Dear Sirs Communication (2004) 312 final - Clearing and Settlement

DG MARKT G1 European Commission Brussels B - 1049 July 30th 2004 By e-mail to markt-clearing-settlement@cec.eu.int Please respond to tony.freeman@omgeo.com Dear Sirs Communication (2004) 312 final - Clearing and Settlement Omgeo Limited ( Omgeo ) 1 is grateful for the opportunity to respond to the Commission communication regarding Clearing and Settlement in the European Union. Omgeo provides critical post-trade processing services in 42 markets globally. Omgeo is writing to you in two roles: as a commercial service provider and also as a representative of its client community. The Omgeo governance structure allows both shareholders and clients to be members of the Omgeo Board of Managers and Omgeo also operates Advisory Board s in Europe, US and Asia Pacific. Our submission is therefore generated using the views and expertise of these multiple resources. In this letter we will explain the position of Omgeo in the European market, the widespread usage of Omgeo systems in post-trade processing and we conclude by offering to assist the Commission in defining the functional definitions of trade confirmation and trade matching. About Omgeo Firstly we would like to provide more information about Omgeo activities particularly in Europe. Omgeo is a leading global provider of post-trade pre-settlement trade management solutions, processing over one million trades per day and serving 6,000 investment managers, broker/dealers and custodian banks. Omgeo has partnerships with service providers, infrastructure suppliers, industry standards organizations, and our clients to increase operational efficiency and reduce risk through STP solutions. Omgeo is a global joint venture between The Depository Trust & Clearing Corporation (DTCC) and Thomson Financial, a leading provider of financial workflow solutions. The two companies have 27 combined years of experience in this area. The Board of Managers includes recognized global experts who provide industry oversight and help shape the vision of Omgeo. For more information about Omgeo go to www.omgeo.com Omgeo European headquarters is located in London with additional offices in Frankfurt, Paris and Stockholm. Omgeo has integrated the OASYS Global, Market Match and ALERT post-trade pre-settlement services formerly operated by subsidiaries of The Thomson Corporation; and the TradeSuite service formerly operated by The Depository Trust & Clearing Corporation s subsidiary, The Depository Trust Company. 1 Omgeo is a joint venture between The Depository Trust & Clearing Corporation and The Thomson Corporation. Omgeo began operations in 2001. It combines in a single business the TradeSuite service formerly operated by The Depository Trust & Clearing Corporation s subsidiary, The Depository Trust Company, with the post-trade pre-settlement services formerly operated by subsidiaries of The Thomson Corporation. Its wide range of services helps Omgeo s clients achieve straight through processing of their trades. More information about Omgeo is available on its website, www.omgeo.com Page 1

Omgeo is regulated as a service company by the UK Financial Services Authority under section 27 of the Financial Services Act 1986. The authorization was granted 28 th February 2001. In the US, Omgeo has received an order of the U.S. Securities and Exchange Commission granting an exemption from registration as a clearing agency to a wholly owned subsidiary of Omgeo (Release No. 34-44188; File No. 600-32, April 17, 2001). Omgeo has approximately 630 clients located in the following EU member states: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden and UK. There are another 40 clients in Europe located in non-eu member states. Additional clients are located in the following countries: Australia, Bermuda, Brazil, Canada, Egypt, Hong Kong, India, Japan, Korea, Malaysia, Mexico, New Zealand, Norway, Russia, Singapore, South Africa, South Korea, Switzerland, Taiwan, Thailand, Turkey, UAE and USA. Omgeo services Our clients use a variety of Omgeo systems: all operate in the post-trade pre-settlement area. The most commonly used in Europe are as follows: OASYS Global OASYS Global is a worldwide electronic trade allocation and confirmation service and is used by broker/dealers, investment managers and custodian banks around the world. OASYS Global facilitates cross-border trading by minimizing the inefficiency and operational risk associated with manual trade processing. The system processes the majority of the world s cross-border Electronic Trade Confirmation (ETC) volumes and is recognized by global regulators including the Securities & Exchange Commission (SEC) in the U.S., the Financial Services Authority (FSA) in the UK and the Toronto Stock Exchange (TSE) in Canada. OASYS Global was introduced in 1993. OASYS Global has received regulatory clearance in a variety of markets so that its confirmation is also regarded as a substitute for the legally required paper certificate. Central Trade Manager Omgeo Central Trade Manager ( CTM ) is the new state-of-the-art STP solution for processing trades from execution through settlement. Omgeo CTM is designed to operate in real-time to facilitate same or next-day settlement for cross-border and domestic trades, for both fixed income and equity securities. Omgeo CTM will replace OASYS Global as the standard European trade processing platform. Market Match MarketMatch is a global broker-to-broker trade matching service. The system allows a participant to agree to or deny trade allegations made by market-side counterparties. It allows users to know that a match has occurred or if trade details mismatch both parties will be informed of the unmatched status and will be shown the trade discrepancies. ALERT ALERT is the industry s largest global database for the maintenance and communication of standing settlement and account instructions (SSI). ALERT reduces trade failure by enabling a community of investment managers, broker/dealers and custodian banks to share accurate SSI automatically worldwide. Omgeo business model In Europe Omgeo operates as a commercial supplier. As stated above Omgeo is regulated by the UK FSA as a service provider, however this status does not grant any ability to enforce usage of its services. Omgeo products are, where possible, intended to be applicable to all markets. However Omgeo is still operating legacy products derived from the precursor businesses prior to the formation of Omgeo as a joint venture. Some of these products are US specific and some are Page 2

