rationalizing affiliate matching and settlement

Contents

New markets, new global

settlement and a new

clearing model................... .2

Go East ...............................2

Cross border trading is

doubly costly ......................3

Consolidated cross-border

trading ................................4

Why affiliate matching and

settlement?..........................4

The drive for operational

excellence ...........................7

Cleared for Globalisation – Time to

Rationalise with Affiliate Matching

and Settlement

Growing equity and fixed income cross-border volumes, an in-

creased focus on cost per trade and an inefficient cross-border

post-trade process and infrastructure is leading global investment

banks to review front-to-back their cross-border trade flow.

Banks need to offer execution to a growing number of markets

and as demand for international portfolios grows; banks need to

consider how they support international settlement and clearing.

A multi-entity approach has resulted in separate back office infra-

structure, operations teams and often each entity has developed

their own custodian network. This inefficient and often costly

process is not scalable and many banks are not well positioned to

support the expected growth in volumes. A new model is emerg-

ing – affiliate matching and settlement – using the infrastructure

and clearing relationship of a local entity to settle and clear trades

in that market for all global entities. This white paper explores

how firms can centralise settlement and clearing and the benefits

to organisations that adopt affiliate matching and settlement. We

suggest that by adopting affiliate matching and settlement, firms

will be in a strong position to compete in cross-border business.

Without a local presence and the

necessary scale to justify a self-clear

model, using local custodians is the

only option available to many firms

looking to expand into new markets.

Cross border assets under custody at

the top 10 custodians has grown 22%

over the last 2 years. This growth is

expected to continue and by the end

of this year, it is estimated that assets

under custody will have over taken

the peak of 43.3 trillion USD

reached in 2007. An opportunity ex-

ists for firms to internalise settlement and clearing and reap the many

rewards of doing so.

Our partner in developing

this white paper:

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Figure 1:

Cross Border Assets Under

Custody — Top 10 Custodians Source: Globalcustody.net

New markets, new global settlement and a new clear-

ing model

Global financial institutions are facing a challenge to meet the increase

in cross-border volumes. A fragmented infrastructure has emerged with

organisations establishing a large presence in each hub location to sup-

port markets in the region. As a consequence, each region has often

developed their own global agent bank network and has responsibility

for settlement and clearing in all markets. This has resulted in an ineffi-

cient and costly process with duplicated agent arrangements which is

not scalable and could be improved through centralising clearing and

settlement.

There is a shift of wealth to Asia and emerging economies in general

and many financial organisations are exploring opportunities to expand

into the Asian market, either offering Asian securities to their existing

client base or attracting clients in Asia looking to trade in global mar-

kets, primarily Europe and US. The high cost to play in the fragmented

Asian market and the local infrastructure required to establish an Asian

franchise is holding firms back. By utilising existing infrastructure and

existing custody relationships in the US or Europe and focusing only on

client service in Asia, an efficient and cost effective model can be im-

plemented to meet these opportunities by clearing all trades through

centralising affiliate entities.

Go East

European and US banks over recent years have increasingly looked

East for new opportunities. Whilst expansion was delayed in the after-

math of the global financial crisis, Asian expansion is now fully back

on the agenda. The complexities of setting up business in Asia should

not be underestimated.

Asia is a fragmented

region with each coun-

try having specific and

varied regulations. Even

with a hub and spoke

model, the cost to be a

full player in Asia is

high – full teams need

to be established in the

hub location, partial

teams in the spokes, full

infrastructure across the

region, local exchange membership and CSD connectivity. This is often

too high a barrier for firms to surmount. Clients though increasingly

want to be able to trade and settle a global portfolio. Banks are under

Each region has often devel-

oped their own global agent

bank network. This has re-

sulted in an inefficient and

costly process which is not

scalable.

Asia expansion is back on the

agenda . The cost to be a full

player in Asia is high and is

often too high a barrier for

firms to surmount.

