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In Search of the Grail

Securities clearing is drawing ever closer to its Holy Grail—fully electronic processing.

If securities clearing were a medieval quest, straight-through processing would be its Grail. In recent years, clearing operations have migrated steadily away from manual, labor-intensive back office work to the streamlined electronic processes that constitute the ideal. Like the Grail, straight-through processing is proving an elusive quarry, a hopeful vision that might never be fully realized. But even in its current imperfect state, straight-through processing is conferring huge benefits on the securities industry.

The promise of STP is simple. By creating standardized, non-redundant electronic systems to handle back-office securities work, firms aim to eliminate costly errors and drive down the time and expense of trading, clearing and settlement. Clearing functions that a handful of operations folks can now dispense within a few minutes' worth of key strokes once required the attention of nine or 10 departments and legions of pencil-pushing clerks.

While the way these functions get accomplished are constantly evolving, what they are meant to do hasn't changed much. It's a process reps understandably ignore — until something goes wrong. But getting it done right without stupid or costly mistakes builds trust and goodwill with your client. And since part of your client's fees go to cover clearing costs, reps need to be able to explain to clients just what they are paying for.

As the industry approaches STP, reps might want to know what services are available that could make their lives easier, whether it's automated annuity ordering or offering life insurance products. Clearing might be a commodity, but, as Jim Almond, an RIA affiliated with Financial Network Investment Corporation in Dallas, Texas, says, you still want a good commodity. “If you get bad corn, you'll make bad cereal.”

And, thanks to the computers, there is much less chance that you'll have to eat lousy corn. Years ago, back offices had to make sure that every bank, investment manager and broker/dealer firm involved in a trade understood and agreed to its terms. They also needed to confirm that the participants had the necessary cash and securities to meet their obligations, and were appropriately credited or debited for the securities or cash involved. Securities and payments for each trade were delivered physically between different broker/dealers and between broker/dealers and their clients. Banks and broker/dealers had to retain physical custody of all the securities, and the lag times in manual processing meant that a lot of redundant information tended to move between the broker/dealers, the exchanges, banks and clients. Each settlement went through so many steps and was touched by so many hands that the system was slow, and unwieldy. In short, there was lots of room for error.

By the 1960s, trading volume on the New York Stock Exchange hit 12 million shares a day, creating a “paper crisis.” Back-office operations were so overwhelmed that the financial markets had to decrease their hours of operation and lengthen settlement periods to catch up on its paperwork. To address this problem, the securities industry created a national centralized processing facility, the Depository Trust Corporation (DTC), in 1973. The National Securities Clearing Corporation (NSCC), a combination of the NYSE's and the Amex's clearing operations, was formed in 1976.

The NSCC was a national automated accounting facility that used a process called net settlement to reduce the number of security credits and debit entries a firm needs to make each day to settle the “street side” of its transactions. Multiple trades at one broker in a stock were netted down to one net movement per security traded and one net-money settlement obligation at the end of the day. So, for instance, a broker/dealer might have bought 10,000 shares of IBM on behalf of 50 different clients from 20 different brokers. In that same day, it sold 7,000 shares of IBM on behalf of 20 different clients to 15 other brokers. The NSCC consolidated all these IBM trades into one, rendering the broker a net buyer of 3,000 IBM shares. Such streamlining reduced the volume of securities and payments exchanged each day by an average of 97 percent.

DTC took this streamlining a step further. Once trades were netted by the NSCC, DTC affected any changes in ownership. As a central depository, DTC freed broker/dealers from having to physically house and transfer securities involved in a trade. In the DTC vaults, these securities were essentially immobilized; all movements were made in the form of electronic book entries between trading partners.

In 1999, the NSCC and DTC merged under the umbrella of the Depository Trust and Clearing Company (DTCC), a holding company owned by participating financial institutions, with a growing number of subsidiaries dedicated to facilitating trade settlement in various markets. These include the Government Securities Clearing Corporation, the Mortgaged Backed Securities Clearing Corporation, and the Emerging Markets Clearing Corporation. In the late 1980s, through NSCC, DTCC introduced services to clear mutual fund transactions, helping centralize that growing market. It has since started processing annuities and is working on a system that will standardize settlements for life insurance products as well.

So what's this got to do with registered reps? For starters, centrally processing annuities can make a rep's life easier by reducing the grunt work associated with selling them to clients. (This is true, of course, for many financial products; annuities are only the most recent illustration.)

Traditionally, a rep had to call the insurer of an annuity to make sure they were authorized to sell it in their jurisdiction. Then he would have to get the application forms, fill them out manually, get a check from the client and send it back by mail. If there was a mistake, the form and check would be returned and have to be resent.

That same broker now has the ability to capture the necessary data and retrieve it from his client database, plunk it into an electronic application and wire it to the insurer through DTCC. DTCC will check the rep's authorization to sell the product, forward the application to the insurer and transfer the money from the broker's account to the insurance carrier electronically. The rep can keep track of the annuity electronically. “We hope to soon bring the same kinds of efficiencies between carriers and broker/dealers to the life insurance market,” says Randy Grespin, managing director of distribution services for DTCC.