aimed at users outside the US. It is Omgeo s intention to retire these legacy systems and focus on developing Omgeo CTM, which is designed as a global trade management platform, as its core offering. Other market structure projects Omgeo has recently provided formal responses to three other organisations engaged in similar consultancy processes. These are: - CESR (Committee of European Securities Regulators), Paris - Securities and Exchange Commission, Washington - Canadian Securities Administrators, Toronto and Quebec We will provide you with copies of these letters which we hope you will find useful. Definitions Section 2.2 of the Commission paper states that a Directive should introduce common functional definitions including trade matching and confirmation. Omgeo is the largest global supplier of services in this area and we therefore wish to provide our assistance with producing these definitions. Owing to the current, standard, 3 day period between trading and settlement, most market participants believe that there is significant value in performing a trade confirmation as soon as possible after trading. The current market convention, for trades performed by institutional investors, is to confirm the market trade (referred to as a block trade ) and the settlement details (referred to as an allocation ) before the trade is instructed to the settlement agent. The trade confirmation process is therefore independent from the settlement process. Omgeo supports this delineation and our systems are therefore designed around this principle. Omgeo also supports the process of same day trade confirmation. The term used by Omgeo to denote this process is SDA - Same Day Affirmation (SDA) - and we will use this term throughout this letter. SDA is the process of capturing and agreeing on details of a trade between the buyer and seller. It does not, in itself, imply how the process should be performed - either by matching or by confirmation/affirmation. Omgeo believes that SDA is a catalyst for improving post-trade processing efficiency and is one of the necessary steps to enable shorter settlement cycles. This subject can sometimes be confused by terminology problems where different markets use similar terms to mean different processes. As stated above Omgeo uses the term Same Day Affirmation ( SDA ) to identify the generic process of same-day trade confirmation. SDA can be achieved by a confirm/affirm process as currently used in many markets or a central matching process as used in Omgeo CTM (or OASYS-TradeMatch in the US). Confirm/affirm is a sequential, reactive process whereby an institutional client and a broker/dealer send data to each other, via a central system, according to a defined operating model. Step 1 - Following execution the broker/dealer sends a notice of execution to the client. This is commonly referred to as a Block Trade. It is defined as being the market details of the trade (price, quantity, settlement date, counterparty etc). Step 2 - The client will send a message to the broker/dealer agreeing or disputing the alleged Block Trade. Step 3 - When the Block Trade has been agreed the client will send details of the allocations to the broker/dealer. (Typically an institutional client will execute a block trade on behalf of Page 3

