Contents:

I. WHAT IS S.W.I.F.T.'S ROLE IN REDUCING RISK?

A. Introduction
B. History
C. Purpose
D. Strategy

II. WHAT DOES S.W.I.F.T. PROVIDE?

A. Standards
B. Network
C. Network Compatible Terminals (Interface Devices)
D. Value Added Applications

III. WHAT PROCESSING RISKS DO INVESTMENT MANAGERS FACE?

A.Securities Settlement Risk
B. Cash Settlement Risk, Including FX
C. Asset Servicing Risk
D.Preparation For Future Processing Changes

IV. WHAT IS THE INDUSTRY DOING TO REDUCE RISK?

A.Industry Standards
B. Industry Initiatives

V. HOW CAN INVESTMENT MANAGERS REDUCE RISK?

A.Techniques to Reduce Risk
B. Using S.W.I.F.T. to Reduce Risk

VI. SUMMARY

A. What Are The Benefits Of Using S.W.I.F.T.?
B. Conclusion

Using S.W.I.F.T. to Reduce Risk

The securities industry is undergoing extensive and rapid change in order to take advantage of emerging investment opportunities; and the processing of the transactions that result from the volume and complexity of these investments is becoming increasingly expensive and difficult to control. To manage this increased processing risk while controlling costs the procedures and tools that are available to processors are undergoing a rapid evolution as well.

Vendors and infrastructure entities are all looking to provide solutions that will position themselves to survive and succeed as the markets change. Almost every day we see mergers, new products and new initiatives that can affect how firms will process trades in the next few years. Cedel and Euroclear are extending their services, DTC has created TradeSuite, Thomson is enhancing ALERT and OASYS, and standards such as FIX and S.W.I.F.T. continue to improve and expand.

While there are many different ways to reduce processing risk and control costs, this White Paper specifically describes how investment managers can use the S.W.I.F.T. message standards, S.W.I.F.T. network, and S.W.I.F.T. vendors to reduce processing risk in the securities industry.

I. WHAT IS S.W.I.F.T.'S ROLE IN REDUCING RISK?

A. Introduction

S.W.I.F.T. (the Society for Worldwide Interbank Financial Telecommunication) provides financial data communication and processing services to support the business activities of worldwide financial institutions for securities, payments, foreign exchange and money markets, as well as trade finance. Its dedicated telecommunications network guarantees the rapid, cost-effective, secure and reliable transmission of financial data using a range of ISO-compliant standardized messages that have been developed by S.W.I.F.T. in conjunction with its users and industry organizations.

Originally designed to eliminate the need for paper-based processes in the financial markets, S.W.I.F.T. has also lowered costs, increased productivity and helped reduce risk in the securities industry by providing several of the key elements necessary for the automation of the settlement process, and by providing a reliable and secure network.

B. History

S.W.I.F.T. began operations in May 1977, to help banks electronically move large numbers of fund transfers among themselves in a secure and efficient manner. When brokers were admitted in 1987, the members created and began using the Category 5 (CAT 5) message standards to structure settlement instructions, confirmations and safekeeping information for securities transactions.

As of January 1999, over 6,500 institutions use S.W.I.F.T. to communicate with each other 24 hours a day. S.W.I.F.T. operates in 178 countries and processes over 935 million messages each year, with an average daily message volume of over 3.9 million messages, and an average daily transaction value of US$2.5 trillion for payments messages, and an estimated $4 trillion for securities messages.

Owned by nearly 3,000 of its user banks, S.W.I.F.T. also connects other categories of non-bank financial institutions engaged in the securities industry, including:

• Securities broker/dealers
• Investment managers
• Securities exchanges
• Central domestic securities depositories and clearing organizations
• Central cross-border securities depositories and clearing organizations such as Cedel and Euroclear
• Trust Companies and Fiduciary Service Providers
• Custody and Nominee Services Providers
• Registrars
• Transfer Agents
• Investment managers were granted full participant privileges at the June 1992, S.W.I.F.T. Annual General Meeting in Brussels. As participants, investment managers have the right to use the S.W.I.F.T. standards, access the S.W.I.F.T. network, and indirectly participate in setting the future direction of S.W.I.F.T.
• Securities Electronic Trade Confirmation (ETC) Service Providers, a new category of participants, were allowed to join the S.W.I.F.T. network as of June 1996.

C. Purpose

S.W.I.F.T. plays an important role in increasing the efficiency of the international financial markets. In addition to its worldwide telecommunication network and the increasing number of message standards for financial instruments, S.W.I.F.T. offers software and network-compatible interfaces, as well as several applications that can be used with the network to reduce costs and risk.

The central organization establishes numerous user committees to refine the standards, and holds a conference (SIBOS) for its members each autumn to review what has been accomplished and to set the priorities for the following year.

Allowing investment managers to become participants was a critical step in extending the use of the S.W.I.F.T. securities standards (and potentially the S.W.I.F.T. network) beyond banks and brokers. This expansion of S.W.I.F.T.'s role is significant for individual investment managers, as well as for the entire securities industry.

There has been a significant growth in the use of the S.W.I.F.T. CAT 5 series of messages since they were introduced. While all of the banks and brokers have not yet established a full electronic S.W.I.F.T. connection for securities, almost all can send and receive some of the S.W.I.F.T. CAT 5 message types. As of February 1999, nearly 724,000 CAT 5 messages flowed over the S.W.I.F.T. network each day, out of the total network traffic of 3.9 million messages.

Due to the industry's trend toward message standardization and automated, electronic counterparty connectivity, securities messages have represented S.W.I.F.T.'s fastest-growing market segment for the last four years and again in 1998 and early 1999 (+ 43%). Over 4,000 banks, broker/dealers and investment management firms sent nearly 150 million securities messages through the S.W.I.F.T. network in 1998, accounting for 16% of the total network message traffic. In 1999, as shown in Figure 1, securities traffic is again expected to grow by over 40% to nearly 210 million messages.

For most of this decade, the securities industry has been shifting away from the use of free-format messages in favor of specific settlement, reporting and custody-related messages. The use of formatted messages, which are encrypted, validated and authenticated by S.W.I.F.T. as part of a firm's overall message routing process, leads to more efficient and reliable communication between parties. Increased back office automation using the standard will result in fewer errors and investigations, and more timely reconciliation.

D. Strategy

S.W.I.F.T.'s current strategy is to position itself to support all aspects of the securities processing value chain (Figure 2), from issuance to issue servicing, by extending the scope of its message standards. This puts S.W.I.F.T. potentially into competition with other service organizations such as the DTC and with vendors such as Thomson and other application vendors.

To avoid direct competition and to serve the industry in as many ways as possible, S.W.I.F.T. has elected to move away from developing applications. Instead, S.W.I.F.T. has shifted its focus toward cooperating with industry organizations and vendors; and is working to connect its network to these organizations whenever possible.

As S.W.I.F.T. began supporting securities firms several years ago, it concentrated on adding new broker and investment manager users to the network. More recently, while continuing to add new users, the emphasis has shifted to helping existing participants use S.W.I.F.T. more effectively. To do this, S.W.I.F.T. has/is:

• Decreased its emphasis on developing and distributing proprietary software
• Increased is emphasis on working with application vendors
• Established a process to measure and report each participant's traffic (Traffic Watch)
• Established a process to measure and report on each participant's STP rates when using S.W.I.F.T. (STP Watch)
• Implementing a new TCP/IP based network that will allow real-time transmission of certain categories of messages

II. WHAT DOES S.W.I.F.T. PROVIDE?

S.W.I.F.T. offers its members a set of standards, a modern telecommunications network, network compatible terminals/interfaces, some software based services and increasingly relies upon third party application providers to deliver value-added products to the industry. Firms can use the standards for free and decide if they want to use the network and the applications provided by S.W.I.F.T.'s vendor partners.

