The oft referred to "plumbing" - the behind-the-scenes systems infrastructure necessary for processing a trade - continues to draw sizable investment by the global custodian community. To gain a better perspective of the critical issues facing the industry, the world's leading global custodians were queried about latest system development efforts. The survey identified a number of new initiatives, but, clearly one area is receiving far greater attention than the rest, namely Straight-through-Processing (STP). This article addresses STP and other current system development efforts.

"Those wishing to remain in the custody business need to increase investment in technology to create efficiencies," says one major custodian. Most custodians agree, as the path to greater processing efficiencies is gravitating toward an industry mantra of STP. STP is the seamless integration of the investor's trade confirmation in any global market through the clearance and settlement process.

A U.K. custodian's view captures the essence of the latest technology juggernaut, "An improvement in operational efficiency combined with a reduction in costs will be the driving force over the next few years throughout the custody industry. This is mainly achievable utilizing STP, allowing for seamless transaction processing in all operational areas." This custodian is working to upgrade STP capabilities, a common objective being pursued by all custodians.

Another advantage is the reduction of risk. "STP allows the industry to better adapt to compressed settlement periods, while minimizing settlement risks, eliminating the need for fax, telex and paper confirmations, reducing costs and providing a full audit trail from input to confirmation," adds another custodian.

"We are firmly committed to further enhancing our service in addition to increasing the level of automation in the UK market where traditionally, work flows have required higher levels of manual effort. Connectivity with client's back offices remains a high priority. By building automated interfaces clients and custodian can achieve efficiencies from the speed of two-way information flow."

In pursuing the STP concept, global custodians and others are converging on a common network solution, namely S.W.I.F.T. "The decision [was made] that the S.W.I.F.T. route would be a standardized mechanism for dealing with not only overseas clients, but larger UK corporates over time," says one custodian. This custodian is currently undertaking "...a major re-evaluation of present S.W.I.F.T. capabilities, ranging from automation and interfaces, to the messages used in our daily operations."

S.W.I.F.T. is the dominant method of communication with global custodians and their agent bank networks. With an ever-expanding list of eligible participants, system usage and message volumes are on the rise. S.W.I.F.T. offers security, standardization, authentication, instant acknowledgment and network protection within a single medium. All global custodians are developing worldwide system solutions based on a S.W.I.F.T. network, presently expanding usage to investment managers. The industry is committed to S.W.I.F.T. and I.S.I.T.C. message formats as a standard method of communication between clients, investment managers, subcustodians and member banks. [More about I.S.I.T.C. later in this article.]

In November 1995, I.S.I.T.C. and S.W.I.F.T. announced a new working relationship to address an industry need - a standard communication between fund managers and custodians. I.S.I.T.C. messages structures and future business requirements were adopted to S.W.I.F.T. standards, both existing and planned.

Recent initiatives by S.W.I.F.T. paved the way for greater acceptance by the securities industry. First, S.W.I.F.T. approved network access by service vendors to provide electronic trade confirmation (ETC) services. Fund managers and brokers may now exchange trade initiation and confirmation messages directly over S.W.I.F.T., using ETC providers.

"ETC services and supporting messages will further our STP goals, and the requirements of increasingly shorter settlement cycles in the global markets," says a major custodian. The S.W.I.F.T. announcement created a flurry of excitement in the industry. "S.W.I.F.T. introduced a new category of message for ETC, causing much interest in the marketplace as current ETC vendors view [the S.W.I.F.T. initiative] as a threat to their business," adds another custodian. This U.K. custodian observed an air of concern amongst fellow users of ETC.

Second, S.W.I.F.T. and the user community are actively developing four additional sets of securities messages: enhanced securities settlement, new corporate action, new derivatives and new collateral management. New developments will embrace "STP compliant" message formats and content.

Third, S.W.I.F.T. introduced additional features to facilitate STP, for example the automatic addition of settlement instructions to trade confirmation messages, the development of a centralized global securities identification number information service, and the expansion of counterparty identification numbers such as BIC codes.

