The Migration to Trade-Date Matching

One of the certainties around shorter settlement cycles (SSC) is that, in order to meet an accelerated deadline, market participants will have to be quicker at completing the pre-settlement stages of the trade lifecycle. And, in its business case analysis of SSC, the Boston Consulting Group (BCG) identified "trade-date matching" as a key enabler of shorter settlement cycles.

Trade-date matching, also known as same-day affirmation (SDA), is the completion of the trade verification process on the same day the trade is executed. The trade verification process involves trade allocation, confirmation and affirmation. The process ensures that counterparties are in agreement about essential trade details such as security identifier, trade date, deal price, number of securities bought or sold and commissions, as well as account standing settlement instruction information.

Manual and Automatic
Due to its ability to reduce the amount of time and expense it takes to move a trade to settlement, there is a clear correlation between trade date matching and SSC. However, while SSC has prompted more discussion around trade date matching, the process has intrinsic qualities that can benefit market participants regardless of the settlement cycle regime they operate in. These include risk mitigation through error reduction, improved handling of exceptions and reduced settlement fails.

Automation could be considered a precondition for completing the trade verification process on trade day. Manual trade verification typically relies on telephone, fax or e-mail communication between counterparties, which are prone to time delays, errors and operational risk. Automation, on the other hand, significantly improves accuracy, making it easier for counterparties to identify and correct errors and reducing trade fails. Moreover, an automated system can readily adapt to fluctuating market volumes, unlike a manual process which can be overwhelmed by a sudden spike in volumes.

There are two methods for matching institutional trades, which are explained in the BCG report:

Automation, on the other hand, significantly improves accuracy, making it easier for counterparties to identify and correct errors and reducing trade fails. Moreover, an automated system can readily adapt to fluctuating market volumes, unlike a manual process which can be overwhelmed by a sudden spike in volumes.

"A majority of firms continue to use sequential matching, whereby, following a notice of execution from the broker-dealer, an investment manager sends allocations, awaits confirmation from the broker-dealer and then sends an affirmation, at which point the trade is matched. Streamlined matching processes, by contrast, eliminates the affirmation step, by making it implicit in the allocation. The investment manager still sends the account-level allocations, but once the confirmation is received and successfully matched with the allocation, the matching system can automatically generate the affirmation and send the matching trade details to all involved counterparties, including custodians."

Importance
The European proposal for Central Securities Depositories and for improving settlement efficiency, known as the CSDR, contains provisions that would effectively require participants to affirm trades on trade date. Meanwhile, other countries are also forging ahead. Canada, for example, already requires 90 percent of trades to be matched on T+1 in its National Instrument 24-101, which provides a framework in securities legislation for more efficient and timely processing of institutional trades. Any future proposals that relate to SSC in other markets are likely to support trade date matching as a key enabler. Without question, it is evident from the BCG's analysis that completing trade verification on the same day as execution is a crucial building block for SSC.

Next month, I will look at settlement matching.

Tony Freeman is the executive director of industry relations at Omgeo. Over the next few weeks, Tony will be contributing to Waters on the various enablers that need to be put in place in order to achieve SSC. The opinions expressed are those of the author, and do not necessarily reflect those of Waters or Omgeo.

Read the other parts of this series:

- The Road to Shorter Settlement Cycles

- The Migration to Trade-Date Matching

- The Need for Affirmation in Settlement Matching