A. Standards

As one of the primary organizations creating international standards for financial services firms, S.W.I.F.T. works closely with ISO (International Standards Organization), ISSA (International Society of Securities Administrators), ISITC (Industry Standardization for Institutional Trade Confirmation), FIBV (Federation Internationale des Bourses), and FIX to support and enhance the S.W.I.F.T. CAT 5 series of securities message types.

There are ten major categories of S.W.I.F.T. messages that support all of the processing activities of S.W.I.F.T.'s members:

Securities firms can use these messages for transactions involving securities, cash, and foreign exchange.

The S.W.I.F.T. ISO Securities Messages that are listed below cover the complete life cycle of a securities transaction, from trading to settlement, including custody and reporting. The messages that support securities processing are in the S.W.I.F.T. CAT 5 series, which consists of eight general groups. These groups cover all facets of securities processing, from trading to settlement and safekeeping. The eight groups are:

• General Messages
• Trade Orders and Confirmations
• Securities Lending and Borrowing
• Settlement Instructions and Confirmations
• Corporate Actions
• Capital and Income
• Inter-depository and Clearing Institutions
• Statements

S.W.I.F.T. has released new versions of the securities message formats over the course of the past three years, and the entire life cycle of the securities transaction (with the exception of the pre-trade Indications of Interest phase) can now be standardized with one or more of these new ISO 15022-compatible messages.

For instance, new Trade Order and Confirmation messages were implemented on the S.W.I.F.T. network in November 1995. The November, 1996 Standards Release brought a new third-party foreign exchange confirmation message and additional changes to the Swaps message standards. In 1998, new securities settlement, reconciliation and corporate events messages were released onto the network under the ISO 15022 Data Dictionary umbrella

B. Network

S.W.I.F.T. has two networks that are used by its participants: The standard network and a forthcoming TCP/IP network.

1. Standard Network

The S.W.I.F.T. network uses a protocol, called X.25, that sends information in discrete units called packets (separate packages of information) and functions over leased or dial-up lines. Packet switching networks such as this are designed to ensure accurate transmission of messages and files over lines of differing telecommunication quality such as are found in many emerging countries. S.W.I.F.T. also supports messages and file transfers through the use of a "Store and Forward" standard, called CCITT X.400.

Messages and file transactions are processed by S.W.I.F.T. immediately, with automatic verification and authentication. If the sender and the receiver are both connected on-line, a message transfer typically takes less than 20 seconds, even for cross-border message transfers.

By automating the sending and receiving of messages, firms can obtain significant productivity gains that will enhance their profitability and processing controls. S.W.I.F.T.'s "black box" architecture gives each firm a simple way to connect to each other through the network, and a consistent methodology for interfacing with their own applications.

S.W.I.F.T. provides a financial guarantee for the delivery of all messages sent over its network. There is a full audit trail, and the system is available 24 hours a day, 7 days a week.

This current process is most effective for operationally oriented messages that are not time sensitive in today's settlement environment. However, as the worldwide settlement cycles continue to be shortened to reduce risk, and as the trade processing activities increasingly require connectivity to the front office's systems, S.W.I.F.T. has developed an interactive, real-time network to support this new level of message traffic.

2. TCP/IP Network

S.W.I.F.T. is currently building a Next Generation, TCP/IP-based communications network that will permit real-time, interactive services that will be used to facilitate S.W.I.F.T.'s role in a variety of global market infrastructure projects, including:

• CLS (Continuous Linked Settlement) in the Foreign Exchange marke
• Bolero in the Trade Finance market
• GSTPA (Global Straight Through Processing Association) in the Securities market

The Next Generation project is being designed and developed in three phases, as follows:

Phase I - Basic interactive services (CLS)

This Phase is driven by S.W.I.F.T.'s users' functional and timing requirements for CLS. Phase I includes a secure IP network covering 500 endpoints in 30 countries, and is scheduled for completion by 2002. The major features are:

• Basic interactive services and interfaces to support CLS and other market infrastructures
• Basic bank-to-bank interactive services
• A new Alliance Lite (browser-based) interface
• PKI (Public Key Infrastructure) Security

Phase II - Advanced interactive messaging (GSTPA)

This phase will support true intelligent interactivity such as that which is required by the GSTPA securities transaction monitor. The network will be extended to 2,500 endpoints in 50 countries and S.W.I.F.T. will be able to offer interactive real-time messaging, including validation and translation. Lite and Gateway (high-volume) interfaces will be upgraded. Phase II will incorporate comprehensive service level monitoring. Central applications will include support for the GSTPA functionality.

Phase III - FIN replication and migration (NG FIN)

In this phase, the network will grow to 10,000 endpoints in all countries on the S.W.I.F.T. network. NG FIN will be released and the migration from Current Generation FIN (CG FIN) to NG FIN will commence.

NG can be visualized as a collection of three technical layers woven together by a common architecture and common services for naming and addressing, security, and service management. The Phases will be developed in the context of these layers:

• Layer 1 - Secure IP Network
• Layer 2 - Information Transfer Layer which include:
• Interactive messages
• Store and forward messaging
• Interfaces
• Message processing such as validation, copy, translation and transformation
• PKI infrastructure
• Layer 3 - Central applications that can be written and/or operated by S.W.I.F.T., or by third parties such as market infrastructures or vendors

C. Network Compatible Terminals (Interface Devices)

S.W.I.F.T. has developed and supported several different platforms over the years, and is now implementing its latest generation of software for PC-based and UNIX-based applications. These products provide electronic interfaces to the network, and make it possible for participants to have a fully automated system.

The Interface Devices that are available from S.W.I.F.T. to connect users to the S.W.I.F.T. network are called S.W.I.F.T.Alliance. This is S.W.I.F.T.'s newest interface product line, which consists of the UNIX-based Alliance Access and the Windows/NT-based Alliance Entry products.

1. Alliance Access

Alliance Access provides multi-network connectivity, focusing on S.W.I.F.T., fax, telex, as well as national clearing system and private networks. Alliance Access provides user-configurable security and is scaleable to accommodate a full spectrum of message volume needs.

It uses a Motif-compliant graphical user interface (GUI) which can be easily learned by users experienced with Windows or Mac software. Alliance Access fully supports S.W.I.F.T.'s USE (User Security Enhancement) software and hardware that provide the foundation for Secure Login and Select (SLS) and Bilateral Key Exchange (BKE).

Alliance Access is based on Open Systems Architecture, and runs today on the following hardware platforms:

• IBM RS/6000
• Sun Sparc
• Digital Alpha AXP
• Bull DPX/20,

2. Alliance Entry

Alliance Entry is S.W.I.F.T.'s entry-level interface and is targeted at institutions that are new to S.W.I.F.T. or that have relatively low message volumes of up to about 1,000 messages per day.

Alliance Entry runs on standard personal computers running Windows/NT, and the hardware and software are priced to minimize capital and operating costs. The product can either be purchased on a license basis or rented on a monthly basis so that the participant does not have to make an up-front investment.

