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New Execution and Clearing Models Bring Value and Savings to the Asset Management Industry New

New Execution and Clearing Models Bring Value and Savings to the Asset Management Industry

New post-trade processes, designed originally for intermediaries, now offer asset managers the opportunity to streamline their operations, reduce risk and make major savings.

The investment industry has made huge strides in the last 30 years. Electronic trading, taking securities trading to screen-based systems, the development of the global custody model, regulatory changes — these have all transformed the industry.

Despite much progress, one key problem remains: the post-trade world has not kept pace with advances in trading infrastructures and investment practices, which are more international and more diversified than ever.

There is still significant work to do, and this is no easy task given the economic environment, the regulators’ omnipresence and the scarcity of resources. But, at the same time, the need to be more efficient gives us the opportunity to improve internal middle- and back-office processes, which so far have been low on the priority list. Here lies the difference — the secret of efficiency and competitiveness.

New practices bring value and cost savings The idea of a client sending an electronic order that is routed across lit and dark pools, filled, confirmed, allocated and sent for settlement within a day is a goal for all STP enthusiasts. The reality is that handling a single order from end to end is possible — at a cost.

Think about a four-jet engine airplane. In normal operation, each engine is only running at 25% capacity. This is because the plane will need to continue flying if any of the other three engines fail. This analogy shows the challenge of building the right infrastructure and associated support and operating platform for an end-to-end execution and settlement service. The platform must handle peaks and troughs without disruption but it must also be cost-effective.

In our quest for efficiency, we would like to introduce two new models that allow a reduction in cost, workload and operational risk.

Broker turnaround trade processing Many intermediaries use executing brokers to access foreign markets. By doing so, they save on the connectivity and membership costs of exchanges and MTFs. How the intermediary accesses the market and how it processes the instructions, including the clearing and settlement, has an impact on the total fee the client — whether retail, private bank or institutional — will have to pay.

Today, two models are being used by intermediaries to ensure the securities purchased get to their clients:

turnaround settlement and third-party settlement.

2

Deliver 50

Deliver 50

Below are a series of worked examples that use fictional firms to depict the various models in use by the market.

Turnaround settlement Take the case of a Spanish broker, called Iberian Securities. The broker is trading with Citi Global Markets in the US on behalf of Madrid Pension Managers and Barcelona Pension Managers. Iberian places an order to buy 100,000 Microsoft. The shares are purchased by Citi on the exchange and settle in an account belonging to Citi (acting as intermediary), which immediately forwards the securities to Iberian’s custodian. Then Iberian sends settlement instructions to its custodian to allocate 50,000 directly with Madrid Pension Managers’ custodian and 50,000 with Barcelona Pension Managers’ custodian. Here the cost of settlement and processing, together with the management of the positions, sits with Iberian Securities.

Turnaround settlement

Iberica Valores

BUY 100.000 Microsoft
BUY 100.000
Microsoft

Citi Global Markets

CONF 100 Microsoft
CONF 100
Microsoft

Custodio CGM

Instructions to deliver 50 to MPM and deliver 50 to BPM

Custodian Iberica Valores
Custodian Iberica Valores

Custodian

Iberica Valores

50 to MPM and deliver 50 to BPM Custodian Iberica Valores Madrid Barcelona pension pension manager
50 to MPM and deliver 50 to BPM Custodian Iberica Valores Madrid Barcelona pension pension manager
Madrid Barcelona pension pension manager manager Initial flow
Madrid
Barcelona
pension
pension
manager
manager
Initial flow

Consecutive actionsBarcelona pension pension manager manager Initial flow Deliver 100 Turnaround settlement implies: • Instructing

Deliver 100

Turnaround settlement implies:

• Instructing onward delivery settlement and managing processing.

• Cost of onward deliveries on both sides (market settlement).

• Operational risk and cost of reconciliation.

