4th FTF Conference on Reconciliation and Exception Processing

On Sept 30, 2009, at the 4th annual FTF Conference on Reconciliation and Exception Processing, industry leaders came together in New York to take on some of the toughest issues involved in managing reconciliation and exception processing operations. Participants included financial institutions like PIMCO, JP Morgan, Citigroup and BNY Mellon, as well as technical vendors and strategists like Capco, Headstrong, Sungard and Omgeo.

Headstrong was represented in the conference by Vinod Jain, Business Specialist, Derivatives Domain Practice. Vinod was a member of the panel discussing Tri-Party Reconciliation of OTC Derivatives and Collateral. Other key members in this panel included Cynthia Meyn, Senior Vice President, PIMCO and Jack Dixon, Director, Derivatives at Omgeo. While conference speakers were able to isolate many key topics and discuss several implementation strategies in reconciliation and exception processing, tri-party reconciliation was clearly one of the thornier issues that may not see industry consensus for some time.

Headstrong reports from the scene with an outline of some of the salient issues taken up during the exposition in general, and related to tri-party reconciliation in particular:

Coping with higher reconciliation volumes

As speakers noted, the credit crisis has put pressure on financial firms to reconcile transactions more frequently, without paying more for reconciliation activities. This involves a high-stakes technical and process assessment, including what systems should be used, where to perform reconciliations, which unit of the company would do the reconciliations and how reconciliations should be done. Technical platforms and services from vendors like Omgeo, Headstrong, Acadiasoft, CLS, CME, Markit and Trioptima are just a few technologies that can potentially keep reconciliation costs low, speakers said.

Automating account reconciliation

Automating account reconciliation is beginning to make sense, with vendors beginning to offer more options for solving the problem. For example, technology supplier SmartStream is now offering both an in-house application for reconciliation and a hosted solution designed to lower the cost of the reconciliation process. Hosted solutions like these might appeal to firms that want to avoid bringing reconciliation technology in-house, as one hedge fund at the conference noted.

On the other hand, existing products designed to do the job often target subsets of the market or fail to address certain technical problems, according to speakers at a session on this topic. For example, vendor Triana is strong in the FX market, but has stayed away from the CDS niche. Another issue is that there's currently no application on the market that can do account level reconciliations for a client - i.e. offer cross-asset reconciliation in a single report. This is where solution-providers like Headstrong come in - a combination of deep domain knowledge fused with technical expertise can present options for custom-built solutions.

Reducing risk in exception processing

Automation may be part of the solution to addressing reconciliation and exception handling, but there's also some tough calls firms will have to make, according to speakers. Setting strict rules for when inconsistencies need to be reconciled can lead to chaos if the tolerance for breaks is too minor.

This was problem that Wells Fargo faced when it dropped its tolerance dramatically, one speaker noted. When the bank pushed tolerances down to much lower levels, the volume of breaks jumped so quickly that it had to restore the previous level almost immediately to make the issue manageable again. And as speakers pointed out, even banks which stick with a relatively high tolerance level for breaks might still run into big problems when the market has a particularly volatile day.

While some of these issues are likely to linger, one way to impose more control is to keep a correct set of reference data on hand, speakers said. Even so, there's still no system to keep track of the history of trades that were reconciled, they noted.

Tri-party OTC derivative reconciliations still a problem

Perhaps the most difficult issue conference members took on was how the industry will manage to roll out tri-party reconciliation. While asset managers would like to increase the frequency of reconciliation with dealers, dealers seem reluctant to give data to the custodian. Meanwhile, there are currently no standards for formatting the data, with some going to brokers in PDF format without including account numbers, and other times, in unspecified data formats including .csv, .xls and others. Meanwhile, sometimes the parties can't even agree as to basics such as whether data will flow across an FTP connection, via e-mail or other method.

Given these wrinkles, it can be very hard for a dealer to tell whether the custodian taking part in this trio is actually providing service to the asset manager. After all, there's no one stop where all parties involved can get the data they need, speakers noted.

Reconciling OTC derivatives and collateral

Given that market volumes are still low, however, this is a good time for firms to fix existing problems with handling reconciliation and collateralizations, so they are ready when volumes pick up. While there are systems that currently do reconciliation and exception processing, firms need an early alert mechanism to handle breaks better.

As things stand, 30 percent of trades aren't collateralized, according to a survey by the International Swaps and Derivatives Association. Given these conditions, it's not much of a surprise that there still isn't an electronic messaging communication framework to exchange margin calls, collateral substitution and interest payment information efficiently with counterparties. The ISDA team is working on this, but it's not clear when the framework will be ready for review, conference members noted.

To manage the full trade life cycle, firms need to have a robust system internally to identify each record and correctly capture what the trader is doing with each trade. Eventually, a collateral management system will need to be able to define and capture the processing rules of the tri-party agreement within the system. Capturing the rules of tri-party agreement will be one of the biggest issues to address, speakers noted.

For more information contact : product.management@headstrong.com