Automated reconciliation solutions were once considered a luxury, but today there is a global trend towards adoption of solutions that can automate the collection and validation of investment data while identifying and providing a workflow for managing exceptions.
Automated reconciliation solutions were once considered a luxury, but today there is a global trend towards adoption of solutions that can automate the collection and validation of investment data while identifying and providing a workflow for managing exceptions.
There are four primary factors driving the increase in reconciliation investment by investment managers, the weight of each factor varying across firms. Investment managers have an increasing need for robust reconciliation capabilities that extend beyond the traditional reconciliation of positions, transactions and cash. Additionally, the current regulatory challenges are driving firms toward improving efficiency and reducing overall operational risk, using reconciliation as a key tool. Thirdly, margins have decreased while transaction volumes have risen, forcing firms to look for ways to reduce the additional costs associated with a manual environment. Finally, investment managers are facing a comprehensive operational due diligence process that includes a thorough examination of their entire trade lifecycle with post-trade processing in the spotlight.
Today’s reconciliation solutions have moved far beyond the basic reconciliation of positions, transactions and cash data. Investment managers have expanded their use of these tools to include the reconciliation of security master information, pricing, profit and loss, NAV, collateral and investment data between internal systems. To highlight the importance of internal reconciliation between systems, consider the post-mortem around the UBS trading scandal of 2011.
According to sources, UBS admitted to the US Securities and Exchanges Commission that its internal controls were “not effective” in identifying the fraudulent trading activity. The same can be said for similar scandals such as Barings and Societe Generale’s failure to identify unauthorised trading activity. There are no guarantees that an event-driven reconciliation solution would have prevented the unauthorised trading, but it certainly may have helped to minimise damage by identifying the activity much earlier in the process.
Increasing regulations have also caused heightened interest in reconciliation investment, as investment managers are under pressure to demonstrate transparency around their business processes to help identify compliance issues and operational risk. Regulations such as the US Dodd-Frank Act and the European Market Infrastructure Regulation demand more transparency and accountability, while introducing additional reconciliation requirements beyond the firm’s existing responsibilities. For example, trade repositories are required to perform portfolio reconciliations under Dodd-Frank, though the regulation does not explicitly ask that buy-side investment managers reconcile against the trade repositories.
Consequently, many investment managers have stated they are looking to automate reconciliation to ensure they have an accurate view of what is being held at the trade repository. There are additional reconciliation mandates that are applicable to investment managers that will be labelled Major Swap Participants according to the US Commodity Futures Trading Commission’s definition, who will be required to reconcile at specific frequencies depending on their swap trading volume. It’s likely that the new regulatory landscape will introduce further reconciliation requirements and firms who have implemented an automated reconciliation solution will be well positioned to manage the additional workload.
Reduction of operational costs is another important factor in the increase in reconciliation investment. For many firms, the back-office holds the largest number of employees and experiences the highest turnover. Automating the reconciliation process not only reduces the headcount needed to manage their activities, it also eliminates the mundane aspects of daily reconciliation that could potentially lead to employee dissatisfaction and turnover. Whether it be the reduction of staff needed to support reconciliation due to heightened scalability, or the elimination of costs associated with staff turnover, it’s clear that introducing an automated solution can reduce the operating costs associated with a manual environment.
Operational due diligence is another factor in this investment increase. In the post-Madoff era, investors are not only looking at performance, but the underlying technology that promotes transparency and helps to mitigate risk. Solutions that automate business processes while providing robust audit capabilities around the activities of staff are in high demand as they satisfy the requirements of both investors and regulators. When you consider the fact that roughly half of all hedge funds who go out of business can attribute their collapse to an operational process breakdown, it makes sense that investors would employ a comprehensive operational due diligence process that helps identify processes that are not automated and thereby fraught with risk.
The due diligence process helps investors identify which investment managers have the proper controls in place to minimise risk involving people, processes and systems. Investors want to know that the firms they invest in have the necessary tools to deal with operational issues when they surface. By investing in reconciliation technology, investment managers are showing clients and prospects that they are serious about mitigating operational risk.
There is no question that interest in automating reconciliation has never been greater. Faced with tough mandates from regulators, and even tougher demands from investors, investment managers are turning to automated reconciliation solutions as a way to improve operational efficiency, mitigate risk and reduce costs.
