The brokerage industry has been on a roll in meeting technological challenges. System upgrades for the 1999 introduction of the euro, the Y2K changeover and the U.S. stock markets’ conversion to decimal pricing all went off without a hitch. However, shortening trade settlement cycles from three days to one - the so-called T+1 project - has put the winning streak in jeopardy.
T+1 has lost a good deal of urgency; post--September 11 disruptions and budget cutting prompted the Securities Industry Association to push the effective date to 2005 from 2004, and now even that is being reconsidered. And progress toward a closely related goal on the way to T+1 has been haphazard.
Known as ISO 15022, this project has had a far lower profile than T+1. And its clunky designation - 15022 is a tracking number assigned by the International Organization for Standardization, the Geneva, Switzerland--based coordinating body for technical standards - doesn’t exactly inspire action.
But like T+1, ISO 15022 is a concern for all three major securities processing constituencies: broker-dealers, investment managers and custodians. The two industrywide campaigns are further linked in that ISO 15022 is designed to help firms automate even the most complicated securities orders to achieve STP, the straight-through processing of trades from order entry to settlement with virtually no manual intervention. Without STP, T+1 isn’t feasible. And without ISO 15022 to streamline the electronic confirmations, settlement instructions and related messages that run through the international Swift network, STP’s true potential won’t be realized. Swift, the financial industry consortium formally known as the Society for Worldwide Interbank Financial Telecommunication, and the administrator of ISO 15022, requires complete compliance by November 16 - a deadline that looks precariously close because many institutions haven’t made the necessary internal systems changes.
Even as Swift insists that the deadline is fixed, others seem to be looking for a T+1-like reprieve. As of early June only 26 percent of the 2.1 million applicable daily transactions were conforming to the new messaging standard. That’s significantly ahead of the 12 percent three months earlier, according to Swift, but considering that the securities industry has known about this change since 1997, the performance is dismal. “It’s condition red,” Swift CEO Leonard Schrank exclaimed at a conference for securities industry executives in April.
It’s not that anyone opposes the change. Rather, many smaller brokerages and investment managers, which don’t have large information technology departments and don’t closely follow Swift’s rulemaking, simply aren’t ready.
The previous messaging standard, ISO 7775, has been deemed unsuitable for the increasing complexity of securities transactions, especially those that flow across borders or involve multiple agents and counterparties. Because financial institutions pour reams of data into the ISO 7775 format in an inconsistent manner, each message has to be interpreted individually. ISO 15022 enables more specific tagging of the data fields within the messages, and hence a much greater likelihood that the transactions are STP-ready.
Swift has been accommodating both standards since last fall in hopes of encouraging an orderly transition; it plans a “cold turkey” shut-off of ISO 7775 after the close of business on November 15. Institutions that aren’t ready might have to revert to labor-intensive and error-prone faxes, setting the STP cause back by months, or worse.
Thousands of small investment firms could find themselves completely excluded from STP. “There are a slew of investment management institutions that apparently do not intend to begin using the Swift network until after the 15022 switchover,” notes Anna Hannon, vice president and Swift relationship manager for Citibank Global Securities Services in New York. “That means we don’t know all of the managers that are out there from a Swift messaging point of view.”
It would fall to Citibank and other global custodians to take up the slack, enforcing compliance - or some form of interim solution - among their clients. If any group is ready, it is the custodians: As of February 91 percent of those linked to Swift were at least in the development phase of 15022 compliance, compared with 68 percent of brokerages and 51 percent of investment managers.
But John Wilson, a director of London-based consulting firm CityIQ, still sees a possible disaster: Custodians could be swamped by exceptions, transactions that need special handling. “The custodians may be ready for 15022,” says Wilson. “But if their clients send in faxes, they will be in big trouble.”
Swift’s Schrank acknowledges that the outlook is bleak, but he’s not budging from the November cutoff. He feels he had no choice but to “read the riot act” in that April speech in New York to a meeting of the International Securities Association for Institutional Trade Communication. Noting that there are two distinct cultures within Swift - the commercial bankers who founded the network in the 1970s and the securities executives who have grown increasingly active and influential in recent years - Schrank criticized the latter: “The securities people in Swift often make fun of the payments people, saying that they are slow, not innovative and boring. But once payments people make a decision about a standard, they stick to the deadline and they don’t whine about it.”
Citibank’s Hannon believes that Schrank overstated his case by “not comparing apples with apples. There are far fewer payments messages; they are less complex and cover fewer functions. The underlying risks are also lower than in securities transactions.”
But Swift’s CEO is more interested in provoking action than debate. A Swift committee suggested a “plan B,” calling on the network to install so-called mapping software that would convert the data to the new format. “A penalty charge would be imposed that would create a motivation for the stragglers to get moving on the 15022 issue,” explains Hannon.
At a June board meeting, however, Swift rejected the mapping option and said it would decide in early August on an alternative contingency: to continue to support ISO 7775, but for no more than six months, and with significant charges levied against the laggards. No interim solution is ideal, says Hannon, “but at least it will prevent increased manual processing of faxes.”
Financial institutions have numerous options for internal system upgrades. For example, Sybase subsidiary Financial Fusion is offering an ISO 15022 “accelerator program,” and SunGard Data Systems developed what it calls a “15022 transformation solution.” U.K. software house Trace Datawise and Antwerp, Belgium--based consulting firm Capco are among those marketing mapping software similar to what Swift was considering.
Yet even some investment managers that have made their 15022 decisions are running out of time. Implementation requires setting up a testing regimen with their custodians. In some cases, smaller fund managers may have to wait for larger custody customers to go through their testing first.
All the snags have put Swift in an uncomfortable position.
“This is the first time in our standards-setting history that there has been a contingency, but that will be it,” vows Schrank. “There will be no third way tolerated. We need to work hard to ensure that no one breaks ranks, and that if they do, they should be shunned.” With luck, that will be enough to keep the industry’s winning streak alive.