D. Value Added Applications

While S.W.I.F.T. has reduced its emphasis on developing proprietary software, there are a few products that are only available directly from S.W.I.F.T., and there also are many applications available from third-party vendors.

1. S.W.I.F.T. Products

There are a limited number of software applications that are available directly from S.W.I.F.T., including:

PC Connect

Users can install this product on a single PC or on a LAN, and connect to any S.W.I.F.T. interface device through a floppy disk or with a direct communications link. It allows users to have a central S.W.I.F.T. connection and distribute their messages over a LAN.

Accord - Financial Trading Matching and Netting

Accord is S.W.I.F.T.'s service for the matching and, where appropriate, bilateral netting of financial transactions. When a deal involving one of the financial trading instruments shown below has been struck between two counterparties, both parties confirm by sending the appropriate MT3xx message via S.W.I.F.T.:

• MT300 - Foreign exchange confirmation
• MT320 - Fixed loan/deposit confirmation
• MT324 - Liquidation notice for fixed loan/deposit
• MT330 - Call/notice loan/deposit confirmation
• MT340 - Forward rate agreement confirmation
• MT341 - Forward rate agreement settlement confirmation
• MT392 - Request for cancellation

If at least one of the deal counterparties is an Accord subscriber, S.W.I.F.T. copies the confirmation messages to the Accord central matching system. Accord then validates the integrity of the message contents (including valid value dates for each currency) and attempts to match it with a counterparty confirmation, based on the message type involved.

Confirmations are classified as Matched if their contents follow the matching criteria specified in Accord. Confirmations are classified as Mis-Matched if they almost, but not quite, match. All confirmations for which corresponding confirmations cannot be found are classified as Un-Matched.

Accord's reporting facilities enable reports to be generated up to several times per day based on the type of match in order for users to react to problems associated with Mis-Matched and Un-Matched confirmations during normal business hours.

A PC-based software package, called AccordWorkstation, provides powerful search facilities to help focus on priority exceptions and problems highlighted by the Accord central matching system. Work queues for all Matched, Un-Matched and Mis-Matched confirmations, in addition to a summary screen, are presented to Accord users in Windows-based facilities. The AccordWorkstation also provides for local archiving of all confirmation data.

Interbank File Transfer (IFT)

The IFT product supplements the message-based transfer products by allowing users to transfer information that is not in S.W.I.F.T. message format, such as business reports, spreadsheets, documents, correspondence, bulk data, etc. This service can replace the use of other networks, or automate a flow of paper from point to point.

The complete IFT service consists of the network and its software, and the IFT application. The IFT service is a store and forward file transfer process that is based upon X.400 standards and the Pift file transfer protocol.

The only restriction is that the maximum file size is 2 megabytes, which is approximately 500 pages of text.

SSI/FX Directory

The SSI/FX Directory allows users to issue and maintain lists of foreign exchange standing settlement instructions (SSIs) in an authenticated and processable format with other counterparties. S.W.I.F.T.'s SSI/FX Directory was launched in July 1997.

Traffic Watch

Traffic Watch was developed by S.W.I.F.T. to help participants manage their network traffic. Users of this service can see the details of all of the messages sent or received by BIC code, counter-party, country and message type. This information helps firms identify opportunities to reduce or re-route traffic to control telecommunications expenses.

STP Watch

During 1997, S.W.I.F.T. developed a prototype of a new Straight Through Processing (STP) analysis application. The new tool produces management reports that help the user understand the quality of the messages they send and receive so they can take corrective action where necessary. By increasing their level of STP users should be able to improve automation, increase operational efficiency and reduce costs.

2. Software from other vendors

Software that is compatible with S.W.I.F.T.'s message standards and data network is also available from over 300 third-party providers. Network Interfacing, Middleware, Message Processing, Financial Applications, and Reconcilement represent only a few of the different types of "S.W.I.F.T.-enabled" applications available from third-party software providers. A complete list is available from S.W.I.F.T., which has a vendor-marketing group dedicated to increasing the number of software packages that can electronically send or receive S.W.I.F.T. messages.

S.W.I.F.T.'s Partner Solutions group co-operates with application vendors in three categories under the SWIFTReady accreditation program. This accreditation process assesses the compatibility of vendor products and services with S.W.I.F.T. solutions. Depending on the degree of compatibility, products are awarded gold and sliver labels. S.W.I.F.T. also accredits service providers based on their ability to guarantee certain service levels and knowledge of S.W.I.F.T.

The key strategy for Partner Solutions is to influence the development plans of the partner products by assigning SWIFTReady labels according to an objective public set of criteria. Products satisfying relevant criteria are given either a SWIFTReady SILVER label or a SWIFTReady GOLD Label.

There are different criteria according to the market and positioning of the product, which relate only to S.W.I.F.T.'s services, products and message standards. S.W.I.F.T.'s Partner Solutions group does not attempt to qualify the quality or fitness for purpose of any product; however, S.W.I.F.T. does require a minimum of five installed client sites in any of the following areas before any label can be assigned:

• S.W.I.F.T. Interface Connectivity
• Support of S.W.I.F.T. Value-Added Services
• Support of S.W.I.F.T. Operational Information Services and Straight Through Processing guidelines
• Support and automation of S.W.I.F.T. Message Standards

The three Partner Solutions relationship/accreditation categories are:

S.W.I.F.T. Ready Gold

This represents the highest level of accreditation for third-party vendors by Partner Solutions. The Gold label indicates the highest level of full compliance and proactive implementation of new Standards and Services.

S.W.I.F.T. Ready Silver

The Silver label conveys a level of S.W.I.F.T.-compliance that gives the customer a sufficient business solution in a S.W.I.F.T. environment.

S.W.I.F.T. Accredited Professionals

There is a separate but parallel initiative within Partner Solutions to promote and support those external vendors who provide consulting, systems integration and training services to S.W.I.F.T. members.

Any vendor is eligible to apply for the label 'Provider of Accredited Services' if they offer services that in some way support the use of S.W.I.F.T. and which are not directly connected to promotion of their own application.

The intention is to build up a database of all the S.W.I.F.T. experts worldwide together with a history of all their projects. The Partner Solutions' Directory contains details on those vendors who have already been accredited as Providers.

The S.W.I.F.T. Accredited Services program is only applicable for vendors who:

• Offer consulting, systems integration, or project management services which are not related to their own product offering

• Offer a range of services and expertise which are complementary or can add a value to S.W.I.F.T.'s own product related and service-related offerings, and with a scope that extends beyond S.W.I.F.T.'s own service offerings

Vendors will be entitled to use the Label 'Provider of S.W.I.F.T. Accredited Services' if they employ at least two individuals that successfully satisfy the Partner Solutions requirements and are validated and registered with S.W.I.F.T. for this service program. The number of staff who can become registered with S.W.I.F.T. is subject to the type, variety, geography and size of the projects undertaken by the company.

