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December 1, 2002

A World Without Fails

By Dr. Anthony Kirby

Traders take pride in exploiting opportunities at the speed of light. The secret may be state-of-the-art algorithms or other technology. But the keys to seamless transaction flow are straight-through-processing (STP) and effective systems integration and processing.

Buyside traders should care about this because STP is the critical path to achieving the three Cs: better cost reduction/avoidance, better controls and better customer service. An estimated 15 percent of cross-border trades in today's markets fail to settle by the due settlement date. About 45 percent of those fails are the result of incomplete STP processes. These problems contribute to the $12bn annual cost of failed trades.

More buyside traders are measured on their performance, including borrowing costs. So it is clear that STP problems can sometimes outweigh the benefits of working the trade.

Still, more volumes, particularly cross-border business - as well as the whiff of shorter settlement cycles - could lead to more errors. That's because matching will need to take place on the trade date.

On another front, the buyside is more sensitive to the prevalence of VWAP trading which is used to satisfy industry guidelines. The buyside must also satisfy best execution requirements. The inexorable growth in program, hedge fund and multi-asset trading, including cross-asset class trading by institutions, is having an effect. There is a more urgent need for smart routing to liquidity hot spots and the STP models.

According to Reuters research, buyside front-offices emphasize:

* The availability of real-time information and real-time updates powering real-time analytics.

* That trading will always be attracted to liquidity, and a streamlined and cost-efficient market mechanism must be in place.

* That firms can achieve better knowledge of available prices. They can do it by centralizing all available price information from exchanges, ready-to-trade IOIs and internal crossing.

* The critical issue of the cost of access to liquidity pools when all prices are combined to identify where it's easier to trade.

Lastly, risk management is becoming more important for buyside firms. Operational risk in particular is becoming a hot topic in preparation for Basel II. (Basel II is the revised international accord on bank regulation from the Basel Committee on Banking Supervision in Switzerland.)

Quality of connectivity is also important. For that reason, FIX is used extensively by many large brokers to exchange order traffic in equities. However, there is a weak link in connectivity requirements because FIX conversations are typically carried out over separate physical point-to-point leased lines. Since 70 percent of STP work is likely to be internal, FIX utilisation must depend on workflows that straddle the front- to middle-office.

There are multiple standards and protocols serving vertical market needs. Harmonization of versions in production is urgently needed. Each logical trading conversation (FIX session) is likely to be slightly different from one counterpart to the next. A firm may use configurable instances of a FIX engine and/or more than one engine to implement multiple connections.

As FIX usage proliferates, the number of individual physical links that each large firm will manage could increase dramatically. That could be a significant cost and management problem. One way to lower this overhead is to use an extranet such as Radianz, SWIFT or NYFIX instead of many leased lines. A firm may still have to manage a large number of logical connections but it only needs to manage one physical connection.

The success in managing this effort will come from the cooperation of the trading community as well as the liquidity provided by the buyside. More liquidity will mean better execution. A broadened interoperability through STP will mean better cost and risk control. That's an argument that will win broad support in the current business climate.

Dr. Anthony Kirby is head of the global STP programme at Reuters.