multiple clients. This necessitates the allocations being separately settled.) The Allocation expands the information to include client and settlement data. Step 4 The process is completed by the broker/dealer using the allocation instructions to generate an electronic contract note which is agreed by the client. Therefore, the market trade ( Block ) and the settlement information ( Allocation ) are both confirmed before a settlement instruction is issued to a settlement agent (a custodian or clearing broker). When a trade is instructed to a settlement agent, it is possible that it may be confirmed again within the settlement system immediately prior to settlement. This is often referred to as pre-matching. General consensus within the market is that a trade confirmation process independent of pre-matching and settlement is a vital risk-management process. Pre-matching often occurs immediately prior to settlement and therefore may not allow enough time for any problems to be resolved. Matching is a term that is widely used and can have many subtly different interpretations. In the context of Omgeo systems Matching is the process whereby both the client and the broker/dealer submit Block trades and Allocations to a central system for comparison. This avoids the sequential and reactive features of the Confirm/Affirm process. However the term Matching is sometimes used to indicate a trade that has been confirmed by manual means or a confirm/affirm method. Therefore - in some contexts the term matched is a synonym for the terms confirmed or affirmed. Because of the potential confusion caused by these terms we fully agree with the objective of creating common functional definitions in this area. However we would also urge the staff of the Commission to co-ordinate with other regulatory groups and trade associations to ensure that, where possible, the definitions are internationally agreed and take account of current market practice.. US market statistics As stated above it is widely agreed that confirming a transaction prior to settlement is essential for operational efficiency and risk reduction. In fact, our studies show that unconfirmed transactions, in the US market, are 37 times more likely to result in trade failure later in the settlement process. Resolving trade failures is time consuming, manual and costly. Despite this, in today s T+3 settlement environment T+0 confirmation rates are far from optimal. In the US market 23.8% of trades are confirmed on trade date ( T+0 ). By noon on T+2 the figure has risen to 87% meaning that 13% of trades are delivered for settlement without any confirmation taking place. It is clearly essential for Omgeo to promote not only the concept of trade confirmation but also to determine the optimum method. From our analysis Omgeo believes that central matching is superior to confirm/affirm. This belief is generated by statistics we are able to produce from the US market. The below data is taken from the OASYS-TradeMatch SM system in the US market, but we believe the lessons are applicable to other markets. March, 2004 TradeSuite Transactions Affirmation Rate Via Current Confirm/Affirm Process T-0 16.5 % 77.8 % T+2 85.7 % 95.5 % Via Electronic Allocations & Central Matching Failure rate 1 % 0.5 % Note: Failure Rate above refers to the reclaim process within the DTC system by which a receiver of securities returns them to the deliverer. Page 4

The findings with regards to this analysis are, Centrally matched trades that utilize an electronic allocation process (e.g., OASYS) experience a superior SDA rate than transactions processed via the traditional confirm/affirm method (77.8% vs. 16.5%) Similarly, in terms of T+2 affirmation rates, centrally matched transactions that also utilize electronic allocations experience a higher affirmation rate (95.5%) vs. transactions processed via the traditional confirm/affirm method (85.7%). The above data also suggests that it is more beneficial to centrally match a trade, as the overall affirmation statistics, and vastly different failure rates result in central matching users experiencing two times fewer trade failures than traditional confirm/affirm trades. It therefore seems that there is a direct correlation between higher SDA rates and greater processing efficiency (in the form of fewer failed trades) regardless of the length of the settlement cycle. At least part of the explanation for this improved performance can probably be attributed to the simple fact that there is more time for processing exceptions if those exceptions are identified earlier in the settlement cycle. Thus, we believe that there is a compelling argument for promoting SDA, regardless of the length of the settlement cycle. A related issue that has been discussed in many other markets is the proposal to make same-day trade confirmation mandatory. Omgeo as a vendor clearly has a vested interest in this issue and therefore will not comment directly on the subject. However we would like to provide a view of this issue based on our experience in many markets. It seems certain that many active and automated firms (broker/dealers, investment managers or banks) will take whatever steps may be necessary to comply with a voluntary industry objective, or code of best practice. However, it is equally evident that some firms will not implement SDA without a regulatory mandate. Relying on best practice recommendations often also produces a state of inertia where participants are waiting for every other participant to move first. The result is that everybody waits and nobody takes a lead. We at Omgeo thank the Commission for the opportunity to provide a response. We are available for any further discussion the staff of the Commission may wish to have and in particular we would be very happy to provide any assistance required to the CESAME group. Yours faithfully, Richard Hughes Managing Director EMEA Omgeo Ltd Page 5