III. WHAT PROCESSING RISKS DO INVESTMENT MANAGERS FACE?

There are several categories of risks facing investment managers today that can be generally grouped as either investment risks or processing risks. The categories of investment risks include Issuer Risk and various market-related risks, including:

• Interest Rate
• Price
• Currency
• Liquidity
• Country/Sovereign

This White Paper focuses on the category of processing risks, which can be initiated by trading and post-trade errors, and which we have divided into the following four categories:

• Securities Settlement Risk
• Cash Settlement Risk, including FX
• Asset Servicing Risk
• Preparation for future changes in processing requirements

Each of these four categories of risk is discussed in the following sections:

A. Securities Settlement Risk

Securities settlement risk is basically the risk that a counterparty will be unable to meet their contractual performance obligations and settle on time; and,

• that they will either never be able to meet their obligation because of a bankruptcy, or
• they will delay their performance and the market will have moved negatively during the delay causing a loss

This category of risk, as well as the categories that follow, is based upon several different potential processing risks, as shown in the following chart:

In general, processing risk is caused by two factors:

• Late, incomplete or missing instructions cause errors. The purpose of STP is to automate the movement of critical information between the appropriate participants from the trade to settlement, thereby improving accuracy and timeliness.
• The length of the time between the trade and the final settlement of the trade increases the chance of default. Regulators worldwide are pushing for a shorter settlement cycle, including T+1 in the US, in order to reduce the time that trading partners are exposed to this risk.

Clearing and settling securities transactions safely, efficiently and cost-effectively across national borders involves several additional areas of potential risk and attention, including:

• Time zone differences
• Technological mismatches
• Procedural differences
• Legal and regulatory restrictions
• Lack of confidence in existing utilities
• Diversity of standards in operational procedures, systems and communications media

The risks associated with these complex and multi-party trades have increased as domestic and cross-border volumes have grown rapidly throughout the 1990's. This rate of growth will vary in intensity over the next few years, but it is anticipated to continue at a high level, and the cost of a fail will remain high.

1. What is the Impact of a Fail?

Investment managers throughout the securities industry continue to communicate a significant portion of their transactions manually. Telephone calls and facsimile transmissions to custodian banks are still common methods of post-trade instruction, especially with cross-border transactions. As a result, the potential for error and delayed transactions remains unacceptably high.

There are two types of failed transactions, each with potential financial risk to the investment manager:

Buy Fail

When a buy trade is executed (the purchase of securities against cash payments), the investment manager makes cash available for the settlement of the transaction. The cash remains un-invested, sitting in a liquid position, until the securities are received. In the event of a fail (the securities are not received on the contracted settlement date), the investment manager has not earned additional income for a cash position that would have been otherwise invested.

Implications of a Failed Buy Trade

Example: A purchase of $25,000,000 U.S. Treasury Notes (6.0% 6/15/02) with a net due of $24,100,000

If the institution does not instruct the bank regarding this transaction, one of the following scenarios will occur:

• When the broker attempts to deliver the security to the bank, it will be DK'd. The broker expecting to receive these funds will now have a negative balance on their books. This claim will be passed on to the institution for its negligence.
• When the custodian bank does not recognize the trade, they will call the institution to inquire if it is a good trade. When the institution recognizes its error, it can:
• ask the bank to accept the security and agree to honor their claim for the overdraft, or
• if time allows, choose to sell a security to cover the overdraft. However, depending on the market conditions, this may not be prudent.

If the bank is at fault in accepting the security, it is their responsibility to honor the claim from the broker.

At a Fed Funds rate of 5.95%, this transaction would have the following costs.

• One Day $ 3,983.19
• Over the weekend (3 days) 11,949.58
• Over a holiday weekend (4 days) 15,932.77

Sell Fail

When a sell trade is executed (sale of securities against cash payment), the investment manager immediately invests the anticipated proceeds from the transaction. In the event of a fail (the securities are not delivered, and therefore payment is not received on the contracted settlement date) the investment manager will have overdrawn its account by instructing the investment of unavailable funds. Further, with no entitlement to the income from the sold securities, the investment manager does not have any earning potential on either the cash or the securities until the transaction is settled.

Implications of a Failed Sell Trade

Example: Sale of $10,000,000 in T-bills for a net due of $9,980,000

Anticipating proper settlement of this trade, these funds will be invested by the institution. If the trade fails, the fail will create a bank overdraft for the institution's and the bank's mutual client.

If this trade does not settle properly, it will cost the institution, the custodian or the broker.

• If the institution is negligent in instructing the bank about the trade, it is their responsibility to compensate the bank.
• If the bank is negligent in acting on the instructions they received, they will have to credit the client and absorb the overdraft.
• If the broker fails to accept delivery of the security after they have been properly instructed, it is their responsibility to compensate the bank/client for the overdraft.

At a Fed Funds rate of 5.95%, this transaction would have the following costs.

• One Day $1,649.47
• Over the weekend (3 days) 4,948.42
• Over a holiday weekend (4 days) 6,597.88

In addition to the interest cost, a fail of a domestic equity for more than three days could create the risk of a "buy-in." The money difference between the original trade and the "buy-in" could be substantial, depending on market conditions, and the party responsible for the fail would have to absorb this cost.

Fails of foreign trades have the additional exposure of an FX transaction where the FX rate can also change over the period of the delay.

For each failed transaction, the investment manager and custodian bank expend resources to research and determine the source of the error, and ultimately identify the party responsible for the fail. Lost income is claimed from the responsible party, but everyone incurs the costs of the investigation process.

2. Growing Global Market

In 1993, global cross-border investment in equities exceeded $150 billion and tripled to almost $500 billion by 1997. Currency and interest-rate volatility is likely to continue increasing the growth rate of investments in the underlying securities as well as in the related derivative instruments.

The growth of cross-border investment has resulted in significant processing problems, particularly in the areas of trade confirmation matching, settlement and reconciliation. Approximately 10% of all cross-border trades failed in 1995, which resulted in losses of over $110 million annually on a global basis.

There are several reasons for these fail rates. The typical trade confirmation and settlement process differs greatly from market to market and is burdened by the overwhelming use of paper-based communication involving fax, telex and mail. In addition, differences in languages, time zones and securities numbering systems, as well as market volatility, all increase the risks and costs associated with settlement.

3. Current Global Environment

Cross border purchases and sales of securities are either presented to a local broker or directly to a broker in the country of investment. If the order is presented to a local broker, that broker either has an office in the country of investment or has a relationship with a broker in that market. Today, there isn't any standard way to transmit this information from broker to broker.

When the trade has been executed, the executing broker must notify the customer through any intermediaries that were involved. At each point in this process, the trade is compared to the order so that any discrepancies can be identified as early in the process as possible. Various local markets have proprietary methods and systems for completing this comparison.

Clearance between the brokers involved in the street-side of the trade is dependent upon local clearing mechanisms; however, clearance between the brokers involved in the customer side of the trade across borders also requires international brokers, global custodians or International Central Securities Depositories, such as Cedel and Euroclear.

The actual settlement of the trade in the local market is also a local concern, and is based upon local market practices; however, the settlement of the customer side of a cross-border transaction requires the participation of a cross border agent such as an international broker, global custodian or International Central Securities Depository, such as Cedel and Euroclear.

Most investment managers do not have electronic direct access to the Central Securities Depositories outside of their home country, if at all. These managers currently rely on the large global custody banks, local custody banks, or international brokers/dealers and contact these agents by phone, fax telex or proprietary network.

Efficient cross border settlement with a minimum of risk requires appropriate standards in:

• Communications
• Services
• Technology

Effective implementation of these standards will require the industry to initially focus on processing steps where the existing infrastructures will not have to be replaced. One cross-border processing area where there is an existing automation gap is for the trade capture and comparison functions, and the industry could benefit from a cross-border multicurrency system similar to the DTC's ID system that could provide these functions.

