Transformer. Securities Processing System - The Next Generation. About the author:

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1 Transformer Processing System - The Next Generation Sriram V Sekar Global Head - Data & Product Manager - Foundation Data About the author: Sriram V Sekar has over 11 years of experience in providing business process consulting and software solutions to the Financial industry (Capital Markets and Insurance). Sriram is the Global Head of Data and the Product Manager of Penstock One Foundation, HCL's foundation data product for the financial services industry and has been instrumental in conceptualizing this product. Prior to the product management role, he was managing regulatory and compliance driven data management processes for a leading global investment bank.

2 Preface processing market is changing with new regulatory directives like MiFID paving the way for a scenario that is moving towards Anywhere, Settle Anywhere. The Investment Firms are re-evaluating their legacy systems with respect to cost and efficiency. New players are coming to the market - private banks are increasingly providing brokerage services to their clients, the merging of private banking and securities wealth management is creating opportunities for banking systems to process securities. All these have increased the need to integrate products and services more quickly, plus the need to deliver scalability, is pushing mid-tier institutions to embrace back-office transformation, which remains a strategic objective for many banks. These banks are increasingly recognizing the benefits of emerging technologies that enable them to act quickly and display the agility to support their customers and counter their competitors. The next generation back-office securities processing systems view is cross-asset and cross-border all contained in one virtual processing and a single data domain. There are many players in the market providing securities processing systems, but none of them currently have the comprehensive functionalities/features that are required to make them the next generation class. Market Forces The securities processing market has been changing with new regulatory directives like MiFID paving the way for a scenario that is moving towards Anywhere, Settle Anywhere. The ISFs (broker-dealers, trading firms, hedge funds, asset management firms etc.) are re-evaluating their legacy systems from a cost perspective and from an efficient processing perspective. New players are coming to the market - private banks are increasingly providing brokerage services to their clients, the merging of private banking and securities wealth management is creating opportunities for banking systems to process securities. While the trading business strategies and implementation are evolving quite rapidly, the clearing and settlement business strategies and implementation to support these new and evolving trading scenarios have not caught up, especially in the European Union. This because of various constraints in the market like non-existence of standard market practices and messaging in the legally more complex area of settlement, barriers identified by Giovannini Committee to an integrated European Union clearing and settlement environment, absence of harmonization of market practices across Europe in the areas of Corporate Actions processing, Tax processing and in legal structures for transfer of ownership etc. While this catching up is happening, the ISFs have started to reassess their securities processing system choices and have started evaluating vendors who provide SPS based on their trading strategies, which is moving towards an integrated cross-border trading and settlement scenario supporting different market practices in the shortand medium-term till all market practices converge in the long term. US has been a trend-setter in the securities processing domain compared to EU in the area of clearing and settlement consolidation, mainly due to the fact that the market is a single domestic one with no internal boundaries when compared with the fragmentation that exists across the national boundaries in Europe. There are still some inefficiencies in the US market especially when it comes to unified system across multi-asset classes, which becomes an important consideration when it comes to supporting Anywhere, Settle Anywhere concept. New-age Movement According to Gartner, in core securities processing systems, banks and broker-dealers are not as far along in the core replacement decision cycle, although the strategic business criticality of securities processing system replacement is increasingly recognized. Rather than embarking on full-fledged replacement, most banks and brokerdealers are currently extending the life of their core securities processing systems whilst analyzing and planning strategic replacement options. With the proliferation of new financial products and the complexity of existing operations, financial technology professionals are realizing there are multiple choices besides pure replacement. Additionally, firms are waiting to scrutinize new vendor offerings. Vendors traditionally focused on other parts of the securities and banking business are extending the development of their products to incorporate securities-processing functions, recognizing the existence of gaining market share in this area. The need to integrate products and services more quickly, plus the need to deliver scalability, is pushing mid-tier institutions to embrace back-office transformation - standardization and integration within the back office will be essential to the success of mid-tier bank ambitions for geographical expansion and for successfully incorporating acquisitions. Most large multinational banks in Western Europe are seeking to leverage business-process-proven practices and IT efficiencies through centralization by consolidating on a single platform for their international operations. The emergence of green-field banks in Asia is putting pressure on existing banks in that region to upgrade their back-office capabilities to compete with these new institutions and match their agility and new product offerings. These pressures are driving a greater focus on the use of service-oriented architecture (SOA) to create consistent, reusable and non-redundant application logic across product

