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TONY FREEMAN: Targeting Two-Day Settlement

December 20, 2011
By Chris Kentouris

"I got a master's degree in office politics," says Freeman, who never attended college. He joined Omgeo in April 2004. That degree might have well ended up being the best one possible. He has plenty of experience in what can go wrong if everyone isn’t on the same bandwagon.

While at the former Chase Manhattan, Freeman became involved with a project promoted by the now defunct Global Straight Through Processing Association to create a global post-trade communications service. That project died in November 2002 after some of the world’s largest financial firms, including Chase, invested over $100 million; technology firms involved in the project who became creditors were also owned over $100 million.

The reason: there wasn't enough interest from buy-side firms. "It's going to be an educational process and one which involves a lot of prodding," says Freeman of Europe’s migration to a T+2 settlement cycle.

Fund managers responding to the EC's proposal to create a two-day settlement cycle cited plenty of operational challenges. Those include: the time to execute foreign exchange trades required for settlement; the reduced time to recall stock on loan or used as collateral; difficulties faced by local operations staff servicing clients in different time zones; and the investment needed to increase their levels of automation for smaller fund managers.

European fund managers meeting a two-day settlement cycle need to communicate -- or affirm-- the details of a trade with their broker-dealers on the day the trade is executed rather than the next day. Such affirmation is often done on the continent the day after the trade is executed.

Unlike European trades, U.S trades don't have to be affirmed to be settled by Depository Trust and Clearing Corp.

Affirmation represents a sequential process after a trade is made. First the fund manager allocates the trade to one customer or parts of the trade to many customers. Then, the broker-dealer confirms the trade. Then the fund manager affirms the trade. Such a process can take place "locally" between the fund manager and the dealer. This can happen either manually -- via fax or email -- or through an automated system. However, using an automated central matching system will more likely ensure that affirmation takes place on the same day a trade is executed.

Such a same-day affirmation also allows custodian banks to recall securities out on loan in time to meet a two-day settlement cycle. If the trades are not affirmed on the day they are executed, the custodian bank will not be aware the trade has been executed and therefore will not be able to recall any securities out on loan for the fund manager.

Using a process called central matching is a way for fund managers to achieve same-day affirmation. That is because the fund manager and broker-dealer can separately input into a third party system where the information will be matched or rejected. Centrally matched trades are considered matched-agreed, which is the equivalent to being affirmed.