4. Cross-Border Settlement Risks

According to many of the studies conducted by the industry, the current processes for cross-borders trades are inefficient and error-prone because of several generic factors. The process is:

• Insufficiently automated,
• Insufficiently inter-connected
• Overly complex
• Generally too slow to respond adequately to business concerns

These deficiencies are based upon several current processing characteristics, including:

• Insufficient use of the automated solutions that do exist in the trade and post-trade processes which support managers, dealers and custodians
• Lack of integration of the few existing automated steps
• Some critical steps occur late in the process, including the calculation of fees and commissions that leads to the determination of net cash amounts by the broker and the acceptance of these amounts by the investment manager
• Settlement instructions are generally provided separately to the global custodian and the broker by the investment manager, often through standing settlement instructions

When the investment manager sends the information through different mechanisms, the two sets of instructions do not always match, and these differences delay settlement.

• Communications regarding fails do not go directly between the parties identifying the problem and the parties with the required information

• For instance, local settlement agents notify the broker and global custodian of fails, and the global custodian must notify the investment manager that has to work with the broker to resolve the problem.

Each transaction generates multiple messages that are only linked to each other with difficulty, and therefore the exact status of a specific trade is often difficult to determine prior to settlement Communications between the broker and the clearing agent, along with those between the global custodian and the sub-custodian, do benefit from substantial automation through the use of S.W.I.F.T.

5. Improving the Global Process

The global settlement process is improving as countries evolve towards the G30 recommendations and as vendors identify niche opportunities, but the high level of fails still results in increased risk and increased costs for all of the participants in the worldwide securities market.

The systems most financial institutions have in place today for handling cross-border securities transfers are often merely the automated forms of the historically manual procedures. It is clear that there is a need to re-think and to re-design the business processes for payments and securities messaging in order to achieve improvements in costs, service quality and efficiency.

This re-engineering of the end-to-end value chain process (involving investment institutions, broker/dealers, banks and market infrastructure) is long overdue if securities processing is to accommodate the growing range of legal, regulatory and operational requirements worldwide. S.W.I.F.T. played a critical role in the automation of payments during the 1980s and early 1990s, and is now looking beyond securities message standards towards participating in the automation of all the parties in the processing value chain.

The industry must avoid developing fragmented standards in order to develop a single seamless processing flow. This streamlined flow will not only reduce processing costs, but will help firms manage all of their risks more effectively. In addition to standards for processing messages, the standards should support basic market practices, such as message types for securities numbering, as well as the need to identify financial institutions and provide dates, currency codes and certificate numbers.

To support this, industry advisory groups such as the G30, ISSA (International Society of Securities Administrators), FIBV (Fédération Internationale des Bourses de Valeurs), ISITC (Industry Standardization for Institutional Trade Confirmation), and IOSCO (International Organization of Securities Commissions), all recommend the creation of electronic trade comparison and settlement systems and standardized means of communicating transaction information.

In Chapter IV of this White Paper, several of the industry initiatives to solve these problems are presented.

The risks associated with cash settlement are similar to those for securities settlement, with the complicating factor of foreign exchange. The issues of the risk associated with foreign exchange have been examined more closely in recent years by the bank for International Settlements, which has issued a report entitled Settlement Risk in Foreign Exchange Transactions (RISE). This report recommended that the problem be addressed in three parts:

• Individual banks
• Industry groups
• Central banks

Since the report identified that FX settlement can take between one to four business days, the settlement risk for individual firms can be huge. To control this risk, the report suggested that firms continue to improve their back-office processing, as well as strengthen their correspondent banking arrangements, netting capabilities and risk management controls.

The report also recommended that the private sector could provide services to assist individual banks to improve their credit procedures, and industry groups could work with vendors to develop multi-currency services the could help reduce systemic risk.

The report encouraged firms to adopt the best practices that were identified in the report, which include:

Limit FX exposures by controlling the restrictive cancellation deadlines for payments instructions Reduce time that is required to identify receipts of the final and/or failed payments by improving their internal back-office and reconciliation processes and improve their correspondent services

One of the reasons the FX market has improved to its current level is because of its use of S.W.I.F.T.'s message standards and the use of the network, which has provided the following benefits:

• Automated message delivery
• Quick and efficient transmission of trade confirmations and settlement instructions
• Third-party confirmation matching systems identify trades that are potential problems

The RISE report specifically encouraged banks to use standing settlement instructions (SSIs) and to limit the cancellation deadline to no more than two hours before the opening of the corresponding clearing system.

The report recognized that the S.W.I.F.T. MTx92 messages could be used, and emphasized that the firms should limit the use of bi-lateral agreements for specific code words, and suggested that all codes be multi-lateral. The recommendations also suggest that firms reduce the amount of time currently used by nostro banks to identify receipts for final or failed payments. The report suggests that all credit advice messages should be sent within 10 minutes of receipt of the credit from CHIPS, Fedwire or other clearing systems.

The report proposes that the suggestions become best practices and incorporated into all agreement with correspondent banks with the objective that banks not following the recommendation will be at a competitive disadvantage.

S.W.I.F.T. has been supporting financial institutions' processing of Foreign Exchange and Money Market transactions far longer than it has supported securities processing. This broad experience has resulted in significant worldwide usage of the CAT 3 series of message types.

Figure 5 shows that over 115 million Forex and Money Market messages are sent over the S.W.I.F.T. network each year, which comprises approximately 44% of the world's volume.

Once the purchase of an instrument has been successfully settled, the on-going activities of asset servicing begin. These activities include:

• Income Collection
• Corporate Actions
• Pricing
• Accounting
• Reporting

These activities require the delivery of accurate and timely information to the investment manager, bank and broker. A Market Data Vendor usually provides this information. Once the information is received, it must be processed correctly.

1. Market Data Vendors

There are several vendors that provide information for specific types of instruments and geographies. At this time, there is no one vendor that provides everything and each vendor has strengths and weaknesses.

The Summit Group, through its subsidiary Securities Operations Forum, publishes the results of an annual survey of the customers of these vendors. The survey identifies how the customers using market data services perceive the vendors' accuracy, completeness and timeliness of data. To review the latest survey on-line (for no charge), visit SOF's web-site at www.soforum.com.

2. Processing

There are two types of applications that are necessary to correctly process these transactions.

Security Master File

Firms around the world are increasingly establishing a central security master file that is accessible by all of their applications, and while some firms have created proprietary applications, there are vendor solutions available.

Processing Applications

Each category of activity for income and corporate actions has its own specific application, but most of these applications go through the same sequence of actions:

Event Notification

Banks, brokers and investment managers are normally notified of an event by their market data vendors through an automated interface, which is usually provided overnight, in batch.

Entitlement Determination

The firm must process this information against their position files to see which accounts are likely to be affected, based upon the positions and the record date for the event.

Notice of the amount due to the account, record date and payment date will be placed in the firm's pending file until the payment date is reached.

Event Posting

When the execution (payment) date is reached, the firm's system will automatically make the necessary entries to each account.

Reconcilement

However, there are many reasons why the amount received or the shares on hand are not exactly what the firm's system thinks the position is. In this case, the firm must reconcile their position and investigate any differences.

