Swift, the banking and securities network that helps speed the flow of funds among financial institutions worldwide, will achieve an important milestone this month: It will complete its conversion to a new messaging format designed to streamline settlement and reconciliation of securities trades.
Like many technology upgrades, it hasn’t gone exactly as planned.
Swift decided to make the switch to a standard called ISO 15022 back in 1997, which was supposed to have been in place last November. As that deadline neared, however, a significant proportion of message traffic wasn’t ready for the change. The cooperative that runs the network -- the Society for Worldwide Interbank Financial Telecommunication -- had to extend the transition period.
The problem? Asset managers, especially smaller ones, haven’t replaced their antiquated systems because they either lack the technological expertise or simply don’t have a compelling financial reason to do so. In many cases, they prefer to stick with labor-intensive habits like sending trade instructions via fax.
“Many small firms don’t care about investing in information technology because they can’t see a massive improvement in their operations,” notes John Wilson, a director of CityIQ, a London-based consulting firm.
The biggest broker-dealers, custodians and mutual fund complexes have many more reasons to care. They sponsor industrywide initiatives like 15022 because they see tangible benefits from standardizing and automating the many links in the securities trading chain. Reducing or eliminating human intervention drastically cuts the incidence of errors, which require costly, largely manual resolution processes. And the fewer the snags and delays, the less an institution is exposed to the risk of a counterparty being unable to cover its settlement obligations.
But there is only so much that big financial institutions can accomplish on their own. If the industry as a whole is to reap the maximum rewards from fully electronic, straight-through processing, then thousands of smaller firms must endorse and comply with the necessary standards. And 15022 alone is not enough; it’s one of a series of STP-related projects that also include the Fix (financial information exchange) protocol for buy-side-to-sell-side communications and the Securities Industry Association’s T+1 (trade date plus one day) settlement timetable. All have gotten tepid support, at best, from cost-conscious smaller players.
That may be about to change. The larger institutions are beginning to take on more responsibility for promoting new technologies that are cheap enough -- and easy enough to install -- to overcome the smaller firms’ resistance. In addition, the industry giants are honing their message about the importance of STP. It didn’t help their cause when the SIA, citing cost pressures and other priorities, said last year that it would no longer press for a 2005 implementation of T+1. Many small firms wrongly assumed Swift would likewise give them a pass on 15022.
“The real issue for smaller firms is, What is their level of pain?” says Thomas Jordan, president and CEO of Jordan & Jordan, a New Yorkbased securities technology consulting firm and administrator of the Fix program. “They’re used to just picking up the phone and letting the sell side take care of everything. The key [to STP] is making the electronic communications easier.”
Peter Tierney, deputy managing director for the Americas at posttrade automation company Omgeo, agrees that small firms need incentives to change their ways. “They love their fax servers,” he observes. “We can give them a reason to push another button and send their instructions electronically instead.”
In March, Omgeo, a joint venture of Depository Trust & Clearing Corp. and Thomson Financial, announced a product specifically designed to modify that fax-loving behavior. Dubbed Omgeo Allocation Manager and scheduled to go live this quarter, it’s described as “a light, Web-based trading system,” developed over the past year in collaboration with Credit Suisse First Boston, J.P. Morgan Chase & Co. and UBS Warburg.
The brokerages plan to make Allocation Manager available to investment management clients for free, figuring that the long-term benefits outweigh the development and deployment costs, which are undisclosed. Omgeo says that the electronic system will cut a small firm’s processing costs to $4 per trade, from $16. The more than 3,000 U.S. investment firms that do fewer than 1,000 trades a month would stand to benefit, Omgeo says.
New Yorkbased Yeager, Wood & Marshall was among the first to test the system. “The connection is Web-based, so there are no costly communications links,” says Gordon Marchand, vice president and treasurer of the firm, which manages $700 million in assets. “It’s easy to integrate with portfolio management and trade order management systems.” Marchand is also president of the Investment Counsel Association of America, a trade group for some 300 investment advisory firms that collectively manage $3 trillion in assets.
This isn’t the only automation breakthrough for buy-side firms below the top tier. In fact, they now have plenty of ways to jump on the trade-efficiency bandwagon, ranging from off-the-shelf software to outsourcing and Web services.
For example, software maker Sybase’s Financial Fusion subsidiary is taking a distribution approach similar to Omgeo’s. Says Financial Fusion president Richard Moore: “We’ve developed a preconfigured Fix engine for the sell side. It will essentially be able to give STP away to the buy side.”
CityIQ’s Wilson adds that small firms also have access to utilities and services like Thomson Financial’s Autex. For less than $1,000 a month, Autex helps traders control costs by locating liquidity sources and executing trades directly with counterparties.
San Diegobased Indata Corp. has sold investment management systems with built-in T+1 capabilities to more than 200, mostly small institutions. Firms managing $1 billion to $2 billion in assets -- among them Dayton, Ohio’s EBS Asset Management; Renaissance Group in Cincinnati; and Greenwich, Connecticutbased Simms Capital Management -- find Indata’s Web-based Microsoft Corp. technology platform robust and economical. “It’s the only one that could provide us with STP on a common Microsoft SQL Server database,” says EBS principal and portfolio manager Bernard Holtgreive.
John Campbell, managing director of State Street Corp.'s European investment manager solutions group, argues that small asset managers are sometimes unfairly criticized for holding up industry innovation. “Smaller organizations in most cases have a smaller set of investment activities,” he says. “For example, they may manage only European equities.” Therefore their technology costs, as a percentage of overhead, are less than those of broader-ranging firms, and systems decisions are easier to make and execute.
Campbell believes that operational problems are actually more concentrated in the middle market -- at firms with $40 billion to $100 billion under management. “The middle group is trying to offer an array of products that touch most securities types,” he explains, but they lack the economies of scale that provide a surer payback on larger institutions’ investments.
Whatever their motivations, legions of investment managers are not contributing to, and too often are hindering, the drive toward STP. “Many of them will say, ‘What I have sort of works and is good enough,’ because there is not enough money in the market to justify making a significant investment in front-office systems,” says Kevin Milne, London-based executive vice president, international, of Macgregor, a leading supplier of trade order management systems.
ICAA president Marchand therefore applauds Omgeo and its broker-dealer partners for the way they are pricing Allocation Manager. “The product is free; it doesn’t get better than that,” he says.
Macgregor’s Milne sees a need for order management systems that can be deployed cheaply -- for perhaps $20,000 to $40,000 -- and “out of the box,” like Omgeo’s Allocation Manager or Sybase’s Fix engine. Macgregor’s own Fix business could benefit from that momentum, notes Milne. “Many firms have used Fix only for orders and executions,” he says. “Now they realize they can put much more across Fix networks, such as trade processing messages and allocations.”
Milne says a two-tier market is shaping up: “Haves,” with order management systems and Fix capabilities, which can avail themselves of advanced execution tools and achieve a high level of STP, and “have-nots,” which will continue to rely on phones and faxes and bear higher commission and processing costs -- until they hit their pain thresholds.
Perhaps all that technology-challenged asset managers need is a push, be it a fine from Swift, a free Fix offering from a brokerage firm or a simple pricing incentive from a custodian. Breaking with their tradition of undifferentiated pricing, custody banks are now charging a punitive fee of as much as $15 for a manual transaction, versus as little as 15 cents for an STP-ready trade.
“There is now some price discrimination in the market, which is good,” says CityIQ’s Wilson. “Does it penalize smaller firms? Yes. But it gives an incentive to invest in automation.”
