Rising transaction volumes could cripple trading systems

Inefficiencies in trade settling need to be addressed by policy-makers, to avoid serious capacity problems in the equity markets.

Sometimes business growth can manifest itself in bottlenecks. As more pension money is poured into the US securities market under the 401-k pension model, Alan Greenspan, chairman of the Federal Reserve, warned policy makers that inefficiencies in trades settling needs to be addressed –otherwise, the skyrocketing volume of transactions could cripple trading systems, creating serious capacity problems in the equity markets.

Greenspan’s warning last week highlights the challenge facing Asia as exchanges are working towards shorter settlement cycles amid the rise in pension investments. In Hong Kong, for instance, there are tales about certain securities houses turning down new clients whenever their settlement systems are overwhelmed by spikes in trading volume induced by volatility.

Geoffrey Sanderson, managing director of Reuters’ securities transactions systems, told a straight through processing (STP) conference in Hong Kong last week the shift towards personal retirement provision coupled with deregulation and low interest rates are responsible for the surge in global demand for securities. STP refers to the automation of securities transaction processing from investors to fund managers, brokers, custodians, clearing houses and depositories.

“The number of trades is growing at a massive rate – 650 million in 1997, through to 830 million in 1998, and 1.2 billion last year – the volume has nearly doubled in three years,” he says. And it is expected to double again by 2002, with institutional money accounting for half the volume.

“Dealing with these huge volume increases, especially on a T+1 basis, will be impossible unless we implement a standardized clearing and settlement process to include trade netting, a central counterparty and fully integrated STP capabilities from order [creation] onwards,” he adds.

Europe, Asia behind US

Sanderson notes while the US has a simple infrastructure, making it relatively easy to introduce STP, Europe and Asia have too many exchanges, depositories and clearing houses, which hinder the transition to a standardized clearing process. For Asia, in particular, the goal of creating a common depository among the many countries in the region is difficult because central depositories are reluctant to forgo their financial gatekeeper role.

For the investment community, another major concern is cost. To set up STP in the US alone will cost the securities industry an estimated amount of $8 billion. On average it will take brokers two and a half years to recover the cost, four years for fund managers and two for custodians.

But the alternative does not come cheap. According to Sanderson, under the current securities transaction system, the total annual expenditure on “non-value added tasks” performed by US asset manager amounts to $30 billion to $40 billion a year. On a global scale, 60% of all trades require some repair or intervention at $6 each, 10% result in mismatch and 15% fail to settle on time. Together, they represent a cost of $12 billion for the global securities industry.

“Savings from STP can be considerable for a large global institution. For instance ... an error rate of 15% ... would cost $7.5 million to repair and manage. It illustrates that getting the [trades] right from the start is a huge bonus for any firm,” Sanderson says.

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