Other processing applications handle accounting, pricing and reporting. All of these functions involve the timely receipt and accurate processing of information about specific securities.

The risks to the investment manager for asset servicing include:

• The manager's records differ from their custodian's records and an incorrect action was taken
• A voluntary corporate action event occurred and the manager (or client) was not informed in a timely manner

In this case the custodian usually is at fault and the manager can be reimbursed. However, if the custodian can show that the manager was notified and the manager did not reply in time, the manager would have to absorb any loss.

• Information for Mutual Funds that arrives too late to be included in the daily NAV calculation can cause problems for a fund when customers subscribe and/or redeem at a value that is subsequently determined to be incorrect
• Accounts that are held for ERISA clients must be completely and accurately priced, and the accounting impact must be correctly reported in the period in which it occurred

These risks can be avoided if the manager runs a complete shadow record keeping system and reconciles routinely with their custodian.

Markets around the world will continue to contract the settlement cycle in order to reduce the risks that are associated with settlement delays, and investment managers will have to constantly modify their systems to be in compliance with these changes.

Managers can wait until the final transition date has been set, or they can use every enhancement or system replacement activity as an opportunity to prepare for T+1 (or potentially T+0). Since the exact processing methodology has not be established for any country, firms should not automatically modify their systems, but they can begin to prepare for the inevitable connectivity requirements, and can consider establishing Middleware to aid in establishing a flexible connectivity environment.

The Summit Group also conducts an annual survey of the leading Middleware vendors and the results of the latest survey are published on the TSG website, TSGC.com.

IV. WHAT IS THE INDUSTRY DOING TO REDUCE RISK?

Firms in the securities industry have reacted to the trends facing the securities processing marketplace by establishing associations such as ISITC and FIX, which concentrate on improving standards and procedures, and developing industry initiatives that define long term goals as well as an evolutionary path towards these goals.

There are two major standards that are increasingly used by securities firms around the world.

1. ISITC (Industry Standardization for Institutional Trade Confirmation)

The ISITC standard for communicating post-trade instructions between investment managers and Custodian banks is based upon the S.W.I.F.T. conventions, and it is network independent. The members of ISITC focus primarily on the post-trade messages that move between managers and custodians, and are continuously improving S.W.I.F.T.'s message standards in these areas.

2. FIX

Several investment managers and brokers have joined together to develop a standard for pre-trade and trade related information communications between managers and brokers, which is called FIX (Financial Information Exchange). The FIX protocol/standard includes:

3. Indications of Interest

4. Orders and Order Allocation

5. Fills

After a slow start, this initiative is gathering momentum, and is being adopted by many of the vendors that provide pre-trade and trading system.

Periodically, industry leaders mutually identify common problems and then work together to identify solutions that will benefit the overall industry, as well as their own firms.

1. G30 Recommendations (1989)

One of the most important initiatives in the last fifteen years was the Group of Thirty which defined nine recommendations that, while not yet universally implemented, have significantly improved efficiency and reduced worldwide processing risk. The nine recommendations that were presented in 1989 were:

1. By 1990, all trade comparisons should be accomplished by T + 1
2. By 1992, all indirect participants should join a trade comparison system
3. By 1992, each country should have a central securities depository
4. By 1992, each country should consider and install a netting system
5. By 1992, all settlements should be DVP
6. All settlements should be made with Same Day Funds
7. By 1992, settlements should be based on a rolling date and finalized by T+ 3
8. By 1990, all barriers to Securities Lending should be removed
9. By 1990, each country should adopt ISO standards

The US is now substantially in compliance with the G30 recommendations; however, many other countries are still working towards these goals with different rates of progress on the different recommendations.

Since then, there have been several additional initiatives to improve US and cross-border processing.

2. Industry User Group (1992)

The Industry User Group was formed in the UK in the early 1990's to improve the level of electronic communication between investment managers and brokers since the group felt that automating trade-related communications between brokers and fund managers via ETC was essential to achieving Straight Through Processing (STP). When this group began working together, ETC applications did not have specific data field formats for delivery instructions and relied either on free-format text fields to communicate information or a vendor's internal standard. The group concluded that a common set of standard settlement instructions (SSI) was necessary and that vendors would have to commit to using the standards.

The group defined the standards within a framework they called the Inter-Vendor Link (IVL), and asked vendors to agree to support them. The vendors that agreed were then "selected" as service providers.

Delivery Instructions

The IUG defined several sets of data:

Business Data

The group stated that trade allocations and confirmations must contain information that adequately describes the nature, direction, size and value of the trade, identify the broker, institution and client, and include relevant business data, such as:

• The (Agent) parties to the settlement
  • Settlement Agent or Custodian
  • Agent Bank, for cash (if different from the Settlement Agent)
• Account numbers for securities and cash
• The settlement (clearing) method and type (e.g. against payment)
• Clearing system member and/or identification numbers, where required

SSI Data

In addition, since some firms will want to automatically process trades based upon the settlement information in the message, the IUG identified several specific requirements, including:

• An indicator flag is required to identify when the settlement is to be based on SSI
• To accommodate instances where more than a single SSI may be applicable in a market, a unique SSI identification number is required
• A validation date is required to establish that the SSI to be used by the recipient of a message is current
• The delivery and standard instruction data items to be transmitted within the free format text fields of an ETC message need to be enclosed within delimiters (an envelope) to distinguish them from any other data within those fields" Data Identification

The IUG realized that until the messages could be completely structured, they would have to use each vendor's available free-form fields along with specific tags that would identify the data related to that tag.

3. The Euroclear Report (1993)

The Euroclear Report identified a number of existing industry-wide problems that need to be overcome, including:

Frictional Costs

The report defined frictional costs as those incremental costs that exist over the life cycle of a securities transaction which reduce the benefits of the transaction itself. This includes the:

• Regulatory burden that limits innovation because of overlapping and conflicting regulations in a cross-border environment
• Costs of local custody services such as tax reclaims, corporate actions and income collection

The settlement pipeline is the time between the positioning of cash or securities for settlement, and the time when the new securities or cash positions are available to the participant for redeployment. Pipeline liquidity risks are those risks that are associated with delays in a settlement pipeline due to gaps in the time between processing cycles.

Legal risks are the risks that are derived from the inconsistent and sometimes ambiguous national laws that can be applied to cross-border securities transactions.

Various groups have proposed numerous ways to solve the growing cross border settlement problem that faces the securities industry. The report identified the major strengths and weaknesses of several of these cross border settlement models, including:

The Multiple Access Model allows market participants to settle their transactions by accessing any one of several channels: local securities depositories, local custodians, ICSDs, global custodians and other market participants.

This model is complex and requires extensive use of message and processing standards; however, it uses the basic infrastructure that is already in place, and it is flexible, adaptable and allows competition.

Worldclear is identified as the most radical model since it assumes the establishment of a new single global securities depository that would safekeep, clear and settle every security in the world.

While this could be very cost effective once in operation, it would require massive cooperation from the major countries, which would run the risk of losing control over the process once Worldclear was established. And, it will be very expensive to establish while requiring each country to write-off their existing investments in infrastructure.

The Global Hub Model proposes that a single point be established that will connect all existing depositories. Each local depository would continue to perform safekeeping, clearing and settlement for local securities. When the depository received a cross border transaction, they would route the message to the appropriate end-point and insert themselves into the settlement process.

