By Tony Freeman, Executive Director, Industry Relations at DTCC

The middle and back office operations of financial institutions have come a long way in the last 20 years. Considered an essential piece of the market’s plumbing, they have had to constantly keep up with increasingly complex workflows, process higher trading volumes at greater speeds, and at the same time adapt to an environment of great regulatory change.

That regulatory change began in the 90s with the introduction of Regulation ATS (alternative trading venues) to ensure operational transparency and regulatory oversight of ATSs that trade stocks listed on a national securities exchange and led to a significant increase in market volumes and new trading venues.

But fast forward almost two decades and high levels of manual and inefficient trade processing continue to exist across the globe. Take exception processing as an example. An exception refers to a transaction that requires manual intervention to ensure that it settles. Poor handling of post-trade exception processing often creates operational risk and a significant amount of inefficiency for the parties to a trade.

In an interconnected, global community – with varying levels of operational capability – there are good reasons why the industry struggles to achieve high levels of efficient processing. Trade data needs to be consumed and processed from many disparate systems, including matching engines, trading counterparties, settlement entities and market infrastructure providers – and the related communications, which are predominantly emails, are overwhelmingly cumbersome to manage and introduce risk.

But technology has made great leaps forward in recent years, bringing middle and back office automation within reach. Firms can now track trades in real time throughout the transaction lifecycle and can tackle challenges such as exceptions more swiftly via dedicated platforms that connect to other market participants and service providers to facilitate timely resolution. Fast, accurate reconciliation is also supported by market and static data services that can enrich data fields and accelerate transaction flows, while analytics tools are improving the ability of firms to identify and resolve persistent sources of failure and delay. The usage of robotic process automation (RPA) is now becoming mainstream and is transforming how routine, non-complex issues are resolved.

Notwithstanding the benefits that these advances have brought to middle and back office processing, the industry remains cognizant that more needs to be done, particularly in the area of settlement efficiency. Recent research carried out by DTCC estimated the collective cost of settlement failures to be US$3 billion per annum globally. In an effort to ensure higher straight-through-processing (STP) and settlement rates, policymakers are acting decisively.

In Europe, the Settlement Discipline Regime (SDR), established as part of the Central Securities Depositories Regulation (CSDR), will soon enter into force, introducing penalties for firms who fail to comply with the regulation. In particular, the measures to prevent settlement failure will require market participants to enhance the efficiency of allocation and confirmation processes; automate the processing of all settlement instructions in order to improve STP and limit manual intervention; and subsequently, match settlement instructions in order to support fully automated, continuous real-time matching throughout the day. The aim of SDR is to improve settlement efficiency across the whole market therefore improved processes are an essential step.

While higher settlement rates can reduce operational risk and increase liquidity, an unintended consequence of the SDR is that it could encourage securities market participants to increase their borrowing activity to mitigate failed trades, leading them to access the securities financing and repo markets more frequently for both cash and collateral purposes. This could incur new reporting obligations, and hence will require enhancements to back office processes under the Securities Financing Transactions Regulation (SFTR), likely to be implemented in Q1 2020, which many market participants may have otherwise considered not applicable to their trading activities.

Putting together the right combination of tools, skills and resources to overhaul middle and back office processing is far from easy but the alternative is considerably worse. In fact, some trade bodies have asserted that the safest way to avoid the many penalties and administrative burden of settlement failure under SDR is to effectively withdraw from market activities that carry the risk of being forced into a buy-in on a limited timescale and which may not honor the economics and objectives of the original transaction. The unintended result therefore could be a significant reduction in liquidity across Europe’s securities markets.

The industry should feel encouraged by the overall direction of travel; transparency, accountability, standardisation and better investor protection are writ large across the vast majority of the last decade’s reforms. However, with the cost pressures that firms are facing as a result of inefficient post-trade processing, it will be critical to continue to automate their middle and back office. Forthcoming European regulations will bring with them further demands when it comes to post-trade. A strategic investment in the back and middle office in order to build a zero-touch environment will have wide ranging benefits, including the reduction of costs and risks for the underlying client, and will ultimately ensure safer financial markets for all.