To assist members in the transition to STP, S.W.I.F.T. offers an STP Analysis service which monitors a member's message traffic to gauge the degree of compliance with newly approved guidelines. Reports provide members an insight into the specific message groups requiring improvement. "We have transmitted instructions to our agents via the S.W.I.F.T. network using S.W.I.F.T.'s standards for message content and format. All major agents transmit trade settlement confirmations and holding's data via S.W.I.F.T. for automatic updates and reconciliation with our systems," says one custodian. While most custodians agree to this processing vision, initial results of the S.W.I.F.T. service indicate that STP is very much in its infancy. For example, "established" communication links between custodian and agent banks show a low degree of STP compliance, in the range of 25% "clean" - not requiring repair.

"We embrace S.W.I.F.T. messaging and uses it extensively throughout our organization. We are rapidly enhancing the number of message types available to the investment management community and expect to see continued growth in the use of S.W.I.F.T.," says one custodian. Most custodians agree.

S.W.I.F.T. proposed a Standing Settlement Instruction (SSI) database for participants. "We are yet to see what impact this will have," says a custodian. The introduction of an SSI will most likely dovetail with other industry solutions, however at this time, details are yet to be publicized. Other popular industry databases already in place include DTC's Standing Instruction Database and Thomson ESG Alert database.

Another custodian plans to use S.W.I.F.T.'s Interbank File Transfer service for transmitting standard extracts and other files to clients using the S.W.I.F.T. network. S.W.I.F.T.'s Interbank File Transfer allows custodians to send the standard extracts - in a secured transmission - without the need for a special set-up process for each client.

"I.S.I.T.C. is a growing initiative and will attract more participants as it continues to develop. Custodians must work to promote the adoption of standardized trade message formats, ultimately reducing risk and streamlining operational flows. Cooperation among custodians, through organizations such as I.S.I.T.C., is key to ensuring client acceptance of enhanced trade communication facilities," says a major global custodian. "I.S.I.T.C.'s objective is to work towards and support the industry's effort to achieve STP from the execution of a trade to its settlement," observes another custodian.

One custodian is working on "...a worldwide technology initiative - STP which includes I.S.I.T.C. as well as enhancing S.W.I.F.T. and proprietary messaging. The project will build a communications system which receives and sends securities-related messages for automated input and processing through our Securities Movement And Control (SMAC), accounting, and reporting systems without manual intervention."

The S.W.I.F.T. and I.S.I.T.C. partnership is a winning combination amongst the global community. "The assumption that this [S.W.I.F.T. and I.S.I.T.C] is the industry standard message format and mechanism, we are building our system upon this foundation," claims another custodian.

Industry Standardization for Institutional Trade Communication (I.S.I.T.C.) is a voluntary association of operations professionals who represent investment managers, custodian banks and industry vendors worldwide. I.S.I.T.C. is currently represented in North America, Europe and South Africa, and is currently implementing a group in Malaysia. I.S.I.T.C. has over 800 participants worldwide and a mailing list of over 4000.

I.S.I.T.C. was organized in 1991 as an ad hoc initiative in North America to create standardization in the settlement process for security transactions. Since that initial success, we have been working to identify other areas of the business where standardization and straight-through processing are needed. The group's primary goal is to reduce financial risk to custodian banks and the investment management community by reducing manual processing of trade data and to eliminate the need for multiple proprietary links between parties.

I.S.I.T.C. focused on the settlement aspects of securities trading between the custodian and the investment manager. With the recent merger of The Industry User Group for Electronic Trade Confirmation with I.S.I.T.C. Europe, the representatives of all three sides of the securities industry will come together- brokers, managers and the custodians to facilitate straight-through processing.

I.S.I.T.C. also works on other industry initiatives, being represented on The Depository Trust Co. Advisory Board, the Mortgage Back Securities Clearing Corp. and the ISO Data Dictionary Project.