The Global CPU Model proposes that a single data center be established that would run the activities of the existing depositories in each country. This would allow each existing depository to continue performing their current functions, but would simplify the transfer of cross border information.

This model assumes that each depository will establish bilateral links with every other depository in the world. This model is the natural end point for the current evolution of the industry in the absence of any unified decision making. In other words, this is what we are likely to end up with if nothing is done.

The report concluded by saying that:

"Investments in the more radical structures of international settlement would not be an efficient means of reducing the significant costs and risks of cross-border settlement, in the near or medium term. Instead, completing the modernization of the local infrastructure as recommended by the Group of Thirty, together with implementing the recommendations contained in the Euroclear report, would be far more effective for the following reasons:

• The costs and risks associated with basic custody services can be reduced by encouraging Central Securities Depositories (CSD's) to develop the capacity to provide them to custodians
• The regulation of cross-border clearance, settlement and custody by CSDs should reflect the fact that only wholesale market participants use their services for cross-border transactions
• Investments in clearance and settlement infrastructure beyond those recommended by the Group of Thirty should be cost-justified"

4. Vision 2000 (1994)

In 1994, the Boards of NSCC and DTC formed a committee to study how the US could "eradicate inefficiencies, maximize the use of technology, eliminate redundancies and reduce costs" in the US. While most of the recommendations were specific for the US domestic market, some of the recommendations had implications for cross border activity.

Four of the categories of findings were specific to the US, and while they provide benefits to the industry as a whole, they do not specifically help investment managers reduce risk:

1. Certificate Immobilization
2. Certificate Elimination
3. Cross Collateralization
4. Common Industry Utilities and Structures

Findings Affecting Cross-Border Activity

The fifth category of recommendations concerned cross border, non-US dollar activity.

• The study felt that the G30's recommendation on settlement ("A Rolling Settlement system should be adopted by all markets. Final settlement should occur by T+3") was critical to the success of the industry and the report emphasized that countries should continue to strive for this goals.
• The report said that ISCC, S.W.I.F.T. and other industry groups in the G7 countries should work to enforce global messaging standards. It recommended that "a board of industry experts from these countries should be convened to act as advisors to the many emerging markets' stock exchanges and depositories. The SIA should then enlist the aid of the New York Federal Reserve bank to work with other central banks to enforce the standards in their respective countries."
• The report also encouraged the "SIA, PSA, and other key industry associations [to] work with S.W.I.F.T., the ISCC, CUSIP and other vendors and utilities to develop common methods of securities identification and description and standard global message formats for securities activities across national borders."
• An important recommendation was that "in parallel with the efforts described above, the same organizations should form a Working Group to define the critical design features of a global trade capture and comparison system." This recommendation led to the establishment of the GSTPA, which is described later in this section.
• The report became more specific by recommending that "Institutional investors as well as brokers and dealers should implement stronger internal controls to ensure that accurate settlement instructions and security descriptions are relayed to settlement agents the first time around."

The basic intent of the Vision 2000 report was finally realized in March 1999, when the directors of the DTC and the NSCC announced that they would merge into a new organization.

5. IOA/ISITC White Paper (1997)

The IOA/ISITC White Paper was developed as a joint effort by the two organizations, building upon their relative strengths in brokerage (International Operations Association) and investment management (ISITC). The goal of this effort was to review what solutions were currently available and to recommend actions that could be taken in the short-term.

This paper defined Straight-through Processing (STP) as "an uninterrupted transmission from the point of trading in one country, through a chain of intermediaries (possibly in several other countries), down to the last entity ultimately involved in the settlement process (the local market depository) - and back. " The group felt that ETC is "an integral part of this process and is critical to all parties for several reasons:

• Tremendous cost reduction potential for all parties involved in the settlement cycle
• Reduction of fails
• Acceleration of settlement cycles (and therefore reduction of risk)"

The Working Party focused only on cross-border equity transactions since the US markets already had an effective ETC process based upon the NSCC/DTC - ID system, and in the cross-border markets the highest transaction volumes consist of equities.

The working paper defined three categories of vendors that are important to ETC:

Network Provider

S.W.I.F.T., is the only network provider that was identified, and the report stressed the value of the 51x messages, which include:

Message Message Name Sent by: 513 Client Advice of Execution Sent by the executing party (e.g. broker/dealer) to the instructing party (e.g. money manager). Equivalent to a notice of execution (NOE). 514 Trade Allocation Instruction Sent by the instructing party to the executing party. 515 Client Confirmation of Purchase or Sale Sent by the executing party to the instructing party. 517 Trade Confirmation Affirmation Sent by the instructing party to the executing party to positively accept the executing party's confirmation. 528 ETC Client-Side Settlement Instruction For use by an ETC Provider to send settlement instructions to the client's custodian. 529 ETC Market-Side Settlement Instruction For use by an ETC Provider to send settlement instructions to the broker's agent.

Figure 6. CAT 51x Message Descriptions

Electronic Trade Confirmation (ETC) Providers

At the time this report was issued, there were five vendors that met the IUG's requirements to be an ETC provider.

• Bloomberg
• CrossMar
• DTC/ IDC
• ISMA/TRAX
• Thomson Financial - OASYS Global and SEQUAL

Connectivity Facilitators

Connectivity Facilitators specialize in supplying software applications (Middleware) that can be used to connect the participants to a financial transaction. The Middleware providers that were identified in this report were:

• 110 LTD
• Braid (Which has since been acquired by TSI)
• NEON (Which has since acquired VIE)

Affirmation And Matching

The Working Party stated that, "However ideal a concept, a centralized matching facility for cross-border transactions is not a likely development -- at least for the foreseeable future. Such development would indeed require universal consensus to build a central, global utility that would need to operate either with rigid rules that every cross-border market operator in the world would obey, or it would have the capability of managing multiple bilateral sets of rules."

The Working Party did feel that the process step of affirming or matching trade confirmations in the cross-border market is critical since it establishes the binding contract between the parties to the trade.

At the time of this report, settlement instructions were only maintained at the investment management firm, by the custodian bank, or within Thomson's Alert system. However, the DTC's service, the Standing Instruction Database (SID) service was just being released by the DTC, and S.W.I.F.T. was considering building a settlement instruction database.

The Working Group concluded that while a single central settlement instruction database could be the ideal solution, it would be very difficult to implement due to conflicting interests. The group recommended that the industry move to an environment where the instructions could be maintained in any one of several databases, and still be accessible using a standard protocol.

The Working Group believed that the number of data elements provided by the investment manager and broker/dealer for the matching/affirmation process should "be kept to an absolute minimum -- the basic trade data should be enriched with settlement details extracted from settlement instructions databases."

The Working Group felt that while progress had been made in implementing common standards, they still remained incomplete for two reasons:

• Existing standards allow a loose interpretation since they provide for multiple options, which make STP difficult
• Standards must support and be consistently adhered to by a diverse group of users which includes small and large firms, single country and cross-border investors, single instrument and multi-instrument investors, as well as the type of firm (bank, broker, managers, etc.)

Recommendations

The Working Group made several recommendations:

Single Group of Standard Codes

"The industry would benefit immensely from the use of common standards for identifying securities, counter-parties and currencies. We also recommend BIC codes for counter-parties and ISO for currencies."

The Industry Should Encourage Multiple ETC Providers

"The industry should see the emergence of several ETC providers as a healthy development [and while they may] compete in commercial terms, ... they must co-operate [by] bringing forward-looking STP solutions that will benefit the market at large."

