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Due to recent events in the financial industry, the current market conditions point to an industry need for improved governance and efficiency in all aspects of the securities trading and post-trading processes. Risk management has emerged as the industry’s top priority.
However, despite logic telling us that speed and accuracy of verification can drive the efficiency of downstream processing (e.g. record-keeping, reconciliations of settlement instructions, corporate actions, claims handling and other functions required to resolve failed trades) and trade settlement, the fact of the matter is that not much light has been shed on inefficiencies in the middle office.
Same-day affirmation (SDA) refers to the completion of the entire trade verification process on trade day (‘T’), leaving more time for exception management and clearing and settlement processes within the intended settlement period, which in most markets means on the third day after trade execution (‘T+3’). It follows then that SDA should be an aspiration for the financial industry to work towards if it is to increase efficiency and reduce risk and thus increase stability. Furthermore, it is logical that automation of the trade verification process is a precondition to achieve SDA.
Last year Omgeo commissioned Oxera, one of Europe’s foremost independent economics consultancies, to produce a study on the middle office and its contribution to the cost of European trade processing. The research helped quantify the value of SDA and showed that through automating the trade verification process, firms can expect significant risk reduction and improved settlement performance. For example, the data provided by a number of broker/dealers suggests that the settlement failure rate of clients with automated trade verification processes has been as much as 50% lower than for non-automated clients.
The report also demonstrated that if a trade is verified on trade day, the risks and costs borne by investment managers, broker/dealers and custodians in the trade verification process could be reflected in lower transaction costs to benefit end-investors, as well as other benefits such as reducing counterparty risk and producing associated beneficial effects on liquidity.
At present the trade verification process is still conducted manually or in a partly automated way by a large number of market participants in Europe, namely small buy-side players. Therefore, those market participants that have switched to automated trade verification are not realising its full benefits when their counterparties continue to use manual processes.
Initiatives such as the potential shortening the settlement cycle in Europe and harmonisation of settlement practices across EU countries could be achieved more easily in an environment where firms have adopted more consistent and efficient trade verification processes.
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