Figure 2:

Multi-Entity Custodian & Instruction Flow

2 TIME TO RATIONALISE WITH AFFILIATE MATCHING AND SETTLEMENT

pressure to meet this demand; otherwise clients may change their in-

vestment bank to one that is able to offer a full global product offering

and suite of services. To avoid the high cost of setup, firms will often

establish local partnerships; execute trades with local brokers rather

than directly on the exchange and use the services of a local custodian.

Outsourcing these parts of the trade lifecycle considerably increases the

cost of trading. It becomes increasingly hard for firms to compete on

cost with local firms or global banks that have the required local struc-

ture in place and have internalised clearing.

Cross border trading is doubly costly

We have seen front-office product COOs move from a contextual desk-

aligned model to an integrated front-to-back model. These COOs are

focusing on cost-per-trade across the full trade lifecycle. Becoming

members of exchanges in key markets has dramatically reduced broker-

age fees and led to the creation of execution centres of excellence. The

effort involved in identifying further savings within pre-trade and trad-

ing far outweighs the benefits. There are no longer any quick-wins. As

the opportunity for cost reduction declines in trading, COOs are in-

creasingly focusing their attention on the forgotten post-trade area. A

COO of a top-tier investment bank believes that “the cost of post-trade

has become disproportionately high compared to the overall cost per

trade”.

Banks are focusing their attention on savings that can be generated in

post-trade across equities and fixed income. Equities has benefited from

huge investment in technology. The emergence of DMA and the switch

from voice-trading to electronic trading has required sophisticated tech-

nology to successfully compete in this business. The result is a vanilla,

greatly automated product with high rates of STP. In contrast, fixed

income suffers from an often outdated infrastructure and processes

which results in very high levels of manual intervention, making the

cost of fixed income processing sensitive to volume increases. The cost

of post-trade will rise considerably with the expected volume increase.

Without changes in the post-trade environment, this is not sustainable.

Furthermore, the cost per trade of cross-border trading for equities and

fixed income is significantly higher than for domestic trades. This is

often due to buying services in an overseas market to compensate for a

lack of depth in local presence and relationships. In an international

business, where a large proportion of growth is expected to come from

cross-border business, this gap needs to be closed.

A general theme of US and European regulation in response to the fi-

nancial crisis is to reduce the level of OTC activity and increase scru-

tiny on high frequency trading. There is a significant drive for increased

transparency and previously OTC products will increasingly be re-

COOs are increasingly focus-

ing their attention on the for-

gotten post-trade area. The

cost of post-trade has become

disproportionately high.

The cost per trade of cross-

border trading is significantly

higher than for domestic

trades. This is often due to

buying services in an overseas

market to compensate for a

lack of depth in local presence

and relationships

TIME TO RATIONALISE WITH AFFILIATE MATCHING AND SETTLEMENT 3

quired to be traded on exchanges and centrally cleared. Based on evi-

dence from equities, exchange trading will result in an explosion in vol-

ume and a reduction in trade size. Opportunities exist for new entrants

to provide increased competition for the incumbents. These factors will

combine to put downward pressure on prices and returns.

Consolidated Cross-Border Trading

When entering a new market a network of brokers is often utilised for

execution. Each entity could have a broker network. It is common for

broker dealers to become members of exchanges, in effect centralising

execution for a particular market. All trade flow across the bank is

routed through the execution entity. This reduces the need to use local

brokers, reduces the cost of trading and improves execution perform-

ance.

An opportunity exists for post trade to follow the lead of trading. A dis-

jointed settlement and clearing model, where each entity has estab-

lished individual local custodian

relationships could be central-

ised with the formation of a

matching and settlement service

to its affiliates. The service

would be responsible for clear-

ing trades in the particular mar-

ket or region for all affiliates.

The matching and settlement

service would be responsible for

managing the local custodian for

all entities or could become a

member of the local CSD. The

service could be, but not neces-

sarily, provided by a distinct entity.

Why affiliate matching and settlement?

