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2012 Top International Operations Executives

The More Things Change, The More They Stand Out
 |  DIANA CHAN: Shaking Things Up, In European Clearing |  CHRIS REMONDI: Increasing Information, Reducing Risk |  NEERAJ SAHAI: Marrying Large-Scale Technology With Boutique Service |  KEVIN MILNE: Making an Exchange Succeed By Working With Rivals |  THOMAS ZEEB: Gold Standard in Securities Processing |  CHRISTOPHER JAYNES: Cutting Out the Custodian Bank |  PATRICK COLLE: Going Global, But Not Everywhere |  TONY FREEMAN: Targeting Two-Day Settlement

TONY FREEMAN: Targeting Two-Day Settlement

December 20, 2011
By Chris Kentouris

Ensuring a two-day settlement cycle for all euro zone markets sounds like a pretty lofty aspiration.

The European Commission says it's necessary to ensure that a new pan European settlement platform created by the European Central Bank can operate efficiently. The future of that initiative called Target2Securities is now in jeopardy as the ECB in October said it had to postpone the launch to 2015.

Tony Freeman, Director, European Industry Relations, Omgeo

The announcement made at the annual SWIFT International Business Operations Seminar prompted plenty of industry talk that the project could very well be cancelled. And for good reason. European securities depositories and custodian banks have questioned the merits of T2S; it might not deliver the cost efficiencies promised.

Just how the fate of T2S will effect a shift to a two-day settlement cycle, otherwise known as T+2, is anybody's guess. But for now at least one industry player, Omgeo, appears to be committed to the cause. Taking up the charge is Tony Freeman, director of industry relations for Europe.

His task is pretty daunting. He has to convince fund managers of the merits of changing their antiquated procedures -- and timing for acknowledging trade details. Forget about faxes, phone calls and emails. Nothing short of a standardized automated process will do. If they don't the trade could fails to settle on time.

“We are explaining to buy-side firms the benefits of full automation and are working c loosely with broker-dealers to identify clients that rely on manual processing and generate additional cost and risk,” says Freeman.

Broker-dealers, insists Freeman, are already convinced of the benefits of automation as they are driven by efficiency and the elimination of operational risk. Custodian banks, which serve as middle office outsourcing agents for fund managers, are also highly automated.

The greater the number of fails the higher the operational risks--and costs-- to fund managers, broker-dealers and banks which have to compensate each other and the investor. Those costs don't even account for the time the parties have to spend figuring out what went wrong.

"The EC believes that a two day settlement cycle will reduce short selling so T2S isn't the only reason for the change," explains Freeman.

Freeman has plenty of experience in the fund management industry. At the early age of 18 -- right out of high school – he took a job as the settlements clerk for a U.K. pension fund company. “It was a pretty paper-intensive environment back then," he recalls. His responsibilities included ensuring portfolio managers and custodian banks did their work correctly.

Freeman has also worked as a systems analyst in the IT department at Robert Fleming, a manager for the International Securities Markets Assocation, now Xtrackter, the matching service now owned by Euroclear, and a relationship manager in the securities services unit of the former Chase Manhattan Bank.

"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.

Freeman agrees that fund managers may have a long way to go but insists that not all are ill- prepared. He has plenty of figures to back his claims. Trades are affirmed the day they are executed about 85 percent of the time in Europe and more than 90 percent of the time in Asia-Pacific. That is almost double the figure in the U.S. market at about 50 percent.

But that still leaves about 20 percent of trades unaffirmed on trade date in Europe. The biggest culprits -- fund managers in France, Germany, Italy and Spain. That pretty much encompasses most of the continent. UK fund managers are pretty automated

Just what will motivate fund managers to change? There is a clear correlation between same-day affirmation and trades settled on time but without a clear grasp of the costs of a failed trade fund managers are unlikely to take action, according to Freeman.

A more likely approach: Freeman cites the 10 British pound sterling fee which drivers must pay to enter the city of London. "The decision has really decreased traffic so increasing costs by creating fines is pretty effective," he predicts.

Although fund managers do reimburse counterparties for any mistakes in their part in failed trades, those penalties are ineffective. The EC has proposed that securities depositories fine members which fail to settle trades on time and if that comes to pass, custodian banks and broker dealers will likely pass along those costs to fund managers.

Yet another incentive: mandating a specific date for implementation. "Financial firms don’t normally allocate the appropriate budget and resources until a deadline is set," says Freeman

Surprisingly, fund managers have shortened the pace at which they execute orders using smart-order routing systems and algorithms. Trades executed in seconds can now be done in milliseconds. But when it comes to the back office snail mail still exists. That slows down the settlement process, particularly when cross-border trades are involved.

Market benefits aside, Omgeo has plenty of financial incentive to ensure that T+2 occurs. It offers a central matching service called Central Trade Manager which allows fund managers and broker-dealers to centrally match trades. Omgeo will migrate all of the 700 fund managers using a legacy electronic confirmation service called Oasys Global by 2012. That legacy system only allows for locally matched trades.

Freeman would not disclose just how much Omgeo stands to profit from a shortened European settlement cycle. But he insists that signing up to use the CTM is well worth the cost. The same-day affirmation rate for fund managers using the CTM is as high as 90 percent, he says.