"Yes" to straight-through processing (STP), "no" to T+1. That's the message that came out of the Securities Industry Association (SIA) as it responded last month to the recent SEC concept release on ways to improve the safety and operational efficiency of the U.S. clearance and settlement system.
If it sounds familiar, that's because the SIA said the same thing two years ago, when, in July 2002, it abandoned the project to shorten the equities settlement cycle in the U.S. from T+3 to T+1 and shifted the focus to achieving industry-wide STP. The new SEC and SIA papers, however, are more about focusing minds and building consensus around collective efforts to augment industry STP rates.
In its concept release, the SEC raised three areas for debate: how to improve the trade confirmation/affirmation process, whether to revisit the project to shorten the settlement cycle and how to progress with reducing the use of physical securities.
Regarding the confirmation/affirmation process, while it continues to support same-day affirmation/matching, the SIA, in its response paper, has changed its tack in terms of how market participants should accomplish the task, and the SIA now takes a non-prescriptive stance.
"In 1999, when we started to figure out how to better process institutional trades, the Institutional Transaction Processing Committee came up with a model using a real-time processing engine to match trades," says John Panchery, managing director and STP project manager with the SIA. "While we think that was a great idea, a lot of parties to the trade don't have that technology, or don't want to invest in that technology because they don't deal with thousands of trades per day. So, how do we reach our goal of electronic confirmations and affirmations on trade date without using some sort of matching utility? The answer is, it really doesn't matter how firms do it, as long as they can."
To reach the goal, the SIA has suggested a phased timetable for moving toward same-day affirmations. It would start by aiming for a 95 percent affirmation rate on T+1 at noon. Once reached, the target rate would be rolled back to T+1 at 9 a.m., then T+1 at 6 a.m., and finally at 10 p.m. on trade date.
But making progress toward same-day affirmations will require some form of mandate from the SEC, in cooperation with state regulators, Panchery asserts. "If we let best practice take its course, we'll all be pushing up daisies by the time this happens," he states. "Some SEC action will be necessary."
As for physical securities, the SIA position is that, while the program of immobilization should continue, it should only be a stage on the road toward the ultimate goal of complete dematerialization. "We will continue with our push to get rid of physical certificates, and we have staff working with the issuing companies and the states that still allow paper," Panchery relates.
Meanwhile, shortening the settlement cycle should remain off the agenda for the time being, Panchery says. "What we found is that for T+3 products there is not that much risk exposure, because those risks are mitigated with the existing systems that are in place," he notes. "There is no cost justification for T+1 right now, and we don't have the foundation of efficiencies that we would need to make it happen anyway."
Road Map for Change
So, in practical terms, what do the SEC and SIA papers mean to the industry? At this stage, not a great deal. The position set out by the SIA is a road map for future change, rather than a plan for a series of concrete steps that would allow the industry to roll forward with future actions plans, says Tom Perna, senior executive vice president with The Bank of New York (BNY). "This is a much more measured approach [than the previous T+1 project]," he says. "So I think it has more buy-in."
It makes sense to move forward on the issues raised by the SIA at this time, Perna suggests. "Firms are still working on STP initiatives anyway for their own efficiencies, so we don't need the T+1 motivation to do that," he continues. "And, as for supporting the issue of dematerialization, I think it's time now. People generally realize you can operate without certificates."
The immediate next step in the process will be the SEC's response to the feedback it has received, such as the letter sent by the SIA, as part of the consultation process to its original concept release. The SEC, SIA and any other relevant bodies then will need to come up with a more precise action plan for implementing the proposals.
"They are working on some of the details, but I don't think we've got any talk about establishing dates," Perna relates. "On the affirmation/matching issue, that is going to require some mandating from the SEC. What they will be working on next will be how to put that together."
Meanwhile, from the market participants' standpoint, the SIA/SEC initiative will require firms to re-examine their processing and STP capabilities, says Jeff Potter, vice president with Northern Trust. "It will also cause participants to employ some sort of technology solution, since the timings will not allow for a 'throw bodies at it' solution," he adds. "The most affected will be firms tied to faxing communications and manual processing. ... If the firms sending faxes do not amend their process, it will be interesting to see how the receivers react to it. Will they just process the faxes or will some sort of disincentives be employed to change the behavior?"
Certainly, bringing every constituent in the transaction chain up to the requisite level of automation to get to same-day affirmation/matching will not be easy. Getting the buy side onboard will be particularly challenging.
"Of the three constituencies - the broker-dealers, custodians and asset managers - the benefit is probably least to the asset managers," BNY's Perna observes. "In addition, the asset-management community globally is going through a difficult period, where they are not having the big growth spurts they did during the mid- to late-1990s, and are focused on their cost base. As a result, they will be less able to support any challenging initiatives -not because they don't want to, but because this is probably not going to be a priority for them."
A regulatory push behind the initiative will be important to ensure that the work needed does not slide down the list of priorities and to give this latest drive toward STP a chance of being successful. "Northern Trust has been interactive with the confirm/affirm process for years. We have also created ways for the investment managers we work with to easily interact with the system," Potter says. "However, creating the tools and getting firms to use them are two different things. The SEC initiative will hopefully create the enthusiasm."
For its part, BNY supports the elimination of paper certificates and will continue to work on STP projects, Perna says. "As regards same-day affirmation and matching, we all have to do some work if that comes about, but that is a very important piece of the puzzle to get STP and, ultimately, maybe earlier settlement."