Deal Execution in an STP World - Part 1: Exposing the Myths
Ask anyone anything about STP and they always seem to expect a figure of 75 per cent for starters with expectations of 95 per cent. My personal image of STP is that of a national water grid, where water is purified and channelled to the recipient on demand via a fail-safe infrastructure of pipes, valves and controls to manage the process.
Technological developments in the deal execution process have had a massive impact on STP by improving the flow of information to traders, risk managers and operations staff alike. For example, online trading systems have improved the STP process in the treasury markets, offering users a single point of access to FX trading. Use of trading portals have also undoubtedly had a significant impact on the flow of deal information: Trades can be struck on an FX portal and an automatic feed reaches the front office, credit lines and limits are checked automatically and the trade is booked, eventually feeding through to the back office system and a confirmation is released to the counterparty. The wonder of automation is evident, but can we call this STP and if so, aren’t some key areas being overlooked?
Invariably, this model of STP will be a collection of automated tasks linked together by manual tasks or processes. Credit limits need to be keyed in to systems, payments need to be released, exceptions need manual intervention. A process that needs manual intervention cannot be said to be straight through, but highly automated it undoubtedly is. When we then consider that there are multiple trading systems popping up all over the place and combine this with the well established EBS and Reuters Dealing systems, our single ‘pipe’ vision now resembles The Trevi Fountain. But this does not matter if we can seamlessly integrate these multiple feeds into the bank’s operation.
In automating this process, do we need to ensure that each transaction traded within the online trading system is correctly reflected in the back office system? Is time of the essence too – can we achieve simultaneous update of systems? There is an assumption that such trades will always be correct. Clearly both parties have agreed to carry out a trade using shared information available to each side and some may suggest that, in the new online environment, a confirmation may not be required. But, can an online trade somehow not reach the front/back office, can the dealer inadvertently cancel it in the front office system or amend the details? Is it possible that two parties can collaborate and book fraudulent trades? Can a dealer manually key a trade into the front office and book it as being an online trade in order to bypass a check or to cover a breached limit? Even in an automated, semi-STP world, deal execution risks cannot be assumed to have been eliminated. Effective controls, procedures and processes are still required from front to back office to ensure minimal error rates.
Understanding the workflow is critical; each link or data transformation adds a weak point to the chain and increases the potential for errors. The online trading system may be fully secure and reliable but the importing of data to the front office system may fail. There is a tendency for many back office checks to be given up as it is assumed that errors will be picked up downstream in the matching process, or even in CLS. But if the trade never hit the front office, where are your safeguards? Do you simply rely on your counterparty to allege a confirmation before you investigate? Independently validating and reconciling the online trading systems’ output to the eventual front office/back office trade information is one way of tackling this.
One obvious barrier to STP is front-to-back office segregation, but it is still common for back office staff to ask traders to clarify a strange instruction or an anomaly, without prior referral to, for example, the underlying Reuters conversation. The back office needs to be able to monitor exceptions and maintain control of unconfirmed or unrecognised confirmations and monitor these through to resolution and have in place their own independent reporting lines and escalation procedures.
One of the most interesting things I find is to step through someone’s vision of an STP process. It may look squeaky clean and efficient but often there are gaps or holes and more worryingly, these institutions do not see these critical weaknesses as they no longer routinely monitor the underlying process. Knowledge is often lost to automation, as is the ability to handle situations where things go wrong or when we have to revert to a manual process. We all work in concrete buildings filled with fire retardant materials, but still we carry out regular fire drills when we evacuate the building, and usually these coincide with cold and wet mornings, so why bother? The likelihood of any fire is minimal – we have statistics to back this up. The reason being, not to prepare for such eventualities is reckless and in the case of FX dealing, criminal. In a bank’s operation, an unknown STP process is like an undesignated escape route, or a pipe that leads nowhere! If things go wrong you may not escape unharmed. It is therefore essential that we document the way through and have in place the procedures to ensure that all the steps and checks have taken place correctly.
The bank’s management should ensure that the operation can function fully in all circumstances. Individuals are obliged to understand the necessary steps that are involved so that in the case of technology breakdown and reversion to a back-up process, they do not, for example, execute a payment without first checking for available funds. Too often though, the investment in technology means that people don’t invest time in maintaining their understanding of what is going on under the surface. This reservoir of knowledge becomes isolated and we hear people proclaim ‘My staff can’t do without me’, or ‘I’ll do that because no-one else knows how to’ and often ‘If there’s a break, we’ll pick it up down the line’. We all like to be valued but this is just poor regulation of the systems infrastructure. Having been at the sharp end of payment system failures, you know that these can hurt. Late payments involve cost. Detailed procedures and practice would dictate that you tackle the high value payments first and, as in the case of a real fire or a flood, you balance damage limitation with risk of injury, albeit to balance sheet and reputation in this case.
Not all trading can be carried out using automated online trading systems. Trades in unsupported currency pairs or large value transactions are often handled on the phone thereby requiring manual input. Thus, appropriate controls, procedures and skills – from front to back office – are every bit as important as they always were. Perhaps more so, now that banks are looking more closely at their counterparties and their cost of trade.
When we understand these links and their weak points we may move a step closer to achieving STP. Each link has its weakness and potential to fail. A tap will make water flow, but this does not in anyway guarantee integrity of the main. More and more though, banks are looking at the bigger picture and beginning to understand that there is a need to validate their STP processes constantly, and to ensure that what goes into the pipe comes out at the other end. System to system reconciliation is one way in which this is being done.
Think of trade capture. A dealer may trade on a multitude of platforms, such as Reuters, EBS, FX Portals, telephone, or through voice brokers. Within minutes, a confirmation can be on its way to the counterparty, but we need to be able to confirm positively that every online transaction was correctly received by the front office system and that every trade was subsequently reflected in middle/back office systems. It is also important to ensure that the source of the trade can be validated, as often this will dictate the extent and method of the checks that need to take place downstream in the back office. System to system reconciliation can help by positively identifying the source of the trade and ensuring that this is reflected correctly in the back office matching system. This is achievable by splitting and feeding any front office feeds from online trading systems simultaneously to the back office matching system, thereby highlighting any subsequent amendments that may take place in the front office. This removes the potential for errors and provides opportunities for real STP.
As with all buzzwords, STP covers a multitude of sins. The increasingly widespread use of online trading platforms represents a huge leap forward in terms of reducing deal execution risks and the need for manual intervention. But that does not mean we can throw away the controls and procedures that have served well in the past. Rather, these must be adapted to the new trading environment and harnessed to the new technologies and workflows.
The next article in the series looks at Front/middle office risks.