Time for better tech as firms fail to tackle trade fails

The drive to innovate is a fundamental human characteristic. However, when I look at certain areas of global financial markets, it feels like we are going backwards, rather than progressing. According to a recent ECB report, settlement fail penalties cost T2S firms over €1.5billion in 2022 while the average number of cash penalties came in at around 1 million per month on average, in what must be seen as a damning indictment of post-trade infrastructure for securities settlement.

Indeed, since the implementation of the Settlement Discipline Regime (SDR) in February last year, T2S participants paid a staggering €141.6 million on average per month in cash penalties, across T2S firms, for late matching and settlement fails. Echoing the upward trend in volumes (rising 3.3% in total value on 2021), the volume of trades that failed to settle rose by 2.91% according to the ECB.

The overwhelmingly manual nature of securities processing means that failed transactions are remarkably common. Until recently, many of these fails had limited consequences. However, when one considers the introduction of these monthly cash penalties under SDR, it has become a costly mistake that many market participants appear to be continuing to make.

This has caused significant ripples across the market, with the Bank of England’s Securities Lending committee, among others, surprised by the high volumes and values of fails. This was echoed in the ECB report, which stated that improvements to settlement efficiency “had not yet materialised”.

How are firms impacted?

The fails we see are largely process-based and, thus, resolvable if a wholistic review is undertaken on each process in the post-trade lifecycle. Presently, operations groups are required to investigate the specific fail (and, ideally, to review the root cause of the issue). But this can also lead to broader reconciliation breaks which complicate matters and impose a resource drain on a variety of teams. When it comes to the drain on the bottom line, it isn’t just the penalty costs that have to be considered either. The funding cost and friction between internal departments that will be derived from a process-based fail must also be taken into account when evaluating the financial impacts of repeated settlement failures.

Beyond the obvious time, resource, and cost impacts of a fail are the reputational and relationship implications. Securities transactions are made for a reason – for example, it may be that the end user requires the stock to meet a trading strategy. Failure to deliver will impact that strategy and lead to tension between the key players in the transaction.

In an ideal world, firms would achieve a 0% fail rate on all transactions leading to zero reconciliation breaks. Unfortunately, however, fails will always occur, so the aim is to reduce the volume and to learn from previous experience.

Leveraging technology to streamline processes

So why, in 2022, were T2S firms leaking significant amounts of monies through settlement fails? Quite simply, too many firms are not using the technological solutions that are available to them to help reduce the rate of settlement failures. It’s clear that solutions that enable higher levels of straight through processing (STP) and visibility will inevitably lead to a reduction in both time lags and process failures. Achieving high levels of STP reduces manual intervention and, even when trades are failing, enables potential fail cases to be detected earlier.

Real-time visibility is crucial to achieving this. Operations teams need the ability to monitor status updates and inform stakeholders of the progress of a settlement at any given point in the cycle, with the aim of minimising disruption and maximising efficiency. This can be achieved by presenting up-to-date (preferably real-time) consolidated, aggregated data in an easily readable format. It’s a source of constant surprise that with so many technology advances in financial markets, many industry participants are currently unable to monitor (and therefore tightly manage) their holdings and obligations in real-time.

The application of new technology can improve these processes by enabling the normalisation and aggregation of transactional data. There should no longer be a need for two separate operations groups to review the same transaction based on single-sided information. Distributed Ledger Technology can enable a single source of truth and immediately share the status of a transaction and associated settlement based on custodian messaging. Furthermore, it can facilitate collaborative and automated workflows between a pair of counterparties, the absence of which is a driver of trade fails.

With the introduction of T+1 in North America in 2024, settlement is going to be even more time constrained. CSDR penalties may not apply for US transactions in the same way, but interest claims on failed trades add another cost to consider. Enhancements to processing and visibility will therefore be of paramount importance. The concerns around how organisations will cope with the shortened settlement windows will not be a new concept.

Now the time to act?

At a minimum, firms should review their transactional flow from front to back and actively decide if the current process is fit for purpose. If inefficiencies are found, it’s time to look at next steps. Is there a need to incrementally update an internal platform or can the time to market and efficiency be improved by reviewing the adoption of external solutions?

With regulatory pressures being the stick while costs and revenue deliver the carrot, there is no better time to review how to move the process for securities settlement to the next level with the use of modern technology. Once T+1 is bedded down in North America, we could see it enter the conversation for Europe, combining with CSDR penalties in a way that will be costly for market participants, unless they resolve the process based fails currently hampering their operations by taking advantage of available technology to enhance their processes.

Alistair Griffiths is Director of EMEA Sales for Baton Systems, the global fintech digitally transforming post-trade processing using distributed ledger technology (DLT). He has deep expertise in the industry, having worked for some of the largest and most respected institutions in the world including Bank of New York Mellon, BlackRock, and UBS. It was at BNY Mellon that Alistair built up eight years of experience in collateral management, sourcing and growing the firm’s Tri Party Collateral Management activity across the global market.

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