It's not when but if and how.

The subject: Two-day settlement of transactions in a fund portfolio. The place: Europe.

If the European Commission has its way, countries in the European Union could be forced to meet a two-day settlement cycle by 2013 at the latest. The panel even sent out a request for comments by March 1 on a proposal to harmonize European settlement cycles to T+2. Most European markets now settle on a three day period; Germany is the notable exception at two days.

A shorter settlement cycle has two key merits for fund managers: reduced counterparty and market risk.

"Nothing good happens between trade and settlement dates, so the shorter the cycle the better," said Joseph Anastasio, a partner with Capco, a New York-based consultancy. "The EC's move could also motivate the U.S. to move to a two day cycle from three days as well.

But it won't be easy, according to panelists and attendees of a webinar hosted by Omgeo, the post-trade communications service provider, on the subject.

"Fund managers aren't opposed to moving to a two-day settlement cycle, even if they aren't that happy about it," said James Cunningham, director of industry relations for BNY Mellon in Brussels.

The proposal is part of the EC's broader initiative to create standardized settlement procedures at European national securities depositories before the European Central Bank adopts its new Target2 Securities settlement system. That system, expected to go live in 2014, would consolidate the settlement functions of European national securities depositories under a single roof The transition to such a centralized system, says the EC, would be a lot easier if all of the countries whose depositories outsourced their settlement activities T2S followed a two-day settlement cycle.

But there is a major downside: should fund managers, broker-dealers and custodian banks not communicate and acknowledge details of the trade in a timely fashion, the trade could fail to settle on time. The greater the number of fails-the higher the operational risk and cost to the fund manager who might well be on the hook to pay the counterparty for the failure to deliver securities or funds on time, said Tony Freeman, director of European industry relations for Omgeo in London.

Surprisingly, fund managers have shortened the pace at which they execute trade orders using smart order-routing systems and algorithms which work at lightning speed. Trades once executed in seconds can now be done in milliseconds. But when it comes to the back office, snail mail appears to be the norm. That slows down the settlement process, particularly when cross-border trades are involved.

"One of our broker-dealer clients in Paris said that about 70% of the trade affirmations it receives from a fund manager are done via fax," Freeman said. "Another fund manager in Australia with global operations said it wouldn't be a problem but a fund manager with operations only in Australia said it was unfeasible based on the number of intermediaries in Europe which would have to process the trade."

Key to European fund managers meeting a two-day settlement cycle will be communicating-or affirming-the details of the trade with their broker dealers on the day the trade is executed rather than the next day. Such affirmation is also typically done in Europe on the day after the trade is executed. However, unlike European trades, U.S. trades don't even have to be affirmed to be settled by Depository Trust Company, the U.S. central securities depository.

"Same-day affirmation is essential and should be mandated by the EC as a prerequisite to T+2," said Terri Van Praagh, head of operations for Europe, the Middle East and Europe at Northern Trust. "Some of our fund manager clients are rebooking trades about 20% of the time now which will not be acceptable under a T+2 environment."

Affirmation represents a sequential process after a trade is made. First the fund manager allocates the trade to one customer or parts of the trade to many customers. Then, the broker dealer confirms the trade. Then the fund manager affirms the trade. Such a process can take place "locally" between the fund manager and the dealer. This can happen either manually-via fax or e-mail-or through an automated system. But using an automated system will more likely ensure that affirmation takes place on the same day a trade is executed.

Such a same-day affirmation also allows custodian banks to recall securities out on loan in time to meet a two-day settlement cycle. If the trades are not affirmed on they day they are executed, the custodian bank will not be aware that the trade has been executed and therefore wont be able to recall any securities out on loan for the fund manager, Van Praagh said.

Neither Cunningham nor Van Praagh said they would entertain the thought of a custodian bank imposing financial penalties on fund managers who either don't affirm their trades with the fund manager on trade date or don't send settlement details to the custodian banks electronically.

However, fund managers might decide to pass along additional costs related to late instructions or manual processing.

"We are asking our fund manager clients to think about the whole confirmation process and use us as an outsourcer to get the fastest instruction to market," Van Praagh said.

Using a process called central matching is also a way for fund managers to achieve same-day affirmation. That is because the fund manager and broker-dealer can separately input into a third-party system where the information will be matched or rejected. Centrally matched trades are considered "match-agreed" which is equivalent to being affirmed.

Freeman said that most of Omgeo's customers are already achieving same day affirmation but did not specify how many fund managers did so using Omgeo's Central Trade Manager, a central matching service for non-U.S. securities.

However, there appears to be a pretty strong correlation. Northern Trust's Van Praagh said that 17 European fund managers who outsourced their back office work to Northern Trust all affirmed their trades with broker-dealers on trade date. That is because Northern Trust affirms those trades on behalf of the fund manager using the CTM.

A study conducted by Omgeo last year also showed trades which are centrally matched are more likely to be affirmed on the day the trade was executed than those which were locally matched -- 86.5 percent to 66.6 percent. Switzerland had the highest same-day affirmation rate within Europe at 87.6 percent of trades while Italy had the lowest at 68.4 percent. The U.S. is even lower at 46.9 percent.

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