Processing & Settlement System at Stock Exchanges
Straight through Processing

Straight through Processing (STP) aims to automate the complete process from trade initiation to settlement. A transaction of an on-line trading system in a stock exchange results out of data input at the ends of seller's and buyer's broker and further processing at the clearing house of the stock exchange. The multi-point operations partly through manual feeding of data and partyly through electronic process, results in errors creeping at some end resulting in the trade details not matching the instruction documents sent across through different terminals. Conventionalt practices involving costly multiple data re-entry from paper documents and other sources have frequently turned to be the source of errors, discrepancies, delays and possible fraud. This results in delay creeping in effecting settlement instructions, which need to be complied with in a certain time frame as per the guidelines of the Securities and Exchange Board of India (SEBI) guidelines, for the custodian. Studies show that the percentage of global trade failures resulting from unmatched trade data is of the order of around 15% of total trades, which in monetary terms is upwards of billions of dollars. Clearly, this is a steep price to be paid for the lack of an efficient processing framework that combines the end-to-end flow of data into a single, seamless process. The Straight Through Processing (STP) technology framework seeks to provide these efficiencies by providing seamless data flow both within the enterprise as well as across the market without any manual intervention. STP allows electronic data processing for transactions from the point of first deal to the final settlement.

As a first step towards achieving error free automated data processing, STP used standardised messaging formats so that communication of data across various market participants would be facilitated.

Indian securities markets have undergone many changes during the last decade. Exponential growth in trading volumes is pushing existing trading systems and processes to capacity and increasing settlement risk. With Indian market moving to a T+3 rolling settlement cycle in line with global markets, SEBI is continuing its efforts to increase the efficiency and transparency in Indian markets. This would result in lowering of trade costs and make Indian markets a more attractive destination for global investors. Indeed it has been SEBI endeavor to make the Indian markets, one of the most competitive and efficient markets of the world. STP enables orders to be processed, confirmed cleared and settled in a shorter time period, more cost effectively and with fewer errors than under traditional methods such as phone, fax, email etc. that require human intervention. It is the human element that slows the trade processes, introduces errors and delays settlement.

The move from a 5 day settlement period to a three day period requires firms to streamline trading processes by way of a foolproof, faster, cost effective and universally acceptable mode of communication among market participants. With changes happening in rapid succession, derivatives markets looking to expand, the settlement risk are increasing and this is pushing the need for Straight Through Processing (STP) and making it a pre-requisite for success of smooth functioning of securities market with a settlement period of T + 3 or less. (now T + 2)

STP involves the automation of the complete trade lifecycle, right from pre-trade, trade to post-trade operations. The underlying impact of an STP environment is to automate the entire process without any manual intervention. STP treats the trade cycle as a single unit, instead of a series of loosely-related messages.

STP is also about effective risk management, of settlement risk at the client and institutional levels. Trade failures arising due to data inaccuracy in the post-trade scenario should not happen as it points to human error and process inefficiencies. This clearly is one aspect of the operation that can be managed and controlled by using appropriate technology framework. This is where STP comes in.

SEBI has set up a committee to examine the feasibility of introduction of STP in the Indian markets in February 2002. . The Committee is headed by Executive Director Shri R.M. Joshi and comprises representatives from RBI, major stock exchanges, depositories, custodians etc.. The committee was set up with the objective of designing and recommending an expeditious solution for electronic transmission of trade and settlement information in the Indian markets, across markets participants. The road-map of SEBI envisaged implementation of STP across various market participants by 31-Dec-2002. The Committee submitted its report during July, 2002. SEBI formed an internal sub-committee to process implementation ofthe recommendations ofthe committee. The SEBI Committee on Straight through Processing has finalized its draft report. The Committee has recommended adoption of ISO15022 standards for usage in communication. Furtheas per the recommendation ofthe Committee SEBI directed that STP be adopted by for institutional investors in the Indian capital markets from 02-Dec-2002. Since then several market participants have adapted the STP framework in their operations. During July 2003 SEBI has extended straight-through processing (STP) to the entire market to smoothen the transaction process.

Broadly the benefits of STP can be listed as:

1. Reduced Settlement Cycle: Reducing the settlement cycle, the time between execution to settlement, will eliminate many of the risks associated with trade processing. Achieving seamlessness will be an enabler for these shorter settlement cycles to assist both domestic and cross-border trades in Indian securities. You cannot get to T+1 without seamless connectivity.

2. Transparency / Audit ability: Managing trades within a single automated process will improve the transparency of the trade status for all parties and will enable organisations (and possibly the regulator) to monitor the process in terms of effectiveness, adherence to regulation and will enhance problem resolution.

3. Reduces Counterparty Risk : Once a trade has been executed there is an element of uncertainty between all parties on the status of the trade and, indeed, whether the trade will settle until it is matched at the exchange. We see in many markets that, for a great proportion of the trades, matching does not take place until settlement date, leaving no time to repair the trade for settlement on time. Trades agreed by all parties and set-up ready for settlement will also reduce the exposure in the event of counter party failure.

4. Reduces Operational Risk: Automating the process from execution through to settlement will, by definition, reduce the manual processes and provide a more timely and accurate process. In avoiding the delays and errors in this manual process you and your trading counterparts will substantially reduce the exceptions. Exception processing is costly.

5. More timely exception processing: Whilst STP will not eliminate all the errors, the point that is often missed is that the earlier the trade is processed the earlier the exception will be identified. This will enable the timely resolution of any problems on the trade date to avoid settlement failure and the costly process of resolution, correction and interest claims.

6. Performance Measurement: It is often said that you cannot manage what you cannot measure. This is true of the trade process and counterparty performance. Management of information throughout the process will be the key to determine success, not only in your own process, but also that of your counterparts. Measure against an industry code of practices and peer groups will help to create the discipline in the market. We should not discount the possibility of publishing performance tables - a case of naming and shaming - to further concentrate the mind.

7. Improve attractiveness of Indian market: Markets throughout the world are continually looking for new investment opportunities. Foreign Investment into India will be determined, not only, on investment opportunity but also on the operational efficiency and risk profiles of the Indian market. Introducing a process with regulatory oversight will only enhance India's profile and therefore its attractiveness to foreign investment.