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September 12, 2006

Alleviating Back-Office Pressures with a New Approach to STP

By Adam D. Honore

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  • Alleviating Back-Office Pressures with a New Approach to STP

The most over-utilized, misunderstood term in financial services has to be STP (Straight-Through Processing). The dream of every operations manager during the T+1 era was the front-to-back utopia associated with sending trades through their entire lifecycle without manual intervention. To some, this meant wholesale replacement of legacy back-office systems. But to others, it meant pulling out critical pieces, like allocations and instructions, from in-house solutions and moving them into outsourced business models. Nevertheless, STP has produced sequential initiatives that solve immediate pain points.

Today, we see increased trade pressures, such as algorithmic trading and direct market access (DMA). These, along with global trading and regulatory concerns, have changed the face of institutional trading and placed heavy burdens on back-office systems. Further, profitability margins are shrinking on a per-trade/per-instrument basis. So, while volume is exploding, margins are shrinking. This is pushing clearing costs up across the board. The most active firms are also the same ones bearing a big share of the cost of clearing. However, they are the same firms engaged in intense price competition.

As a result of the tremendous growth in trading activity, the industry should expect to spend approximately US$15 billion on brokerage, clearing and exchange fees just in 2006. Based on recent trends, such as increased trading activity and expansion into global markets and alternative investments, the industry will sustain a compound annual growth rate of 19 percent over the next four years.

This growth is a sign of willingness by firms to expand operational initiatives in lieu of initial larger expenditures on technology. This is a response to increased trading volumes.

The vast majority of those expenses are incurred by the top 10 firms in the market, where agency and proprietary trading volumes are the highest. Although the top-tier firms are paying much more for clearing, they are also driving significantly more trading volume to offset those costs.

Even though clearing costs are on the rise, firms are posting record revenues despite lower per-trade commissions. For now, revenue growth is outpacing clearing cost growth by nearly a two-to-one margin, on average. This growth is encouraging for progress made thus far on post-trade processing initiatives. The growth also highlights firms' ability to scale operations to meet increasing demand, especially as volumes continue to increase. Growth comes from more algorithmic trading, interest in global markets and alternative investments.

Basically, financial institutions are spending in areas in which revenue is coming in the door. For these firms, a majority of the budget is spent on servicing the buyside. Transaction Cost Analysis (TCA) tools, connectivity, and expansion in fixed-income and international markets are dominating budgetary agendas.

Enterprise Data Management (EDM) efforts are also generating enough interest to justify increased spending. While not directly related to STP initiatives, EDM efforts are structuring firms to make significant leaps in processing. Executives are realizing that moving bad data faster is not the answer to their problems.