3 offerings, as well as to enable mapping of data across the entire process flow to support risk management, deliver the required levels of customer service, and gain the benefit of analytical tools. Back-office transformation remains a strategic objective for many banks, which are increasingly recognizing the benefits of emerging technologies that enable them to act quickly and display the agility to support their customers and counter their competitors. Gartner forecasts that the U.S. middle- and back-office spending in investment services will grow at a 3.13% CAGR through 2009, and external spending will grow at a 4.03% CAGR to more than $10 billion through The security is then traded between a buyer and a seller through various means. Once a security is traded then it goes through a process of clearing by the clearing houses and then proceeds through a process of settlement and safekeeping by the custodians/central securities depositories (CSD). During these stages, a security can be subjected to corporate actions from time-to-time and the counterparties involved in the buying and selling of securities can also lend or borrow securities, include the securities as collaterals to meet their margin requirements with the custodians who also act as central counterparties (CCP). In all these various stages, the firms which deal with securities transactions will also have to manage risks that arise out of these transactions. According to an Aite Group survey on Capital Markets IT Spending Priorities in 2007; Settlement, trade processing, and systems integration account for three of the top four systems priorities this year. Issue & Listing/ Available for Trading Order for (Buy /Sell Transaction) Process Corporate Actions on Settlement Process Please rank the following in the order of priority for 2007 IT initiatives (n=13) Global Trading & Settlement Rank One Rank Two Rank Three Rank Four Rank Five Figure 1: System priorities for IT initiatives Introduction to Processing Systems Processing Systems (SPS) are typically used for the posttrade clearing and settlement of securities transactions by firms that provide Investment. These systems play a pivotal role in the firms' desire for providing efficient and effective Straight-Through Processing (STP). Processing Compliance Solutions Systems Integration Business Intelligence Solutions Market Data Processing Pre/Post Analytics Reference Data Wealth Solutions OTC Derivatives Processing Workflow Tools Broker Workstations Payments 3 15% 15% 15% 31% 15% 15% 15% Corporate Actions Processing Imaging & Document Production 0% 10% 20% 30% 40% 50% 60% 70% transactions typically go through multiple stages in its lifecycle. A security is first issued by an issuer, which then gets listed in an exchange or is available for trading in any other trading facilities. Source: Aite Group, online survey of 13 IT executives, 2007 Figure 2: Stages in Transactions lifecycle A more detailed process flow depicting the relationship between various entities involved in the clearing and settlement process in the Indian Market and providing an insight into the activities and dependencies of these entities is shown below. The process flow can be slightly different for different markets depending on the regulations and market practices followed in that country. Investor 16 Pay-out $ Bank 16 Pay-out 1. Buy/ Sell Order 2. 11,13,17 & 19 Pay-in & payout of funds Broker & securities 12 Ensure fund availability for Ensure fund availability for 10. Netting/ Obligations Depository Custodian Figure 3: Process flow depicting relationship between entities involved in & Settlement Safe Keeping of Lending & Borrowing of Collaterals & Margin, Risk 7. Institutional trades for allocation 4 & 20 Margining 15 payin & processing by CC 15 Funds & 18 processing by 10. CC Netting/ Obligations modification 8 & 9. confirmation process 3. Position Monitoring Exchange Corporation 5. details to CC

