No fund manager likes to fail in his or her trading strategies. It’s bad for business.

The same can now be said for failing to settle trades on time. With profit harder to come by, fund managers must pay closer attention than ever to why their trades are failing to settle—and then take steps to prevent the failures from recurring.

“In a bull market we could afford to be a little inefficient. But during the economic downturn, that doesn’t fly with management any longer because it is eating into our bottom line profitability,” says one top operations manager at a New York investment firm.

The first blow in the fight against failures remains automating and speeding up otherwise paper-based communications between fund managers and their broker/dealers and custodian banks. Other measures: relying on workflow management, data aggregation and analysis tools from custodian banks or software firms to smooth each step of the process in matching details of trades and then clearing and settling the transactions.

Fund managers estimate that at least 2% of U.S. equity trades don’t settle on time, which is three days after the trade is executed.

That figure can be even higher for fixed-income, over-the counter derivatives and foreign securities. A failure could cost the fund manager anywhere from $10 to $100 in administrative costs alone to fix. That’s not including interest charges, which can add $5,000 to a $50 million trade.

Affirmations Are Critical

The biggest cause of failures: Fund managers either affirm their trades too late or not at all. “While broker/dealers confirm trades quickly, fund managers aren’t making affirmations a priority,” says Judson Weaver, managing principal at Capco, a New York-based consultancy. He recommends that fund managers affirm the details of transactions such as the price, the number of shares and description of the investment—in an automated fashion with their B/Ds immediately rather than the day after trade date to ensure that there is sufficient time for any corrections to be made.

“The U.S. market is unique in allowing trades which are unaffirmed to be settled at Depository Trust Company,” says Lee Cutrone, director of industry relations for Omgeo, a post-trade communications service provider in New York. The 10% of trades which end up unaffirmed will likely end up as a “trade reclaim” or DK (“don’t know”) notice from the B/D or as a settlement failure. About 40% of U.S. equity trades are affirmed on trade date when fund managers use Omgeo’s TradeSuite or TradeMatch matching service.

Michael Fiscella, global head of equity and fixed income cash processing for Morgan Stanley in New York, recommends that the U.S. market evaluate adopting a match-to-settle approach to trade settlement. “Fund managers and broker/dealers have also been in talks with the Depository Trust Company to require certain U.S. equity trades to be affirmed before they are settled, but so far the DTC has not backed such an initiative,” he says.

Data Errors

Yet another reason for the trade fails: an error in the post-trade information. That could mean getting the details of the transaction incorrect or a mistake in the settlement instruction sent by the fund manager to the custodian bank.  “Too often the fund manager’s operations team is rekeying information from a front-office system to a back-office settlement system when the data should flow seamlessly between the two,” says Paul Thomas, managing director of international operations for global technology firm Fiserv in London. Fiserv’s TradeFlow software automatically sends a copy of the trade details from the fund manager’s order management system to its settlement platform and will notify the fund manager if the trade fails to be matched.

Daniel Simpson, CEO of Cadis, a global data management software firm in London, warns that the potential for error in post-trade instructions is even greater for fund managers which outsource their middle and back-office operations to custodian banks because the fund manager and custodian bank could be relying on different information.

Fund managers using Cadis’ EDM software can reconcile the information from their front office to the bank’s custody platform and the corporate actions system. The software will also link the B/D’s confirmation to the fund manager’s securities lending system to verify if the securities are out on loan. Then, a message must be sent to the custodian bank to recall the securities.

To reduce errors in settlement instructions (which can also occur when there is a discrepancy in which depository should settle the transaction), Fiscella, also executive sponsor of the reference data working group of the International Securities Association for Institutional Trade Communication, recommends that fund managers use the template created by the buy- and sell-side trade group to fund managers to populate and update the data fields correctly. Most fund managers rely on Omgeo’s Alert standing instructions database.

Close Watch on Failures

While preventing trades from failing is ideal, keeping track of when they happened and why is also important. Global custodian Citi will aggregate the data on the trades which fail to settle on time for its fund manager clients immediately through its CitiDirect for Securities web portal service. A separate Middle Office Trade Operations service allows fund managers to receive information on their failed transactions and the reasons from all of their broker/dealers and other custodian banks daily. Citi will also provide a monthly report which breaks down the fails by market, asset class and B/D, says Chandresh Iyer, head of global custody.

Middle Office Solutions, a New York-based firm, also aggregates information for fund managers on all failed trades through a Web portal and it allows fund managers to receive information from B/Ds or custodian banks of a potential problem prior to settlement date. The cost savings: potentially over $300,000 annually from cutting the number of potential failed transactions and speeding up the cleanup time.                                             

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