Rationalisation of agent bank network

By centralising all settlement and clearing through one legal entity

banks can enjoy economies of scale. In the regional model, each entity

would establish custody relationships in each market. There would be

duplication of accounts, additional effort to create legal agreements for

each entity, individual credit reviews and multiple network manage-

Settlement and clearing could

be centralised through a

clearing service which would

be responsible for clearing

trades in their particular

market or region for all affili-

ates.

Figure 3:

Cross-Border Affiliate Matching and

Settlement Flow


ment teams. Up to 3 or 4 network management teams could have a rela-

tionship with the same custodian in a particular market. This is an un-

necessary overhead. Centralising settlement and clearing for a market

into one entity allows a rationalisation of the agent bank network and

will improve operational risk

A centralised settlement and clearing model could also realise signifi-

cant cost savings. A minimum fee or sliding scale pricing structure of

custodians rewards volume and there is often a requirement to pay ini-

tial fees. Individually, each entity may not have sufficient volume to

receive the best rates. Collectively, the entities may meet the volume

levels required and a significant cost saving could be realised. Scale is

key, and one Asian based operations manager said “once trade volumes

are over 1,000 a day a centralised clearing model comes under serious

consideration”. Another head of operations predicted that they would

save 55% of post-trade costs as a result of extending this model further

and internalising settlement and clearing by adopting an affiliate match-

ing and settlement model in one Asian market, they also expect to

achieve similar savings across other Asian markets from adopting affili-

ate matching and settlement.

Global Inventory Management

An efficient capital and collateral management process is paramount in

the evolving financial landscape. Centralised settlement enables the

establishment of a global inventory to allow entities to effectively util-

ise their own local positions as well as positions of other affiliates. A

short position in one entity could be covered by a long in another entity.

With a centralised cash account, real-world loans and borrows could be

reduced through internal loans and borrows. This could lead to less in-

traday and overnight credit requirements, opportunities for funding op-

timisation and reduce the cost of carry and external borrowing costs. By

internalising the settlement process through affiliate matching and set-

tlement, settlement performance is improved whilst maximising collat-

eral usage. Even within a centralised model, it remains important for

each entity to know its true position, with one securities operations

head going so far as to say “the success of affiliate matching and settle-

ment depends on the stock record”.

Client Service Differentiation

Client service is fast becoming the key differentiator for clients deter-

mining their investment bank of choice. Affiliate matching and settle-

ment can lead to an improved client experience. Factors important to

clients are confirmation timeliness and accuracy, settlement rate, fails

management and MIS & reporting. Often delays in confirmations are a

result of incorrect data. With a centralised matching and settlement

Collectively, the entities may

meet the volume levels re-

quired and a significant cost

saving could be realised.

In a centralised settlement

and clearing model, an accu-

rate stock record for each

affiliate is critical.


model, clients only need to manage one set of SSIs, compared to many

SSIs based on entities and markets traded. Once SSIs are setup as part

of the initial client on-boarding process, on-going maintenance should

be minimal thus reducing the time and effort from clients whilst seeing

an improvement in trade performance. Improved inventory manage-

ment and internal borrow process should filter through to clients in the

form of improved settlement rates.

IT Capacity

Some IT systems are under strain from the growth in volumes and may

reach breaking point as volumes continue to increase. Volume increases

will be driven by the move of OTC products to exchanges and the

likely reduction in trade sizes which will increase volumes even further

and continued growth of cross-border trading. The impact of cross-

border trading to capacity will be significant. Simple vanilla trade flows

are turned into complicated multi-leg transactions as soon as the exe-

cuting entity is different from the client entity. What should be a

straight forward cross-border trade can often involve four real-world

settlements; executing entity with exchange, local entity with the client

and an inter-entity trade between the two entities. This has conse-

quences for system performance, storage capacity and 3rd party messag-

ing costs where settlement is not internalised. Affiliate matching and

settlement has the potential to reduce internal trade messages and asso-

ciated costs by 50%.

