T+2 POTENTIAL POST-TRANSITION WOES: CONFIRMATION / AFFIRMATION

The transition to T+2 settlement throughout the European Union (EU) is scheduled for January 2015. Some countries may transition before this date. Henceforth, from January 2015 equity and bond trades will settle two days after trade date across the EU. This is a major accomplishment as it’s the first region to reduce the time between trade and settlement date from T+3.

One unknown consequence of this change is the impact on Confirmation / Affirmation (C/A) rates.  The C/A process occur between institutional investors (buy-side) and their brokers (sell-side). Institutional trade volumes represent the largest number, and greatest value, most broker’s business. 

The C/A process is the presentation (confirmation) of trade details by the sell-side and approval (affirmation) from the buy-side. The current rate of successful affirmation on or before T+1 is between 60-70%. In a T+2 environment positive affirmation must be made on trade date.

Un-affirmed trades must be reconciled to ensure timely settlement and to avoid failed settlements. In the current T+3 environment manual work-arounds are used to identify and resolve un-affirmed trades. But  in a T+2 enviroment, with one less day, manual work-arounds will be less effective. As a result the industry must respond to this situation to ensure the success of T+2 settlement.

There are alternative responses that can address this situation; one is for the buy-side to review and respond to the confirmation on trade date. Another alternative is for the buy-side to empower their custodians to affirm trades on their behalf. Both will permit sufficient time for exceptions to be resolved and advise custodians of the pending settlements. Both alternatives can be implemented with minimal changes to buy-side internal worksflows and minor technology modifications.

These alternatives are short term solutions to the C/A process. The global industry needs an integrated model so that the C/A process is incorporated into the order-trade workflow. The C/A process should be automated with minimal touch-points required. There are systems in place today that come close to this model, but they have not been fully embraced by the community. The industry must determine why these systems aren’t  fully utilized. They must address these issues or commission development of a system that is acceptable to all order to trade lifecycle participants

What’s your opinion on this situation?

               Any idea why affirmation rates are so low?

                        Are  there other viable alternatives?                        

                        

MORTGAGE BACKED SECURITIES 2.0 – PART ONE

Twice in the same week two entities published their recommendations on a new mortgage securitization process that would turn mortgages into tradable securities. Their motivation is to ensure that lending institutions are able to access the capital markets.

The need for a reset to MBS 2.0 is that the agencies responsible for purchasing and securitizing mortgages issued by lending institutions, Federal Home Loan Mortgage Association (FHLMC) and Federal National Mortgage Association (FNMA) were absorbed by the federal government. This action was in response to the credit crisis, increasing late payments and growing defaults by homeowners holding mortgages securitized by FHLMC and FNMA. Both agencies, known government sponsored enterprises (GSE), were public companies owned by shareholders before being taken over by the federal government.

Prior to the credit crisis the role of these agencies was to purchase qualifying mortgages, turn the mortgages into securities, and guarantee the timely payment of principal and interest, which were sold to investment banks who in turn sold them to investors. This process was established in the late 1960’s and was designed to provider lending institutions with a way to move the mortgages off their books and recapture the capital lend to home buyers.

Congress and the Federal Housing Finance Agency (FHFA) are struggling with finding a system to improve market liquidity and address the potential risks causing market disruptions. The ultimate solution will come from the federal government; particular focus will be on correcting some of the shortcomings of the original model, such as:

·        Implicit guarantee that the federal government would back the two GSE in the event of a crisis. This certainly was true……

·        Marginal impact on low to moderate income home buyers

·        Conflicts in regulations and between public and private objectives

A new securitization model is a critical step in the recovery and at a minimum, must ensure

·           Consistent, nationwide supply of mortgage financing for residential mortgages to qualified home buyers

·           Assistance to low and moderate income homebuyers, i.e. subsidized mortgages

As I wrote in an earlier blog, the ideal response to this opportunity will be a result of a collaborative effort between Congress, FHFA and representatives from the Capital Market. This mix of interests will ensure that each is represented and that the model will be a “best practice” approach to the stated objectives. At this point the following are some of the broad principles that should be addressed:

·        Securitization model that combines a federal government and private industry guarantee that timely principal and interest payments will be paid to investors on qualified mortgages

·        Transparency on the underlying mortgages in any securitized pools or tranches sold to investors

·        Investment grade rating on the securitized pools or tranches

I will review the recommendations offered and explore this topic further in another blog. Meanwhile, let me know your thoughts regarding..

What is your opinion about this?

Your ideas on the new securitization model?

Are there other viable alternatives available?

CLEARING ENTITIES – WHEN ARE THERE TOO MANY?

It seems that every week there’s an announcement of a new clearing entity supporting a market or product. Clearing is critical and provides safety and risk mitigation for market participants. But I wonder if there can be too much of a good thing?

Granted, clearing is a basic requirement of a sound financial services industry, and should address trade matching, collection of initial and variation margin and the clearing entity acting as the Central CounterParty. But is forming a new clearing entity the most effective approach?

In a market without a clearing entity, one is needed to provide critical services. This often requires regulatory changes, perhaps on a national scale, to begin the process. The local infrastructure must be in a position to support this process. This includes funding and contributing the expertise to define the processing and control functions. This is a heavy burden for an emerging or pre-emerging market to undertake.

Perhaps leveraging the expertise of an existing clearing organization, rather than creating a new entity, is a better alternative. This would permit clearing services to be made available faster and potentially with less pain and expense usually associated with forming a new entity. The potential benefits of this approach are considerable as it would reduce the costs associated with development and encourage the use of clearing in new markets.

Further along this line, I question why new clearing entities are being formed in markets where there is an existing entity already providing clearing services.  Are clearing services for one product substantially different from another product?  Are there benefits of using an existing platform?

If there are legislative or regulatory issues that demand a new entity, the industry should appeal this situation as it results in a fragmented clearing process. Additionally it requires firms to join multiple entities, support redundant interfaces and holding positions and balances across multiple entities all which results in increased costs.

Perhaps some products can’t be co-mingled or require unique processing streams and / or reporting.  Or segmentation may be required to mitigate associated risks. This can be addressed via a holding company structure where different processing streams within a clearing entity would maintain the required segmentation.

The old approach of “cloning” an existing infrastructure, to support a new requirement, has been the “go to” approach for financial services firms for far too long. As seen many times, this seemingly simple approach is costly in the long run with multiple interfaces, maintenance of different but similar applications and processing multiple processing streams.

Once in-place these cloned systems are almost impossible to replace or eliminate due to the ever evolving demands for new products, faster processing or new markets.

Fewer clearing entities will flatten the landscape and reduce fragmented processing streams. It will also support cross-margining and improved collateral management. In the future fewer clearing entities will ease the transition to global interfaces among clearing entities.

So, when will we learn from the hard lessons and modify our approach to the never-

ending demands of the industry?

What is your opinion about this?

           Are there other viable approaches available?

                 How many clearing entities memberships does your firm have?