STP For Risk Reduction Back in the Spotlight

"I think that the various systems of confirmation, affirmation and allocation today, are still cumbersome for an asset manager to have to deal with," says Fabian Vandenreydt, head of securities and treasury markets at Swift. "There are various ways of doing things ─ for some asset classes you do confirmation for one and affirmation for others, etc. We advocate making that simpler by having clear market practices and harmonizing the way people are supposed to deal with those things."

Automation
One of the ways of doing this, according to Swift, is through widespread adoption of straight-through processing (STP). The automation of business processes and the removal of human ones play into most areas of risk management in trade cycles ─ regulatory risk, operational risk and cost risk, chief among them. Indeed, the reliance on what may seem like archaic methods of communication ─ the fax machine, for instance ─ introduces levels of strain that many on the sell side are beginning to find cumbersome. "For operational risk, a counterparty is more risky if confirmations are late or not done," explains Vandenreydt. "I do think that going forward, providers will demand greater margins, or will be less open to negotiation as far as service levels are concerned. People are very aware that the operational risk they bear is unsustainable if they don't have smaller players on electronic confirmation systems."

Party Line
There are key problems inherent with this, though. In order for STP to work effectively, there needs to be as many parties in an STP chain ─ an automated sequence of confirmation, affirmation, settlement and everything in between ─ as possible. However, the associated costs with upgrading to a fully-electronic system can be overbearing for what Vandenreydt terms "smaller players". The confluence of standard practices and the help of larger vendors and institutions such as Swift, he argues, are essential in breaking this mould.  "We're looking at promoting industry standards and especially electronic trade confirmation (ETC) practices, understanding that various syntaxes and connectivities will coexist ─ and having ways to translate those things into an industry-accepted data model," he says. "So, buy-side firms that do participate in electronic confirmation don't need to have a huge cost upfront to migrate all of their systems to a full industry standard from day zero."

Risk Reduction
The push for continuous automation in trade cycles isn't down to pressure from the bigger institutions, funds and others alone, of course. New regulation aimed at the reduction of systemic risk and other areas is playing into the drive in a big way. "There is a move to T+2 in certain markets, which would obviously make it fairly unbearable to keep on doing things manually," he says. "That's certainly one [area of impact] and to me it's the biggest to be honest. Also, I think that the collateral that people will have to put in place to be able to stay in business will have to be very transparent and optimized, and the less automation you have in the way that you handle confirmations with your clients, the more collateral you need to set aside. With respect to the Dodd-Frank Act, as far as trade repositories are concerned, there will be much stricter reporting regimes, and the quality of what has to be reported to those trade repositories will become higher. The matched trade is of a higher quality than an unmatched trade, so it calls for matching systems that are in demand."

Attitudes
However, with differing attitudes on cost and risk burdens, as well as the seemingly interminable conversations around STP implementation, Vandenreydt warns against assuming that regulation and the current economic climate will force an immediate shift. "Today, an asset manager sends a fax because he knows that will be accepted through the process," he adds. "But I think that when custodians and brokers highlight the risk that this creates for them and for the asset manager and that there are simpler ways to handle them and move them progressively to affirmation systems, then I think they'll move toward electronic methods...but I wouldn't bet on this happening in the next six months."

Swift's recent whitepaper, STP - A New Look At an Old Idea ─ can be found here.

The Bottom Line:

• As trades become faster and more sophisticated in nature, traditional methods of communication are becoming unmanageable.
• However, cost barriers for smaller players decreases the efficacy of STP chains by removing the ability to communicate in an efficient, electronic manner.
• Companies such as Swift advocate a half-and-half approach initially, where traditional methods can be automatically translated to work in an STP chain, thus reducing zero-day costs for smaller firms.