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Automating Exception Management in Securities

A contributed piece by the Managing Director of SunGard eProcess Intelligence.

The following is a contributed piece written by Jeremy Bentley, Managing Director, SunGard eProcess Intelligence.

Progression towards T+1 is focusing much attention on STP in the Securities market. Initiatives such as GSTPA are driving forward the gradual progress towards a more standardized settlement processing environment where automated systems can deliver the greatest benefits. However, the prospect of a compressed settlement cycle also has a fundamental impact on operations risk management.

Simply put, if something goes wrong with a transaction, the time available to identify, research, mend and reprocess it prior to settlement will be uncomfortably tight for most institutions' current back-office processes. This is fundamental for the competitive positioning of fund managers, broker/dealers and custodians alike. Reputation and brand are becoming more important alongside a fierce downward pressure on prices. However, players still have to measure price against risk.

This has led to some considerable attention not merely on the automated processing of non-problem transactions, but also the possibility of automating the management and reprocessing of problem ones. Straight Through Exception Processing (STEP(tm)) has already come of age in the FX markets. Now a number of players in the Securities markets have implemented such STEP systems to deliver immediate risk management and competitive advantage, as well as putting in place a fundamental part of the overall systems re-engineering required to address the T+1 prospect.

This article reviews the subjects of risk, cost and competitive back-office advantage of STEP in the securities field, and identifies where automated exception management can deliver tangible advantage, even in the T+3 environment.

T+1-Pressures and Opportunities

In a move to mitigate settlement risk, the Securities and Exchange Commission in the USA is strongly backing the drive to T+1, proposing that the Depository Trust Company support the new settlement cycle by July 2002. This is against the background of statistics which indicate that current reconciliation and settlement systems are increasingly unable to cope with the markets' volume growth.

In 1999, the percentage of the average daily share traffic on Nasdaq, Amex and NYSE awaiting confirmation prior to settlement hit 12%, double the rate in 1994, but less than one third of the projected rate for 2002. And this is before the market has seen any more than the tip of the retail market e-trading iceberg, and the continued love-hate relationship with 'dot-com' stocks, both of which are creating unpredictable peaks in trading volumes. So back-office capabilities are being squeezed from both sides-the emerging demands of T+1, plus market growth and volatility. Whereas the move from T+5 to T+3 simply required, in many cases, a refinement of the settlement processing status quo, the move to T+1 presents the prospect of substantial re-engineering of the entire process for handling institutional trades.

Like any change in a market, T+1 represents a huge potential opportunity for those organizations prepared to get their systems in shape early on. Put another way, unless institutions make significant investment in their front- and back-office systems now, they are likely to find themselves struggling to keep pace with change, and may ultimately be forced to outsource their technical requirements to those who had the foresight to bite the bullet earlier. Beneficiaries of this kind of outsourcing opportunity already exist in the payments market, and are also emerging in the approach to CLS in FX.

Reducing Cost, Reducing Risk

However, the Securities industry has the opportunity to gain from the experience of others. In the FX and Money Markets, where STP was invented, technology solutions organically grew first into STP, and then into the notion of Straight Through Exception Processing or STEP(tm). The Securities industry has the chance of dealing with both at the same time (containing costs, mitigating operations risk and gaining quicker competitive advantage). Moreover, there are clear advantages to be gained from STEP in the current T+3 environment.

In consulting engagements with those securities industry pioneers who have already implemented STEP, we found a new version of the 80-20 rule. Broadly speaking, the 80% of transactions that passed straight through without a problem consumed only one fifth of back-office costs. In contrast, the 20% of transactions which hit a problem consumed a disproportionate four fifths of back-office overhead. This means that if just a quarter of those problem transactions can be automatically identified, investigated, repaired and reprocessed, that delivers a hard dollar, bottom line reduction of 20% of back-office costs.

Exceptions increase processing costs. They also damage service reputations. Yet, because exceptions frequently result from internal mistakes or other causes, they can often be identified and rectified before a counterparty or client is aware of their existence. So it follows that competitive advantage derives from automating the management of exceptions as they arise in-house, before they are obvious to the outside world.

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