Third-party settlement Another method of settlement consists in further streamlining the operational process. In this case, Iberian places an order to buy 100,000 Microsoft. These are purchased by Citi on the exchange. Iberian then advises Citi to settle 50,000 directly with Madrid Pension Managers’ custodian and 50,000 with Barcelona Pension Managers’ custodian. The broker never settles across Iberian’s accounts but with the underlying clients.

This solution reduces the number of settlement instructions and therefore the operational costs and risks.

Institutions generally pay a premium on their commission for intermediaries to support third-party settlement as there is additional work that the executing broker, in this case Citi, has to perform. There is of course additional risk. As the recipient of the shares is not the actual trading counterparty to the original trade, there is built-in complexity should any settlement errors occur.

Third-party settlement

Iberica Valores Instruct to BUY 100.000 Microsoft Instructions to deliver 50 to MPM and deliver
Iberica Valores
Instruct to BUY
100.000 Microsoft
Instructions to
deliver 50 to
MPM and deliver
50
to BPM
Citi Global Markets
CONF 100
Instructions to
deliver 50 to
Microsoft
MPM and deliver
50
to BPM
Custodio CGM
Third-party settlement implies:
Deliver 50
• Simplification compared to
Turnaround Settlement.
Custodian
Custodian
Madrid
Barcelona
• Separeate instructions of onward
delivery orders still required.
pension
pension
manager
manager
Deliver 50

Initial flowrequired. pension pension manager manager Deliver 50 Consecutive actions Automated third-party settlement In

Consecutive actionspension pension manager manager Deliver 50 Initial flow Automated third-party settlement In order to further reduce

Automated third-party settlement In order to further reduce the costs and the complexity, a new automated model is being delivered by some custodians, including Citi. In this model, Iberian will provide specific instructions in its order placed with Citi (via a FIX Protocol tag), indicating the onward delivery details (50,000 to Madrid and 50,000 to Barcelona). These will be used by the custodian to create settlement instructions automatically once the order is completed. This allows the client to use open architecture standards to advise the custodian of the onward deliveries without the broker having to pay a premium to the executing broker or alternatively invest in infrastructure to manage settlement instruction creation and management.

Not only does Iberian Securities benefit from eradicating its internal settlement instruction process and technology, but all the settlement instructions are sent within seconds of the execution (supporting T+2 settlement), while the static data for commissions, market fees and standing settlement instructions are hosted and maintained by the custodian. Iberian also benefits from the latent scale of the custodian’s technical platform, smoothing out the effects of high- and low- volume processing needs.

3

Automated third-party settlement

Iberica Valores Instruct to BUY 100.000 Microsoft with instruction to onwards deliver of 50 to
Iberica Valores
Instruct to BUY 100.000 Microsoft with
instruction to onwards deliver of 50 to
MPM and 50 to BPM
Citi Global Markets
CONF 100
Microsoft
Custodio CGM
Automated third-party
settlement implies:
Custodian
Custodian
• Simplification compared to
turnaround settlement.
Madrid
Barcelona
pension
pension
• No need for separate
instructions of onward delivery
orders as they are included in
the initial trade order.
manager
manager
Deliver 50
Deliver 50

Initial flowtrade order. manager manager Deliver 50 Deliver 50 Consecutive actions Solutions for the asset management

Consecutive actionsmanager manager Deliver 50 Deliver 50 Initial flow Solutions for the asset management industry Allocation

Solutions for the asset management industry

Allocation processing What asset managers need is a service that caters for both their in-house flows (where they choose the custodian and broker) and their third-party mandates (where the client chooses the custodian and sometimes brokers for research).

Take the example of an institutional asset manager called Iberian Asset Management, which provides asset management services for a number of its own funds and for pension plans). It will typically have a set of portfolio models that it executes across a number of clients. The underlying pension plan or fund will have its own custodian relationships that will have to be used by asset manager.

