. In looking for guidance, or a point of proof, all we have to do is look to our neighbors in the north, Canada, who are the first and only country to pass an SDA mandate. By 2012, Canadian Securities Administrators will require institutions to match 90% of their trades on trade date. In the past few years, they have been working towards this mandate by increasing the total required percentage of SDA trades every year. As they have raised their required SDA trade percentages, they have seen reduced susceptibility to operational, market and settlement risk and tremendous cost savings.
The case for Same Day Affirmation is too compelling to be ignored. Omgeo has developed a holistic approach to confirm all the details on the trade date and is looking to bring awareness to those that have an interest in an efficient financial services community to move the back-office, and SDA, into industry conversation. Automation breeds more automation and, together, we can shift the trading environment from being manually laden to a universal, connected electronic marketplace to maximize risk mitigation and efficiency while minimizing costs and resources.
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