Innovative technologies, like DLT, have a role to play in post-trade processing, writes Bill Meenaghan, Founder & CEO of SSImple
While post-trade services might not receive as much attention or recognition as other areas within the financial industry, such as trading or investment banking, they play a vital role in ensuring the stability, transparency and integrity of financial markets.
One aspect of post-trade, standing settlement instructions (SSIs) – the foundational set of data needed to settle every transaction – has not attracted much attention until now.
Used by numerous financial institutions including custodians, prime brokers, buy-side/ outsourcer firms, broker-dealers and other third parties, SSIs establish standardised settlement information with their counterparties. In short, they help automate and streamline trade settlement processes, reducing the need for manual intervention and potential errors. Simple right?
Not quite. It is estimated that €300 million (£261m) of buy-in penalties, which have been live under the Central Securities Depositories Regulation (CSDR) Settlement Discipline Regime (SDR) since February 2022, may have been levied in the first 12 months alone. According to AccessFintech, SSIs cause 30% of settlement failings, meaning that approximately €90 million in SDR penalties for TARGET2-Securities depositories are directly linked to incorrect SSI data or the incorrect SSI being used.
Both are now avoidable, so, what are the reasons for slow progress and what is the way forward considering rising interest rates, staff resolution costs and the move to T+1 confirmed for the US and Canada this time next year?
Poor SSI data quality is not a new problem, it has been around for many years. But it is unlikely to be solved if we stick with the process that is in place today. What is the root of the problem? Well, it is data really.
SSIs can cause settlement failures if there are inaccuracies or discrepancies in the SSI details and this can happen for one or more reasons.
First, there is manual error. SSIs are frequently turned into unusable PDFs to ensure that the data cannot be amended. This leads to manual entry, as they are usually sent over email, which can lead to mistakes such as typos or incorrect account numbers.
Second, there is outdated information and high maintenance. If the SSI details are not updated promptly after any changes, eg. a change in the sub-account details, this can cause a discrepancy in the settlement process.
Third, a lack of standardisation or transparency. The absence of standardisation across different financial institutions (FIs) can create confusion and lead to misinterpretation of the SSI details. Different custodians use different names for the same fields, e.g., sub-custodian, sub-agent or local custodian. Once created, these PDFs get sent to the buy-side client who is managing that portfolio. In turn, they send it on to the 40-50 broker-dealers they use, who then need to interpret the SSI information and add it to their system. Each broker-dealer does this individually.
Lastly, fragmentation. The lack of a truly centralised complete SSI database and industry-wide standards has led to fragmentation and inefficiencies in the settlement process, particularly for cross-border transactions. I estimate that there are at least 10,000 buy-side firms who share SSIs, the majority being smaller rather than large FIs, that do not have any means of sharing SSIs electronically. These SSIs need to be interpreted before they can be used and cause delays for the counterparties and third parties who need to use them.
If there are discrepancies or errors in the SSI details, this can cause the settlement process to fail, resulting in delayed or cancelled trades. In Europe, as mentioned earlier on, the EU’s SDR is live and that means penalties can be levied for failure. In turn, this means increased costs, operational inefficiencies and risk in the settlement process, and highlights the need for further innovation and standardisation in this area.
Choosing the correct SSI
The world is constantly evolving, and the settlement process is no different. If you bought a UK security twenty years ago it is likely it would have been traded on the London Stock Exchange and settled at CREST. There are now more exchanges and settlement venues, and European rules allow for more competition in this space. Securities can be issued in one country and settled into any other approved depository, e.g., German securities can settle into Euroclear France.
In choosing the correct SSI based on the settlement parties involved, one must consider these nuances for correct enrichment, otherwise settlement failures will occur.
These are just some of the reasons why the wrong SSI can be used. The data may be perfectly correct, it is just that the counterparty is expecting the security to settle in a different central securities depository (CSD).
The financial industry is exploring innovative technologies to improve the efficiency and automation of SSIs, including the use of distributed ledger technology (DLT) to enable real-time updates and greater transparency in the SSI process.
The aim must be to further enhance the accuracy, speed, and security of the settlement process, benefiting all the parties involved. That is my focus and I look forward to helping reimagine the way SSIs are stored, shared and enriched across the industry.
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