T+1, the security industry's big technological initiative, is rolling through corporate financial systems, seemingly far removed from mutual fund portfolio managers' trading floors, or even their busy back offices.
But make no mistake, the initiative to move trade settlement from the current three days to just one day - known as trade, plus one, or T+1(the industry moved from T+5 to the current T+3 in the mid 90's) - will happen despite delays. In fact, straight-through processing (STP), the system that will lead to T+1, is already making its presence felt. Financial service professionals who think this is an issue for a handful of corporate propeller heads are missing the point.
Broker/dealer Raymond James Financial Services (RJFS), St. Petersburg, Fla., is determined not to get left behind. RJFS has incorporated portions of Comprehensive Software Systems' (CSS) Sabil software to get a head start for its 4,200 independent reps.
"We're using account profiles to set up our client accounts. It gives all of our branch offices and remote offices the ability to establish their own client accounts in real time, which enables STP," says Tom Loney, vice president of software development at Raymond James. "They don't have to call into the home office to set up an account."
First, Straight Through
Loney notes that this is a big change. "In order to accommodate [STP] in all of our systems, we need to start analyzing the impact and scope out the work necessary so we can be done when the time comes," says Loney. "Fortunately, the work that needs to be done for T+1 is the same work that straight-through processing requires."
Originally, the Securities Industry Association (SIA), Washington, had been pushing to shorten the settlement cycle from three days to one, but in mid-July the organization stated that it would not reexamine the conversion before 2004, choosing instead to focus their efforts on STP over the next two years.
"The industry needs to focus on more effective straight-through processing before it is in a position to evaluate a conversion from T+3 to T+1 settlement," said Allen Morgan, Jr., chairman of the SIA board and chairman and CEO of Morgan Keegan & Co. of Memphis, Tenn."
Meanwhile, the SIA-approved STP program will build on the SIA's STP/T+1 program, which has been underway for the past three years. Key projects include improved processing of institutional trades, electronic book entry to replace physical securities and payments, and a range of other automation projects that address the processing of corporate actions, such as recapitalizations and dividends, stock lending and syndicate underwriting.
In fact, earlier this month, in on open meeting on Feb. 4, the Securities and Exchange Commission voted to update 25-year-old laws regarding centralized depositories of stock certificates(see MFMN 2/10/03). Noting that 97% of all stocks are held in depository receivership, with transfer agents and custodians charged with the task of recording ownership, the SEC continued: "The amendments will eliminate unnecessary restrictions in the rule to reduce compliance burdens on funds and fund boards without jeopardizing investor protections."
"The big reason for the delay is converting to T+1 is going to be really expensive and will cause a lot of pain for some people," says Bill Wager, a managing partner at Hunter Green, a technology consulting firm in New York. "The fact that the SIA is backing off doesn't mean it is abandoning the idea," he said.
In fact, T+1 experts advise financial firms to adapt early to avoid the mad rush that is bound to occur as the 2004 deadline approaches. "When T+1 does become mandated, there will be a buying curve when consultants are hard to come by and authorization of books and records resources are going to become tight," said Chris Poelma, CEO and president of CSS in Denver. "Waiting to convert will cost firms more in the long run."
Conversion costs depend on the volume of trade and office size, but the brokerage industry can expect to pay about $17 billion, according to Shahin Shojai, director of strategic research at the New York-based Capco Institute. "You've got cost implications not just for a broker/dealer or for a group of CFPs [certified financial planners], but also for the exchange interfaces, which have to take the data, settle the trade and then track it," Poelma said. "Then there is in-house training and negotiation on per-price trade."
A financial planner can expect to spend 10% more per trade commission and pay training costs of between $3,000 and $5,000, Poelma added. But switching to a system like CSS, he believes, will more than offset this cost. A parent broker/dealer can expect to pay about $3 million over a five-year period to adapt, which includes installing new data center equipment.
Planners who exercise transactions with parent brokerage firms will only have to retrain themselves on the new system because the parent firms will be doing the actual conversion. "Our back office and broker/dealer is Charles Schwab. They are on the cutting edge of all the technological advances," said Hamilton Lewis, a CFP in Houston.
There are changes on an individual client level, as well. Mutual fund complexes and planners will have to change the way they handle their clients' money. Currently, the three-day cushion allows money managers time to collect the funds. T+1 will require that they have the money in advance, which means they must move money out of banks and into their own jurisdictions.
The Reserve Funds, a money market fund in New York, believes it can solve this problem. "With our new FDIC-insured deposit accounts, financial planners' clients have no excuse not to bank with their planners because the products we now offer give them FDIC protection. This obviates clients' arguments for moving transactions away from financial planners over to the bank," said Bruce Bent, Reserve chairman and CEO. "The cash has got to be where the transactions are happening."
Bent stressed that The Reserve Funds is completely T+1 and STP prepared. "All the trades come through us and settle the same day, so it's not a cost issue. We don't use outside transfer agencies because we are totally internalized in all of our systems," Bent said.
Lower Risk
An advantage of STP and subsequently T+1 is reduced risk because it quickens the rate of trades and purchases. Under the current system, billions of dollars could be lost from a terrorist attack or a deal gone sour, for example.
Another benefit is increasing sales volume. "With STP, the industry will be able to handle a lot more transactions than you can right now. Market volumes have gone up for the last 200 years and will continue to increase. T+1 is going to make it a lot easier," Wager said.
But first, it's going to be harder.
"Firms that don't do clearing settlement for other firms and retail brokers are not going to get much of an advantage," Wager continued. "The concept behind T+1 is it's got to be paid in one day. You don't have the three-day float anymore to get the check in. That's a problem."
Also, many back-office workers could lose their jobs when the transition occurs. Stock certificate printers, workers involved in clearance and members of the Securities Transfer Association may lose business because physical securities will be replaced by electronic stock certificates.
Straight-through processing and T+1 are new business models, which may consolidate the brokerage industry, according to Wager. The implications could be far-reaching. Just as the Internet democratized the marketplace, consolidation in the brokerage industry may result in the start-up of a slew of independent Charles Schwabs.
Juliette Fairley is the author of Cash in the City: Affording Martinis, Manolos and Manicures on a Working Girl's Salary (Wiley, March 2002). She can be contacted at www.cashinthecity.com.
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