The latest addition to the DTCC is Omgeo, a joint venture between DTCC and Thomson Financial designed to speed up the settlement of institutional block securities trades by consolidating communications among broker/dealers, institutions, and their custodian banks. Here's an example of how this works: Fidelity, for example, might want to buy 100,000 shares of IBM and allocate them among its various mutual funds. The order would be directed to an individual floor broker or the broker/dealer's floor trading desk, which would work the trade. The broker might find Janus wanted to sell 50,000 shares from three of its funds and MFS wanted to sell another 50,000. The fund companies would enter a trade. But say Fidelity houses assets for Magellan at Bank A and assets for Contrafund at Bank B. Janus, meanwhile, is dealing with 10 other custodian banks. Each bank now has to be contacted separately, creating lots of back and forth between the banks, brokers, institutions, and DTCC. Enter Omgeo, which provides a central clearing place for such information so institutions can just send one message to inform all their custodian banks of trade information and provide a final settlement instruction to DTCC. (Omgeo is not the only option here: Some firms have cobbled together software systems to create Omgeo-like capabilities in-house.) “Everyone realized there needed to be a faster electronic process,” says Steve Letzler, a spokesperson for DTCC.

Each of the steps described above brings the system closer to the STP grail. But, as noted, that goal is elusive. The next improvement in the process was supposed to be T+1, or reducing settlement time to one day. But especially in the current economy, that goal has been indefinitely shelved. “T+1 is very expensive,” says David Weiss, a senior consultant at Jeremiah Associates in New York and author of After the Trade is Made. “You have to ask what you're getting in return, and firms don't think it's worth it right now.”

Nonetheless competitive pressures prod clearing firms into a state of constant upgrade. And there are glimmers of STP everywhere. Many firms have it internally, but it's not yet system-wide, let alone global. “Everyone is doing their best to make sure that you can eliminate as many hands in the middle of processing, but different firms are at different levels,'' says Fiserv executive Dennis Donnelly, current chair of the SIA Clearing Firms Committee. “It's a matter of their priorities.

Even within automated systems, some procedures must be still be done the old fashioned way. Although 90 percent of the volume at Bear Stearns's Global Clearing is handled electronically, 10 percent remains labor intensive. That 10 percent of the business is where 90 percent of the costs lie. “We have clients who do business purely electronically, and it's a snap,” says Rich Lindsay, head of Global Clearing. “And then there's the client who wants to pick up the phone. You need to have people to answer phones and faxes, and any time a human touches things, services cost more.”

Eventually systems will change, but many firms' investments in expensive old-style equipment bind them to the older methods. “T+1 is dead,” says Robert Blaine, head of clearing services at Raymond James. “But STP in a T+3 environment is pretty close. We match trades on a daily basis. The settlement side of this is looking a lot closer to T+1 than T+3.”

Leaders of the Pack

Essential data on some top clearing and settlement firms

Bear, Stearns Global Clearing Services

Global Clearing Services (GCS) provides each client with four levels of relationship management: technology integration, training, upfront client needs and ongoing support. Global's PC-based workstation, WebBroker, can use either the Internet or dedicated lines. It features contact management, portfolio management, performance reporting and order-entry software. Global's back-office application, called Web Shell, facilitates the writing of reports, 1099 statements, customer account forms and confirmations. It also manages the dissemination of client information through the Internet. Through Bear Stearns, Global has access to a variety of trading desks to clear specialized products, including global derivatives.

Fidelity Investments Institutional Brokerage Services Group

Fidelity provides solutions to a range of clients including broker/dealers, registered investment advisors, third-party administrators and trust institutions. Its online brokerage platform, Streetscape, provides a single point of access to real-time market data, news, and independent research. Streetscape integrates trading and service functionality with investor account balance and position data. Advisor Channel is an integrated analysis, trading and reporting system that helps fee-based investment professionals to manage and rebalance portfolios and to support proprietary wrap programs. Fidelity's systems operate on a proprietary platform that includes client reporting, tax reporting, tax-lot accounting, management reporting and middle-office solutions. Its statements were recently ranked Number One by Dalbar for clarity and completeness.

Fiserv Securities

Fiserv Securities and Fiserv Correspondent Services merged in 2001 to create a single platform for securities clearing and execution services. The company's three products, FSI Professional, FSI Investor and FSI Administrator provide customer management and sales support, including a comprehensive contact management system and sales management tools for broker/dealers to handle internal business operations such as entitlements and sales flow. End clients can get access to account information and research through the Internet or over the phone. Fiserv traditionally has traditionally had a focus on bank brokerages.


The firm's workstation, NetExchange Pro uses proprietary technology to offer a full range of products and services, including cash management, mutual-fund and annuity programs, retirement accounts, asset management, managed accounts and research. NetExchange Pro can be downloaded to Windows for mobility. NetExchange Client allows reps' clients to access accounts and trade on the Internet or over the phone using voice recognition technology. Pershing recently added global capabilities for clients who conduct transactions in different currencies. The firm serves RIAs, many of them former insurance agents, on a separate platform.

SWS Securities

SWS has grown from 12 employees in 1972 to more than 1,000 today. It offers a variety of financial services, from processing of securities transactions to online investing. Although its market is somewhat concentrated in the southwest, it has correspondents in more than 40 states and 5,000 affiliated sales people in the United States and abroad. The firm asserts that what SWS lacks in diversity, it makes up for in personal touch. The firm is building a new platform for RIAs.

US. Clearing

U.S. Clearing provides full-scale execution, clearing and settlement services. It features an Internet brokerage platform that integrates market data, research, trading, cash management and account access. Its Advantage Portfolio Management Program is a turnkey product for fee-based advisors that incorporates trading, custody, performance reporting and administration in a Web-based format. Mutual funds are screened and selected from an extensive universe of major fund families and portfolio managers undergo a thorough due diligence process.

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