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," said a 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 do not 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.
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," said Judson Weaver, managing principal at Capco, a New York consultancy. He recommends fund managers affirm details of transactions such as price, number of shares and description of the investment — in an automated fashion with their broker-dealers 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 Co.," said Lee Cutrone, director of industry relations for Omgeo, a post-trade communications service provider in New York. The 10% of trades that go unaffirmed will likely end up as a "trade reclaim" or DK ("don't know") notice from the broker-dealer or as a settlement failure.
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 Co. 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 said.
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," said Paul Thomas, managing director of international operations for the global technology firm Fiserv in London.
Daniel Simpson, the chief executive 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 that outsource their middle- and back-office operations to custodian banks, because the fund manager and custodian bank could be relying on different information.
