Executing a trade is simply one step in a chain of activities. Actions are engaged pre-trade, as the trade occurs, and post-trade. Commonly, the latter is often overlooked as post-trade activities and processes are mission-critical components of successful trade execution. Once a trade has been executed, the counterparties must match details, green light the transaction, change ownership records, and make arrangements for the exchange of cash and securities. If reconciliation, clearing, and settlement do not go smoothly, trades will fail and a failed trade is not only financial risk but a reputational risk as well. In over-the-counter markets that are not standardized, the matching process is even more critical.
Reconciliation needed at every level
Markets move fast and trades transpire at lightning speed. Even the best traders make mistakes, and small mistakes can spawn huge liabilities, particularly when firms engage in high frequency, computer-based trading. For both large firms with high trading volumes and smaller operations with lighter trading activity, counterparties and clients expect the process to be error-free.
For firms with complex needs, reconciliation is the foundation of the trade flow and information gathering process. Large companies with multiple trading desks have even more sophisticated needs. Not only must they reconcile individual trades, but they need to gather intelligence that will help understand the performance of each trading desk. Hedge funds using average pricing determine cost basis as part of the reconciliation process, while commodity firms and energy utilities use reconciliations to manage the analysis of physical inventory.
Operational Due Diligence ups the ante on Trade Matching importance
Trade affirmation and reconciliation have been an important consideration in operational due diligence since the ’90s. But today, matching has assumed significantly greater importance in the due diligence process and is considered a critical component in any due diligence study.
In the past, auditors, investors, and regulators typically gave reconciliation short shrift, asking whether a reconciliation process existed and, if so, requesting that the policy be stated. But today’s due diligence questionnaires demand a detailed outline of the process, including a description of the specific activities undertaken, information about the manager who runs the process, and how it’s integrated with the other elements requested in the ODD process.
Factors to consider when reviewing your Trade Matching process:
There are several factors firms need to consider in determining the efficacy of their matching process:
Scalability– Reconciliation costs can grow exponentially as firms add new products, increase the number of accounts, expand broker relationships, and gain investors. Designing a flexible reconciliation process to account for projected growth can save a lot of money in the long run.
Efficiency – Any worthwhile reconciliation process should be designed to make you more efficient. For example, you should be able to quickly ascertain the overall status of a trade and drill down into details on demand.
Prioritization – It’s important to know what factors carry the most risk and ensure that reconciliations incorporate these factors based on significance. Incorrect account numbers or setup issues involve less financial risk than breaks like buy versus sell or missing trades.
Aggregate Data – Just because reconciliation can match on every detail doesn’t mean that it shouldn’t offer aggregated summaries as well. Often, duplicate matches are mistakenly added when a new account is onboarded. This error increases the support footprint and, potentially, cost. Instead, by adding all accounts to the same reconciliation process, you can easily view match status across accounts.
Buy versus Build – When it comes to building your trade match process versus buying a solution, your firm’s priority can dictate what best fits its needs. Commonly, proprietary trading firms tend to favor bespoke processes built around the specifics of their operation, while startup hedge funds often choose an off-the-shelf software solution. It is important to understand your strengths and needs before deciding on whether to build in-house or look for outside solutions.
Post-trade processing is too important for firms to take a casual approach. Trade breaks can spiral into significant costs, and clients unhappy with execution may look elsewhere for opportunities. Every firm, large or small, needs to ensure that its post-trade process can seamlessly and accurately support their business.
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About the Author
Rebecca Baldridge, CFA, is an investment professional and financial writer with more than 20 years of experience in creating content and research for asset managers, investment banks, brokers and other financial services clients. She’s worked for some of the biggest names in the industry, including Merrill Lynch Asset Management, JP Morgan Asset Management, BNY Mellon and Franklin Templeton. Rebecca also spent 9 years as an analyst and director of equity research in Moscow, working for several Russian banks. In late 2019, she founded Quartet Communications, a boutique communications firm serving financial services clients. Her writing has been published in outlets including Pensions & Investments, MSNBC.com, Inc. magazine, and Investopedia.com. She holds a B.A. in Russian from Purdue University and an M.S. in Finance from the Krannert Graduate School of Management at Purdue.