4 Investment services firms (ISF), so far, have been focusing on silobased securities processing with different systems focusing on different asset classes. While conventionally, this approach did provide the efficiency and focus on STP for a single asset class, from a changing market scenario perspective; this approach is handicapped to provide a true STP across multiple asset classes. Next Generation System View The next generation back-office securities processing systems view is cross-asset and cross-border all contained in one virtual processing and a single data domain. Currently, none of the ISFs and brokerage houses in the world can boast of having such a system catering to all the securities processing requirements across various markets. While many major ISFs have started developing such systems internally, there have been failures of such initiatives in the past and there is always a cat-onthe-wall situation between such build strategies, which is perceived to be highcost and high-risk and buy strategies from product suppliers in the market, which also comes with its own cost and risk factors. Some of the key features that need to be considered while evaluating the next generation securities processing systems are: - Real-time processing of multi asset class across different markets - Cross-referencing across markets, parties involved, securities etc. - Support for global master securities database with performance and volume scalability - Unified cross market processes enabling cross-border activities - Combined brokerage and custody operations (global and subcustody functionality enabling in-house custody services) - Multi-currency & cross-currency processing capabilities - Multi-location, multi-entity, multi-language, multi-time zone support - Support for different implementation models - centralized, decentralized, ASP/BSP etc. Business Partner Data Warehouse Collateral/Risk Customer & Account Corporate Action & Tax OTC Derivative System - Real-time and batch interfaces to exchanges, other trading venues, clearing houses, settlement venues - SOA The following picture depicts the next generation securities processing system showing the various business components/functionality and their interdependencies with the internal ecosystem of an investment services firm and with the external market participants. External Information Vendors Reference Data Treasury System Fund Administration Reporting Borrowing & Lending Safekeeping/ Cash Corona CSD/Custodian GCM/Fund Provider Figure 4: The next generation securities processing system The system should support the following business components supporting the complete life-cycle of post-trade securities processing using best practices and workflows: - and settlement supporting netting and clearing of trades, transactions, positions, settlement instructions, settlement of instruments and cash, confirmation and reconfirmation with custodians, payments including brokerage, fees, tax, commissions and fails management with settlement status and risk monitoring Customer Order Asset & Settlement Accounting Fund Providers Point of Execution Internet Trading Application Instructing Capture Cash Banking Infrastructure IPO Processing - Safekeeping supporting asset servicing (instruments and cash), agreement management, margin lending, instrument borrowing, lending pool, collateral management and reconciliation - Portfolio calculations and performance measurement SWIFT Oasys Global CSD/Custodian GCM/Fund Provider - Flexible and scalable solution that supports future expansion of business into new markets, new products and new business areas - Support for private banking and wealth management enhancements - STP & event-driven processing capabilities supporting the 80:20 transactions rule - Corporate action event processing and tax management - Post-trade risk management - capture and instructions management - Limits and exposures management etc.

5 The summary view of the technical reference architecture is depicted below: Business SOA/Web Process Flow Control BPM Business Rules Business Rules Repositories Supporting SOA/Web Mgmt & Settlement Safe keeping Corporate Action Business Process Transformation Routing Common Data Security Auditing Fault Handling Fee Adapters Logging Communication... Middleware or API... Figure 5: Technical reference architecture The macro-level business processes or the actual business scenarios of the next generation securities processing system are orchestrated in this architecture using business decisions, business rules and micro level business services. The orchestration is designed and implemented to support distributed environment which enables deployment of business workflows at multi-location. All services of the system are integrated through federated enterprise service bus pattern that allows seamless integration. Conclusion and Looking Forward There are many players in the market providing securities processing systems, but none of them currently have the comprehensive functionalities/features that are required to make them the next generation class supporting the evolving regulatory directives and business needs of full STP across all asset classes and cross border trading and settlement processes in the more-standardized, virtual marketplaces that European Union is moving towards. The ISFs are continuously looking to reduce the operational costs and at the same time handle increased trading volumes and complexities. The market is ripe now and will continue to be so for the next 5 years at least with firms either building in-house systems or looking for vendor offerings in the securities processing space that is mature in terms of technology and functional offerings and that is reliable. Enterprise solution is the way forward! References 1. Capital Markets IT Spending Priorities in A report by Aite Group - June Sell-Side Brokerage Security Processing Systems: Market Overview - A Gartner report - July The Future of and Settlement in Europe - A report by Bourse Consult