Inefficiencies in the securities settlement process can have serious knock-on effects throughout the transaction chain. Charifa El Otmani, director of capital markets strategy at Swift, discusses how this impacts asset managers today and how transaction tracking can help.
Can you give us an overview of some of the settlement inefficiencies in the market today?
A lot of work has been done in recent years to improve settlement efficiency. Based on data from the Swift network – which mostly covers cross-border settlement and reconciliation flows – we see, however, that currently, about 1 out of 20 transactions ends up failing.
In fact, according to Swift Watch, 4% of settlement instructions are cancelled before or on the settlement date; 1% of settlement instructions are cancelled after the settlement date; 5% of settlements are completed after the settlement date.
The introduction of cash penalties for settlement fails under the Central Securities Depositories Regulation’s (CSDR’s) Settlement Discipline Regime was meant to push the industry to address some lingering issues. And although there was an initial drop in settlement fails ahead of CSDR’s implementation, ail rates are increasing again. So, it’s clear that the industry has a real opportunity to improve its settlement processes.
What impact do settlement inefficiencies have?
For institutions across the securities transaction chain, settlement fails result in added costs and risks, including for asset managers. The buy side’s primary purpose is to maximise returns for investors through portfolio management. And post-trade processes – like trade settlement, which are handled by a chain of intermediaries including global custodians, local sub-custodians and central securities depositories (CSDs) – are largely outside the asset manager’s control.
However, when something goes wrong in the intermediary process, and a trade fails to settle on time, it creates additional work for the buy-side too. This is because firms will need to spend time and money finding a resolution and manually managing exceptions. Fails might also have an adverse impact on buy-side liquidity, as the non-delivery of assets can disrupt inventory management and collateral optimisation.
Such issues risk being a distraction for asset managers, who would rather focus on generating returns for clients and not dealing with trade fails.
How important is it that settlement efficiencies improve?
Capital markets participants are operating in an environment where margins are tight and cost pressures are growing, owing to a combination of shrinking revenues, client fee pressure, an influx of new regulations and higher operating costs. By solving some of the inefficiencies around settlement, financial institutions will be able to reduce costs. It also means firms can concentrate more on revenue-generating activities and innovation initiatives that enhance the customer experience.
Secondly, the European Commission’s CSDR Refit could result in targeted changes being made to the rules. A major concern for the industry is whether the proposal for mandatory buy-ins will be resurrected, having been delayed during the initial implementation stage. If cash penalties don’t incentivise market participants to improve their settlement efficiencies, then mandatory buy-ins could be reintroduced.
The Commission will be looking very closely at trade settlement data, and its decision on whether to impose mandatory buy-ins will consider those metrics, among others. So, it’s in the industry’s interest to address the issue head-on.
Will the eventual adoption of T+1 help facilitate settlement efficiency?
The shift to T+1 by certain countries is likely to put pressure on market participants to refine their settlement models. Right now, India is phasing in T+1 for its equity market, while the US and Canada are planning to adopt T+1 in 2024. Other markets across the world could follow suit.
T+1 is likely to bring about a number of risk management benefits, but it simultaneously has scope to cause disruption. From an operational perspective, T+1 means that trade confirmations and settlement matching must take place within a few hours of the trade’s execution – raising the possibility of a spike in trade settlement fails and cash penalties. Again, this will likely encourage the industry to look at ways to enhance settlement efficiency.
How can the industry tackle this?
One of the reasons why trades fail to settle on time is because of the lack of transparency into the actual post-trade lifecycle. An asset manager, for example, will not have much insight into what is happening across the lifecycle of a transaction, and neither will their broker, which means there can be a lot of back and forth between counterparties and intermediaries when something goes wrong.
Having visibility throughout the transaction chain of intermediaries would help solve this. And here’s where the unique transaction identifier (UTI) comes in. The UTI is an existing, industry-recognised standard – the ISO 23897:2020. Industry-wide adoption of it would help firms identify transactions at risk of failing and take corrective action ahead of the settlement date.
This is because the UTI facilitates greater transparency and enables market participants to track transactions throughout the entire securities lifecycle in near real-time, just like tracking a package in our everyday lives.
What advice would you give to asset managers?
The use of the UTI in securities settlement is a foundational initiative. While it’s currently being used to give market participants better visibility into the post-trade lifecycle, it could be applied more widely in the asset management industry. For instance, managers could eventually leverage UTIs to increase visibility on fund subscriptions and redemptions and their related payments or for corporate actions processing – especially complex voluntary events.
I encourage all asset managers to learn more about the benefits of the UTI and, ultimately, how it can help them not only improve their own processes but also open opportunities to enhance their customers’ experience.
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