Many of the custodians give high marks for the two Depository Trust Company (DTC) accomplishments, in particular the industry's move to same day funds settlement and a compressed settlement of trade date-plus-three in 1995. The role of DTC in the global marketplace was greeted with mixed reactions.

DTC, in conjunction with the First National Bank of Chicago opened a depository in London to provide a local depository facility for local banks and broker/dealers. The London Depository accepts deposits of U.S. physical securities, provides same day credit and sends the certificates to DTC's facility in New York, facilitating timely settlement of US securities. In addition, the U.K. office promotes DTC's ID system in Europe to provide a local routing system for automated trade instruction flow from local investors to custodian banks. DTC also partnered with the International Securities Clearing Corporation (ISCC) to form the International Depository Corporation.

The promotion of DTC's ID system may be a daunting challenge in the international marketplace, as global custodians based outside the U.S. are most critical of the initiative. As one U.K. custodian said, "DTC ID has been investigated and found less suitable for our requirements than a traditional sub-custodian."

DTC - and other vendors - were granted access to the S.W.I.F.T. network to supply ETC services. "It is unclear whether other ETC vendors will join the S.W.I.F.T. network. The London Stock Exchange is selling their Sequal product - this confuses matters even further," observes one custodian. [After the survey, it was announced that Thomson financial Services acquired Sequal and several ETC vendors joined S.W.I.F.T.] The outcome of DTC's entry into the global fray - out-from-under the "umbrella" of regulatory mandate enjoyed in the U.S. - makes the outcome of the evolving global scenario somewhat uncertain.

There is no lack of systems work to be done in supporting the constant change in the global securities markets. Other system projects mentioned by the custodians follow.

Millennium

It will be necessary for global custodians - and all industry players - to ensure that systems recognize the year 2000 onward. "The necessary modifications to our systems are being identified at this stage to prevent difficulties toward to end of the decade," says one custodian.

Another custodian, undertook a firm-wide project in early 1996 the issues. Year 2000 audit and software code was installed by an outside firm. This custodian claims "a very early start on the problem relative to our securities industry peer group and, as a result, anticipates substantial cost savings." Resource constraints are expected to impact competitors as the work required to adjust systems far exceeds the total pool of programmers available to work the problem. This custodian now incorporates a Year 2000 tested provision in all software contracts.

CREST

A priority for U.K. custodians for the past couple of years is preparation for the commencement of CREST. CREST was launched on 15th July 1996 with the first CREST settlement date on the 19th August. CREST, the central depository developed to dematerialize U.K. share certificates is targeted for start-up in 1977.

CREST will enable each participant to hold stock in accounts, from which stock can be transferred, allowing equity trades to be settled against sterling payments an the basis of electronic messages transfer, i.e. book entry. Messages - also in electronic form - will be passed to the company registrars, required to respond rapidly and inform CREST of the completion of successful registration. Legal change of ownership only occurs once the entry on the company register has been updated by the registrar.

U.K. custodian developed an interface to CREST including "...changes to internal operations to enable us to offer both a full UK custody and settlement service within a CREST environment." The custodian used the CREST network supplier, S.W.I.F.T.. A smooth transition from Talisman to CREST is expected by this custodian.

Foreign Depositories

Local securities markets worldwide have introduce major new developments. For example, The Netherlands implemented the central depository (NECIGEF), a new communication infrastructure. In Australia, local market participants completed the implementation of CHESS 2, to support trading and settlement.

CGO

The enhancement to the Central Gilts Office (CGO) system, scheduled for al 1997, will require modifications to the record keeping of gilt trade upon the custody system.

EMU

Implementation of the European Monetary Union will require the creation of additional information within the static data maintained on the custody system.

ISO

Work on the Data Fields Dictionary should benefit the community as a whole, not just in standard messaging.

© Copyright 1999 - 2004 Buttonwood International, All Rights Reserved.
14 Wall Street, 20th Floor
New York, N.Y. 10005 U.S.A.