Centres of Excellence

In response to increasing volumes, the impact of globalisation and fo-

cus on risk and control, banks are employing a variety of operating

models. Securities post-trade teams are often established in regional

hubs to support markets within the local timezone. The teams are asset

class aligned with an understanding of the local market and customers

and a basic understanding of global markets. The establishment of a

clearing entity with the market knowledge, expertise, infrastructure and

relationships would allow the creation of centres of excellence. Such a

model removes the unnecessary duplication of having teams spread

across the globe, consolidates subject matter expertise, co-locates the

people who have the required detailed knowledge and experience to

best manage risk and resolve issues. Synergies can be leveraged

through integrated systems and management. The execution and clear-

ing entity can focus on the market side of the transaction, leaving the

client entity to focus on the client. With a single point of contact rela-

tionship management model for the client, the client can be provided

with a consistent experience regardless of the market traded.

The establishment of a clear-

ing entity with market knowl-

edge, expertise, infrastructure

and relationships would allow

for the creation of centres of

excellence.

Affiliate matching and settle-

ment has the potential to re-

duce internal trade messages

and associated costs by 50%.


The drive for operational excellence

Centres of excellence can be the first step on the path to a cost-effective

operating model. The regional focus can be maintained with the crea-

tion of utilities which are developed as a response to common require-

ments across product lines. Synergies can be leveraged across identical

processes. This model can be globalised with the creation of a centre

focused on core processing activities. Often, these are functions that

could be suitable to be completed in an offshore location where labour

arbitrage savings and economies of scale can be realised.

A centralised settlement and clearing model could be extended further

down the trade lifecycle into Asset Servicing. In particular, corporate

action processing would benefit greatly and operational risk reduced by

the formation of centres of excellence, local teams with local market

expertise.

Has the time come to fully internalise settlement and clearing? Clearing

is a cost and a potential revenue stream for investment banks. Within

investment banks, prime services are actively creating a client clearing

offering in response to regulation and the increase in products that will

be required to be cleared. Self clearing would internalise clearing, al-

lowing banks to benefit from economies of scale and a reduction in fees

and securities financing costs.

The light is shining brightly on post-trade, and operations teams will be

under increasing pressure to implement process improvements. Cen-

tralising settlement and clearing by adopting affiliate matching and set-

tlement is an enabler to a more efficient and cost effective cross-border

trading model.

A centralised settlement and

clearing model could be ex-

tended further down the

trade lifecycle into Asset Ser-

vicing.


About Broadridge

Broadridge is a technology services company focused on global capital markets. Broadridge is the market leader enabling

secure and accurate processing of information for communications and securities transactions among issuers, investors and

financial intermediaries. Broadridge builds the infrastructure that underpins proxy services for over 90% of public compa-

nies and mutual funds in North America; processes more than $3 trillion in fixed income and equity trades per day; and

saves companies billions annually through its technology solutions.

Through its Gloss solution, Broadridge offers an industry-leading multi-asset transaction processing, settlement and book

keeping solution for international operations, enabling firms to capture, process and settle multi-asset transactions in virtu-

ally any currency and market.

For more information about Broadridge, please visit www.broadridge.com.

To learn more about affiliate matching and settlement, contact Paul Clark on +44 (0) 207 551 3000 or e-mail

[email protected]

About Investance

Investance is a global business and technology consulting firm, focused on the financial services industry. Since 2001, the

firm has grown to over 260 people, with offices in London, Paris, New York and Hong Kong. Investance’s range of services

includes capital markets research, which builds on our strong core consulting capability and deep market knowledge to pro-

vide insight and thought leadership for our clients. Find out more about Investance by visiting www.investance.com.

This report was commissioned by Broadridge and produced by Investance. The findings are based on industry research and

detailed interviews conducted by Investance.

Figure 1 Source: © 2011 globalcustody.net. Reproduced with consent under licence. Extract from source:

www.globalcustody.net as at March 16, 2011

http://www.broadridge.com

http://www.globalcustody.net

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