Fund managers may soon be faced to make a tough choice if they want to reduce operating risk and cost.

They will either have to affirm U.S. equity trades with their broker-dealers before settlement-a process otherwise called "match to settle"-on their own. Or they may have to use an electronic post-trade matching service that acknowledges the details of the transaction with the broker-dealer right after the broker-dealer has confirmed the details but before the trade has settled.

A committee of the International Standardization for Institutional Trade Communications (ISITC) at a meeting in St. Louis on Sept. 12 suggested that fund managers be required to automatically and completely acknowledge the details of the trade with a broker-dealer, before each trade can be settled. The trade group represents some of the world's largest fund managers, broker-dealers and custodian banks.

Meanwhile, the broker-dealer operations committee of the Securities Industry and Financial Markets Association (SIFMA) will also meet with members of the Asset Managers Forum at SIFMA's office in New York on Sept. 23 to decide whether SIFMA should recommend a "match to settle." A trade group representing fund managers, the AMF works under the umbrella of SIFMA and first recommended a "match to settle" process last year.

Why don't fund managers affirm their U.S. trades before settlement?

Nobody has a clearcut answer other than they don't have to. And because the industry has not been able to quantify the risk or cost of unaffirmed trades, the problem remains unsolved.

"As a rule of thumb, some of the larger institutional fund managers, including mutual funds, see the value in affirming trades quickly but small- to mid-tier ones don't and are willing to absorb the costs ," acknowledges Judson Weaver, managing principal for New York-based consultancy Capco.

But such a lackadaisical approach doesn't sit well with some operations executives. "Fund managers shouldn't think about the potential for trades failing to settle on time as the key reason to affirm trades on the day they are executed," says Michael Fiscella, a member of the board of directors of ISITC and global head of equity and fixed-income processing at Morgan Stanley in New York.

While the percentage of trades that fail to settle on time because they aren't affirmed is pretty miniscule, Fiscella contends, fund managers should consider their inability to identify "true risk items" before settlement date. It is up to the fund manager and not the broker-dealer to sift through all unaffirmed trades and identify trades that won't settle on time or will settle erroneously. That's not possible, Fiscella said.

Then there are the cleanup costs which fund managers, broker-dealers and custodian banks face. Lee Cutrone, director of industry relations for Omgeo, a post-trade communication service provider in Boston, estimates that if only 10% of U.S. trades confirmed by the broker-dealer are never affirmed by the fund manager, a whopping $4 trillion worth of transactions are at risk for either failing to settle or for settling erroneously.

One operations executive at a large global fund in New York told Money Management Executive that his firm spends between $10,000 and $20,000 a month to address "exceptions." These are trades which either don't settle on time or settle erroneously. "I can't quantify how much of that expense is related to unaffirmed transactions, but if even half is, it comes to about $5,000 to $10,000 each month," he says. That amounts to $60,000 to $120,000 a year for just one fund manager. The amount reaches hundreds of millions of dollars across the thousands of fund managers executing U.S. transactions.

But so far, the Depository Trust & Clearing Corp., the umbrella organization for clearing and settling of U.S. equities and fixed-income trades, has not backed the notion of "match to settle." It would need to do so for the practice to be implemented. That means it would have to file for a rule change with the Securities and Exchange Commission. DTCC is registered with the SEC as a clearing agency.

DTCC's Chairman and Chief Executive Donald F. Donahue told the International Securities Services Association (ISSA) on June 2 in Wolfsberg, Switzerland that "settlement matching of course has never been the practice in the U.S. and making such a change in a market with our volumes would be difficult at best." The trade group includes some of the world's largest custodian banks.

Donahue pointed out that rather than mandating that fund managers affirm trades before settlement, some securities operations experts believe that fund managers and broker-dealers should be required to use either an electronic confirmation-affirmation system or a central matching service.

When asked about the DTCC's stance, Susan Cosgrove, director of clearance and settlement at DTCC, told Money Management Executive, "We will make a decision in consultation with our members after analyzing the opportunity to mitigate risk versus introducing any unintended consequences of precluding settlement."

There is little distinction between requiring a "match to settle" system or using a confirmation-affirmation or central matching service. If fund managers were required to affirm trades before settlement, those using Omgeo's Oasys TradeMatch would need to affirm trades by noon two days after the trade is executed (T+2) for them to be allowed to settle.

The difference between affirmation and matching is splitting hairs. Affirmation describes 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 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 guarantee that affirmation takes place on the same day the trade is executed.

Central matching is the opposite side of the spectrum of post-trade communications. Central matching means that the investment manager and broker-dealer do not input their understanding of the trade details sequentially with one side waiting for the other. The fund manager and broker-dealer instead do so independently and separately into a third-party system where the information will be matched or rejected. Centrally matched trades are considered "match-agreed" which is tantamount to being affirmed.

Omgeo, jointly owned by Thomson Reuters and DTCC, offers two central matching services.

One is called Omgeo Central Trade Manager (CTM). But that is for cross-border and non-U.S.domestic trades only. A separate Omgeo platform called Oasys-TradeMatch does match U.S. fixed income and equity trades centrally, which creates a defacto affirmation.

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