Multiple Settlement Instruction Databases

"The industry should tolerate multiple settlement instruction databases: some will be centralized, and others decentralized and residing with the custodians and brokers. Access to all databases should be via a standard message protocol, to enrich the transaction with the necessary data. The Working Party encourages S.W.I.F.T. to complete a development in this direction as promptly as possible."

Trades Should Be Matched or Affirmed

"ETC Providers should be allowed to offer facilities that match confirmations with allocations. An independent process should match trades wherever possible. Trades should be affirmed if matching is not possible."

Block Notification to Custodians

"Blocking of all allocations by custodians will result in some added complexity but substantial cost saving to the industry. The Working Party supports research into this concept."

Standard Message Formats for ETC

"The S.W.I.F.T. ETC message formats should form the standard for communication among all parties."

Message Standards Need Review

"Message standards should be reviewed in order to eliminate instances that [discourage] Straight Through Processing."

Custodians Should Assist Investment Managers Implement ETC

"Where investment managers use a third party ETC provider, custodians are encouraged to offer them a way to capture their trade activities, process their allocations, and link them to their ETC provider."

Summary

This joint IOA/ISITC Working Group concluded "ETC, as the primary component of STP, is absolutely essential for the securities industry to evolve from its current fragmented efforts, to an efficient set of interconnected information processors.

"STP will revolutionize trade processing and settlements, and the march towards it will become unstoppable. Therefore, all steps to promote and achieve STP need to be encouraged, and unified toward a common objective. ... the industry needs to agree upon interchangeable alternative ways to direct trades through the various steps that assist the various parties involved in their respective processing roles, regardless of the service provider(s) that these parties may choose to use."

6. IDC White Paper

The IDC White Paper looked at the need for STP from a different perspective and identified a number of problems in the industry today. This study identified the problems from two perspectives. From the viewpoint of the Broker/Dealer and the Investment Manager, the problems are:

• Managing cross border order flow
• Coordinating the multiple parties involved
• Orchestrating intermediaries
• Manual element in directed commission business
• Origination and executing occurring in different places

The paper also identified a number of problems that exist from the Custodian's point of view:

• Incomplete messages
• Incorrect Standing Instructions
• Varied of communication methodologies
• Existence and interpretation of different standards
• Disparate proprietary systems
• Untimely instructions

To develop a strategy, the White Paper also identified several trends that it felt were necessary to define a solution, including:

• Use of the Internet and Intranets
• Increased distributed processing
• More comprehensive and specialized regulatory reporting required immediacy in communications
• Shorter settlement cycles and high volumes across borders

And, the paper identified a number of specific concerns that had to be considered if the recommendations were to succeed:

• Different practices in different countries
• Different tolerances for error between markets
• Time schedule constraints between countries
• Coordination of cash and security movement
• Effect of uncertainty in cash projection

7. Reducing Interbank Settlement Exposure (RISE, 1996)

In March 1996, the Committee on Payment and Settlement Systems (CPSS) of the Central banks of the Group of Ten countries issued a BIS report entitled Settlement Risk in Foreign Exchange Transactions, and called upon banks to resolve these issues within two years. Building upon several earlier reports, the G-10 report describes how individual and central banks can improve how they deal with FX risk, and how industry associations can help.

The report stated that "a small Working Group was formed with representatives from major US foreign exchange banks and S.W.I.F.T. to agree on Terms of Reference and to draft a straw-man as a framework for the basic requirements for improvements of Cancellation and Reconciliation recommendations." The draft was completed and reviewed in the various banks, and potential changes were reviewed throughout the first quarter 98.

S.W.I.F.T.'s initial role has been to "co-ordinate, facilitate, act as the catalyst, assist the group(s) of banks in setting the criteria and recommendations for the potential Service Level agreements [since] S.W.I.F.T. is the neutral, preferred and trusted third party and the leading carrier of FX related transactions in the world.

In September 1996 S.W.I.F.T. produced a response to the G-10 Report in the form of a brochure called Today's Solutions to Tackling Forex Settlement Risk - Call to Action. Promotion of FX risk reduction actions and initiatives is part of S.W.I.F.T.'s Foreign Exchange and Money Market strategy."

The recommendations that were produced were based upon the fact that FX is competitive, complex and rapidly changing as a result of EMU and services such as Continuous Linked Settlement. Since the legal and liability issues are different in each country, the global approach needs local implementation.

While the recommendations were essentially the result of US-based activity, the sub-committee issued these recommendations to start the process, and the guidelines are intended for use worldwide to reduce common risks. The recommendation centered around the:

• Cancellation and reconciliation practices
• Use of the Standing Settlement Instructions
• Use of S.W.I.F.T. message types

8. DTC TradeSuite (1998)

In 1997, The Summit Group assisted DTC in evaluating the need for several processing alternatives, which resulted in a new series of DTC products to support Straight Through Processing, called TradeSuite.

TradeSuite was built upon DTC's Institutional Delivery (ID) system, Standing Instructions Database (SID) and the DTC Hub, which, according to the DTC "currently deliver over 2 million post-trade and settlement messages daily to more than 10,000 institutional investors, broker/dealers and custodian banks."

TradeSuite consists of four products that provide a single point of access for global post-trade communications between counterparties. The product supports FIX, S.W.I.F.T. and DTC formats, and uses TCP/IP, SNA or x.25 protocols. The four products are:

TradeMessage automates the exchange of post-trade messages between brokers, custodians and institutions, including block trade notices of execution, allocations, trade confirmations and affirmations.

TradeMatch automates the comparison of investment managers' allocations with brokers' trade confirmations, enabling early trade agreement or identification of potential exceptions, while triggering settlement messaging for matched trades without the need for separate affirmations.

TradeSettle provides accurate, automated settlement processing by electronically enriching allocations, trade confirmations and settlement messages with account and settlement data from DTC's Standing Instructions Database (SID), and then routing settlement instructions to custodian banks and brokers' clearing agents. DTC trades settle automatically.

TradeHub provides real-time global communications services. Open architecture facilitates connectivity to other leading global networks and order management, portfolio management and ETC systems.

Also according to DTC, "TradeSuite has been designed to support users' global post-trade messaging and settlement processing operations through the continuing evolution of the industry's post-trade STP model. TradeSuite provides a platform for users to meet the challenges presented by a greatly increased volume of cross-border trades and a further shortening of the settlement cycle."

9. Global Straight Through Processing Association (1998)

The GSTPA was organized to "promote the efficient electronic flow of cross-borders trade information on trade date from the point-of-trade to all parties involved in post-trade activities, in a cost-effective and secure manner."

To meet this goal, the group looked at all of the interactions between the participants in the trade and settlement process. Since the communications between the broker/dealer and the clearing agent, and those between the global custodian and the subcustodians are already largely automated, the GSTPA decided to concentrate focus on the communications between the broker/dealer, the investment manager and the global custodian.

The GSTPA recommendation is based on the following principles, as quoted from the GSTPA's report:

• "Multilateral inter-connectivity is the backbone of the solution, linking all parties to a transaction at the earliest possible time in the trade life cycle
• A transaction will be progressively enriched and followed-through during its entire life cycle, rather than dealt with one message at a time
• Matching of the net cash amounts that must enrich the allocation will be preferred to a confirmation/affirmation process
• Global custodians and broker/