Reconciliation Must Evolve With the Times

Given the downturn of the markets, the last 18 months have witnessed a considerable churn in the reconciliation-technology solutions that address the securities and investment industries. We have seen a proliferation in the need for generic reconciliation, the birth of Virtual Matching Utilities (VMUs), an evolving real-time performance prerequisite and the case for technology investment becoming ever more onerous. One could argue, to some degree at least, that the two aspects are linked; with institutions now being compelled to find increased efficiencies to prop up profits in the face of falling revenues.

Most banks and securities houses have, for some years now, successfully automated the essential but mundane tasks of bank account and securities in custody reconciliation. The majority of firms have purchased packages for this purpose, and six software vendors share some 80 percent of the global market for these applications.

However, the same institutions are now striving to use reconciliation applications in new ways - many of which were not foreseen when the existing systems and processes were established. They also need to move straightforward cash-at-bank and securities-in-custody reconciliation from being a batch-driven process to a near real-time process. One of the business drivers behind this change is the upgrading of core transaction-processing systems to real-time operations, enabling intra-day reconciliation, which, in turn, promotes competitive advantage through improvements in customer service and liquidity management.

On the theme of competitive advantage, in a recent survey on exchange-traded derivatives, improving customer satisfaction was identified as the biggest challenge facing operations professionals in investment banks, stockbrokers and fund managers. Respondents also flagged the quality of reconciliation processes as being a concern, together with the need to improve reconciliation accuracy, cope with increasing regulation and counter downward pricing pressure from clients.

Practitioners have recognized that they now need to reconcile and check the integrity of many more types of data on an everyday basis. Larger firms usually employ many different individual applications in both the front and back offices to process different instrument types effectively, feeding cross-product consolidators such as general ledger, risk management and credit-control systems. How can data integrity and compliance be guaranteed when all of these systems hold records about the same client, security, position or transaction?

The answer is that without regular reconciliation between the internal systems there are simply no guarantees. Major areas of operational risk, not to mention significant losses have sometimes been uncovered only as a result of either customer complaints or through regulators' scrutiny. The response of the firms affected has usually been to set up ad-hoc task forces as and when the issues are uncovered. Unpicking and dealing with complex problems that have gestated over months, if not years, often requires the full-time involvement of a number of highly skilled staff for a protracted period. And, as soon as they have finished resolving the current crisis, unsurprisingly, another one emerges.

To tackle these issues at the source, institutions are seeking systemic solutions that are flexible, robust and scalable. The aim of these generic solutions is to identify, measure and control these operational risks at the earliest possible opportunity. With respect to generic reconciliation systems, three fundamental characteristics have to be inherent in the solution.

First, generic reconciliation solutions have to be much more flexible with respect to the formats in which they accept data. Bank reconciliations are used to accepting data in Swift format, and stock reconciliations are used to data in either Swift or CSD formats. But data is now being sent by a potentially very large number of internal systems, and may be the result of either a dedicated reconciliation-interface program or just the result of a standard inquiry or report that is part of the back-office system. It might be in fixed-width format, comma-separated format, an XML string or even a formatted text file. Reconciliation systems now have to be able to accept data in all formats, and transform it to deliver accurate reconciliation with a 90 percent plus match rate.

The second fundamental characteristic is the ability for end-users to write business rules. If, for example, the reconciliation system is required to compare records of debt-security positions held in two systems, then there are a potentially very large number of data items - such as the average price, accrued interest, accrued days, and yield to maturity - that should either agree precisely or agree within a defined tolerance. Users must be able to set up these, often very complex, business rules without having to ask the vendor to make code changes or to supply expensive consulting resources.

The third characteristic of generic reconciliation is the presentation of the output. All reconciliation systems have a set of standard inquiries that are used by operations staff to investigate failed matches and to make manual matches. In a generic solution, these inquiries must be more adaptable, intuitive to use and flexible than they were in the past. An inquiry format that was designed for a simple bank reconciliation, involving just one currency and no client positions, will almost certainly not be a suitable format for a reconciliation involving a CSD, where the firm holds over 100,000 individual lines of stock belonging to more than 10,000 beneficial owners, and the regulator insists on segregation.

Therefore, end-users have to be equipped with tools to modify the appearance of the output according to the purpose of the reconciliation. Once again, it is not acceptable to have to request code changes or consultancy assistance every time a new reconciliation requirement is identified, as the direct and time-to-market costs will outweigh the benefits.

An altogether new trend is the establishment of VMUs, and particularly the CLS Bank, where best-practice involves both cash and stock reconciliation on the day of settlement, not on S+1. CLS member banks, in all time zones, need to ensure that they have received the necessary payments from their customers by the start of the CLS working day; 07:00 a.m. Central European Time (CET). Equally, customers of CLS member banks may need to substitute securities placed as collateral with their CLS member bank before 07:00 CET, and if they have not reconciled their positions in custody, they will not know what collateral they can move.

In response, both Swift and U.K. Telecoms company Cable and Wireless have launched initiatives to provide banks with cash balance and transaction information in real-time. These initiatives are due to go live in 2003, and the existing reconciliations system may not be able to interface with these new services.

Looking forward, the desired panacea is that VMUs will process vast numbers of transactions centrally to reduce risk and improve processing efficiencies. However, these and other co-operative infrastructure initiatives will continue to require peripheral trade matching, reconciliation and exception-management solutions within every organization to ensure processing efficiency and compliance objectives are satisfied across the business.

The payback for establishing high-performance trade matching, enterprise-wide reconciliation and exception management is significant. A direct correlation exists between the installation of such systems and the ability to redeploy full-time employees into areas of exception processing and customer service. Even when revenue growth is hard to come by, the upside from these key infrastructure and resource-redeployment initiatives can be material in delivering bottom line growth. From the perspective of the business case to invest, the timely delivery of the solution into a production environment is crucial in achieving the targetted ROI.

In conclusion, near real-time, enterprise-wide reconciliation is now a practical objective, not just speculative or wishful thinking. Properly implemented, it will help deliver operational, reputational and credit-risk reduction, together with raising both customer satisfaction and profitability. It pro-actively eliminates areas of exposure, which is by far the better alternative to setting up expensive reactive task forces to deal with problems that could have been prevented. Organizations that are seeking to replace or enhance an existing reconciliation application, should ensure, first, that the replacement system can work in real-time or near real-time; and second, that it has the flexibility to cope with the considerably greater variety and complexity of data that enterprise-wide reconciliation entails.

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ABOUT THE AUTHOR

Costa Christodoulou, CEO, City Networks Limited

Christodoulou has worked for over 19 years in the financial-services-IT industry. Market areas covered include securities trading and settlement, asset management, treasury and retail banking.

The vast majority of his employment has been with organizations such as Misys, ALLTEL and Unisys.

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