In a similar trade to the one mentioned above, Iberian buys 100,000 Microsoft from Citi in the US. Citi executes the order and advises Iberian of the fill. As Iberian’s trades are always configured to be allocated, Citi expects to receive an allocation instruction for the shares. Currently this is generally performed through Omgeo and the services it offers. However, if Iberian sends the order and the allocation via FIX to Citi’s Order Trade Manager (OTM), Citi will match the confirmation and allocation, and create the corresponding settlement instructions to settle against the underlying funds. This process eliminates the cost of Omgeo and also eliminates the need for settlement instruction issuance and management, resulting in productivity gains and cost reduction.

The next step will be for the allocation instruction to form part of the order so that the entire process is automated and processed continuously.

Streamlining the post-trade process So far, asset managers have been using a relatively complex post-trade structure, having little choice and limited options for improving the efficiency of the process. This is set to change.

The integrated execution-to-custody (E2C) model that Citi has been proposing to the broker–dealer and private bank communities for some years now offers major advantages to the asset management community. This is a model that combines Citi’s brokerage capabilities with its clearing and settlement expertise. E2C automates the post-trade process. By automatically creating the settlement instructions, it reduces settlement costs and operational risks.

Some asset managers are already enjoying a simplified version of E2C where their service provider acts as an intermediary broker in the chain, distributing the trades to underlying brokers. However, the idea with E2C is to reduce the number of intermediaries to a minimum, including at the brokerage level, by directly using Citi’s brokerage structure. Up the chain, the brokerage service can be complemented with research services; down the chain, with integrated clearing and settlement.

E2C is an end-to-end service that offers huge pluses for asset managers. It provides access to alternative trading platforms (MTFs), offering best execution, and the ability to connect to all the relevant clearing houses (CCPs), thereby allowing cross-margining. It offers the most efficient settlement services globally, thanks to Citi’s proprietary network of subcustodians in more than 60 countries. And finally it incorporates the turnaround function, automated third-party settlement and allocation services mentioned above.

Thanks to the allocation and automated third-party settlement functions, asset managers can enjoy this streamlined process and receive the securities directly in their account with the corresponding depository. Reallocation becomes a thing of the past.

As is apparent from the broker–dealer world, there is a strong first-mover advantage here. The post-trade process is becoming an increasing focus of attention and an area where efficiency can really make a difference. A less efficient post- trade process is a cost to the fund and it will affect its ranking.

At Citi, we understand that operations are now a crucial element of competitiveness. The combination of services within E2C presents a major advance for the asset management industry, allowing asset managers to benefit from the same efficiencies many broker–dealers and private banks already enjoy.

With our long-standing involvement in every stage of the securities trade cycle, the breadth of our client base and our commitment to continuous investment, we are well placed to push the boundaries of what is possible in the post-trade world and replace complexity with simplicity wherever possible.

AM industry: Current model

   

Asset manager

 
 

Intermediary broker

 
     
 
     
 
     
 

Broker 1

Broker 2

 

Broker 3

Broker 4

       
 
       
 
       
 
       
 

Clearer

Clearer

 

Clearer

Clearer

broker 1

broker 2

broker 3

broker 4

       
 
       
 
       
 
       
 
 

AM global custodian

 
 

Allocations — market settlement

 
 
   
 
   

Depository

 

Depository

 

fund 1

fund 2

Sometimes used Streamlining the process for AM Asset manager EC2 Primary MTFs exchanges Citi Global
Sometimes used
Streamlining the process for AM
Asset manager
EC2
Primary
MTFs
exchanges
Citi Global Markets
Alternative
CCP
CCP
CCP
brokers
Access to 96 markets,
of which idrect access
to CSD in 60+ markets
Citi as Custodian
Depository
Depository
fund 1
fund 2

More information

Edward Duff E2C Sales EMEA +44 (0) 207 500 1146 edward.duff@citi.com

Eugene O'Herlihy E2C Sales EMEA 44 (0) 207 986 0752 eugene.oherlihy@citi.com

Nigel Solkhon E2C Product EMEA +44 (0) 207 508 9215

nigel.solkhon@citi.com

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