The management of failing trades should be more automated, according to Paul Bowen, senior executive of operations at Corfinancial.
In an opinion piece, Bowen said that a key focus for the industry should be “acknowledging the need to more effectively manage the point in the trade lifecycle where the settlement process really ends”.
“Is it enough for the custodian to simply report to the asset manager that a trade has failed to settle and financial losses will be incurred by someone?”
Bowen explained: “In terms of the inexorable industry move to T+1, this issue of settlement tracking will soon shift from important to mission critical. It's an uncomfortable fact for both the buy- and sell-sides that, despite great leaps forward in trade processing technology, a significant proportion of trades still fail to settle on time.”
Bowen stated that as a result, some estimate the value of equity transactions at risk of trade failure “could be north of $970 billion”, and the value of fixed income transactions at risk could be more than $300 billion.
As a consequence, the cost of stock borrowing to avert the risk of trade failure on this scale could be as much as $4 billion, he predicted.
Bowen commented: “Some estimates suggest that more than a quarter of institutions on Wall Street have a fail rate higher than one in five. It's a big problem and an area of the trading world that has traditionally been very weak.”
Following the common settlement cycle for securities of T+2, in between trade date and settlement date two days later, there are a number of reasons why a trade might fail on settlement date, continued Bowen.
“The seller might not have the stock—stock might be out on loan, or the settlement instructions may be incorrect. For example, the fund manager could have instructed the custodian to settle the trade in one location, such as Euroclear, while the broker might be trying to settle the trade in the Depository Trust Company, so effective delivery versus payment cannot occur.”
“I believe that there should always be continual checks in the trade processing lifecycle, so that when an instruction is sent to a custodian to settle a trade, the custodian is able to respond with messages highlighting the changing status of that trade until it settles”, Bowen said.
Bowen concluded: “If asset managers wish to significantly reduce the risk of trades failing to settle, then I believe that there is more to do to ensure that trades are effectively monitored if firms want to avoid settlement failure and not pay for it.”
