OTC Trade is processed through multiple systems and processes within the firm. To ensure that all the systems and processes are aligned to each other appropriately maintaining a perfect copy of the trade at all the time in all the places is vital. The recent credit crisis has brought renewed focus on reconciling the trade details with counter party as a measure of strengthening the risk management process. Reconciliation with counterparties or external service provider would confirm that the trade is correctly reflected in the firm's book and matches with the counterparty records.
Reconciliation Process
The process involves a series of steps to be completed in the preparation phase, execution analysis and post analysis phases. Reconciliation process involves defining
- Why to reconcile
- What to reconcile
- Whom to reconcile
- When to reconcile
- Where to reconcile
- Who will reconcile
- How to reconcile
- How to resolve
- How to Optimize
Process
Reconciliation within a firm is relatively less troublesome than with external systems. The interaction of multiple external entities starting with Fund Administrator, Asset Servicing, Industry Utilities and Counter Parties makes the external reconciliation process consume more time and resources.
The dynamics of external reconciliation as against internal reconciliation to a firm are highlighted in fig. 1.
The five major areas of external reconciliation are:
1) Reconciliation with Confirmation Platform
2) Reconciliation with Payment Processing
3) Reconciliation with Trade Repositories
4) Reconciliation with Central Clearing
5) Reconciliation with Collateral Systems
Internal reconciliation could be between two or more -
1) Business units
2) Processes or
3) Systems
Interface with Internal Reconciliation Process
The interaction between the internal and external systems and processes is more complex to identify. For example – A mix of payments processed by Clearing Houses and payments processed for not centrally cleared trades would reconcile with Internal Payment Confirmation system. Similarly the data from external trade repositories will not match 100 % with the firms golden copy of the trade. This is because due to various CCP models the trades are reported to Trade Repositories by the Clearing Houses either on net basis or on gross basis.
But the partial interaction between the internal and external systems and processes is more complex to identify. This involves analyzing the complete reconciliation process and managing the exceptions. For example – A mix of payments processed by Clearing Houses and payments processed for not centrally cleared trades would reconcile with Internal Payment Confirmation system. Similarly the data from external trade repositories will not match 100 % with the firms golden copy of the trade. This is because due to various CCP models the trades are reported to Trade Repositories by the Clearing Houses either on net basis or on gross basis.
- Most firms are at a matured stage in reconciling electronically confirmed trades with records from electronic confirmation platform on a regular basis. Firms should maintain a uniform set of trade workflow status terminology and rules to match with confirmation platforms and integrate the manually confirmed trade records with it.
- Due to absence of industry wide payment affirmation and confirmation platform for otc trades, the payment reconciliation process is designed specific to a firm. Settlement of a payment without a dispute is considered a reconciled payment.
- The establishment of multiple repositories for each product class increases the pressure on the reconciliation process. Availability of standardized data leads to automation in reconciliation process. Validation rules to extract the correct set of data and identification of the cut off time to send / receive the trade population for reconciliation can be automated.
- With the emergence of two distinct set of clearing models 1) Futures style Model and 2) Keep it as OTC Trade, the update to trade repository is done on net basis in the first model and on gross basis in second model. The buy side firms should establish new reconciliation process and identify what data they would receive from the clearing members.
Challenges in External Reconciliation
TAccording to Darren Measures, Clearance & Collateral Management Sales Head for JP Morgan "A single gateway or a service provider to interact with the external entities for reconciliation helps to achieve optimization in reconciliation process. Customization of a reconciliation framework to suit the requirements of multiple set of clients becomes easy without losing the benefits of scale and efficiency."
Firms challenge is to optimize the existing reconciliation process and to identify the interaction point of Internal with External reconciliation across five different business processing areas – Trade Confirmation, Payment Confirmation, Trade Repositories, Clearing House and Collateral Management.
A complete set of hundred percent of data reconciliation is required where the external platforms are aligned with internal systems fully. With the central clearing now a reality, reconciling a complete set of clearing house data with the internal golden copy is an addition to the complete set.
Multiple data format would be received from external sources for the same product type. Reverse engineering logic would help to match the external data format with the internal records.
A cost benefit approach towards reconciliation process would justify the reconciliation process .The cost and time involved to prepare the required population of data for reconciliation is highest in the reconciliation process.
The process of agreeing on the attributes for each variety of products and for a function among parties is a time consuming process. Providing incorrect data for external reconciliation would create more breaks.
Exception Processing
Exception processing and identification of threshold limits for each reconciliation process goes hand in hand. To achieve a robust workflow with audit trail in the exception processing is a challenging task because there is no standard solution to resolve a reconciliation break each time. If the tolerances levels are close and tight, there will be an increase in the number of exceptions. But at the same time having loose tolerances level defeats the purpose of using reconciliation as a tool for counter risk management.
Outsourcing and Reconciliation
The increase in the reconciliation cycles brings operational and infrastructure challenges. Firms have outsourced the reconciliation in back office and middle office to specialized agencies like asset servicing or use the services of industry wide platforms to connect with the counter parties. An upsurge in outsourcing the back office related work is a natural start to outsourcing. It is critical that while outsourcing, the remaining processes are not disturbed and the internal service level agreements are still met. The cost benefit analysis in the short term to outsource processes may seem attractive. But the challenge is to sustain the level of benefits in processes optimization in the long run.
Conclusion
Increasing the frequency of reconciliation process consumes more firms' resources. Firms thrive to invest for an integrated reconciliation approach to reconcile trade details and exposure internally within the firm and with external entities across all otc asset class.
Availability of centralized electronic platform for Trade Confirmation, Payment Confirmation and Collateral Management together with the existence of Trade Repositories and Clearing House's, would bring more automation to the reconciliation process. There is a continuous search for a reconciliation platform which can be extended across geographies, business divisions and asset classes. An integrated reconciliation and exception Processing platform should have the following features
- Identify key parameters for each product
- Common static data
- Control rules for reconciliation at the first step
- Setting up the reconciliation process cycle
- Provide early warning signals of the breaks
- Control the impact of the breaks on the downstream processing
- Identify the workflow for exception processing
- Dash Board for reporting
- Client level position reconciliation
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
