Improving Operations Through Automated Reconciliation

Until recently, reconciliation has not been considered an essential project for some firms. It sometimes takes a significant financial loss, due to an avoidable oversight, to initiate the search for an automated reconciliation solution. Rather than focusing exclusively on technology that drives revenue, market participants should also consider technology that helps to preserve revenue, in order to maximize the effectiveness of the solution.

Lurking Risks
Many buy-side firms are still struggling with outdated and manual reconciliation systems that will not be able to meet the demands of complex trading operations and are putting the firms at risk on a daily basis. For example, some buy-side participants use accounting systems or third-party vendors' reconciliation solutions that are ill-equipped to handle the challenges associated with today's asset classes. Furthermore, these systems adopt a silo-based approach to reconciliation that promotes redundancy, which leads to inefficiency.

Firms that still use Microsoft Excel are limited to a basic matching engine with minimal data validation and no audit functionality to track changes to the data within back-office operations. In some cases, firms are manually reconciling their data, introducing a new set of risks. The likelihood of an oversight in a manual environment is not just possible, but indeed probable, given the substantial human factor.

Without an automated reconciliation system, buy-side firms face a number of risks, including lacking accurate cash and security balance information prior to the start of the trading day, having inaccurate account valuations when generating client invoices at month-end, and having multiple reconciliation processes that promote redundancy and inefficiency.

Getting the Benefits
Although the buy side is aware of the hidden risks, in some cases they choose to delay addressing the situation in favor of other projects, relying on continued good fortune to stave off a devastating issue. Firms should be looking for reconciliation solutions before such an issue occurs. One of the most important things to consider when evaluating options for an automated reconciliation solution is that it includes intelligent integration of positions, transactions and cash to eliminate process redundancy. Firms should also consider a solution that supports not only today's reconciliation requirements, but those of tomorrow.

The obvious benefits of implementing an automated reconciliation system include improving efficiency, promoting transparency and minimizing operational risk. Beyond the obvious, automating the reconciliation process also helps facilitate a smooth monthly financial close workflow that supports every area of the investment manager's business. The financial close process helps establish key performance indicators (KPIs) around all participants, including custodians and prime brokers.

The reconciliation solution helps with the root-cause analysis, as well as with identifying potential solutions for those custodians and prime brokers with KPIs that indicate below average performance. At the end of the day, an automated reconciliation solution plays a major role within any internal control environment that is looking to improve accuracy and eliminate barriers to the timely completion of financial close.

Supporting the Whole Business
The benefits of having an accurate and automated reconciliation system extend beyond the trades themselves to help make the entire firm more efficient and profitable. Traders and portfolio managers rely on accurate cash and security balance information prior to the start of the trading day. The client billing area of an investment manager relies on accurate account valuations when generating client invoices at month end. An automated reconciliation process also helps to ensure accurate account valuations and cash/security balance information.

To help mitigate risk, firms should increase the frequency at which they reconcile. Daily reconciliation of positions, transactions and cash provides the knowledge base for making appropriate investment decisions. Firms should also view reconciliation statuses in near-real time to identify exceptions that have the greatest materiality.

In addition, firms need to automate the acquisition, normalization and delivery of reconciliation data and utilize a comprehensive audit and security model, to truly decrease risk. Taken together, these steps can help investment management firms meet the checks of supporting their trading operations and their clients today and into the future.

John Landry is CEO of Electra Information Systems, which specializes in post-trade data aggregation, reconciliation and settlements.