T+1: putting the “party” back in “counterparty”

The importance of counterparty performance management in T+1 compliance

Efficient post-trade settlement depends on counterparty performance. As financial firms gear up for T+1, counterparty performance management is becoming increasingly crucial.

Counterparty performance management measures, analyses, and ultimately supports the ability of a party involved in a financial transaction to meet a variety of obligations in an efficient and accurate manner to facilitate timely settlement. When counterparty performance is strong, it goes a long way towards reducing the risk of settlement failures, which in turn improves the overall efficiency and stability of the settlement process.

The trade lifecycle is typically facilitated by intermediaries such as custodians, brokers, and clearing houses. Settlement failures can occur when one of the parties involved is unable to fulfil its obligations, either due to financial distress, operational errors, or other unforeseen circumstances. These failures can result in delays, additional costs, and even systemic risks to the broader financial system. Subsequently, this can bring financial, regulatory, and reputational consequences to the party at fault.

How does counterparty performance management help?

Counterparty performance management is critical in mitigating settlement risks and improving post-trade efficiency. There are several ways in which it can help, including:

Ensuring that all parties involved in a transaction have the necessary financial resources and operational capabilities to fulfil their obligations.
For example, a buyer who lacks the necessary cash to settle a transaction may cause delays or defaults, which may cause disruption to the settlement process. Similarly, a seller who fails to deliver the securities as promised will result in settlement failures. To address these risks, counterparty performance management typically requires market participants to meet certain credit and operational standards before entering or continuing a trading relationship.

Reducing the likelihood of disputes and errors during the settlement process.
When counterparties are reliable and transparent, it is easier to reconcile differences in trade data, confirm the accuracy of SSIs, and resolve any discrepancies in a timely and efficient manner. Having a transparent and collaborative relationship with your counterparties will reduce the effort, cost and risk involved in trade errors and disputes.

Reducing the need for manual intervention and unnecessary trade-processing touch points.
In some markets, settlement failures result in costly and time-consuming processes such as buy-ins, where the buyer must purchase the securities from another seller at above-market prices. Such processes can be expensive, time-consuming and have both a negative reputational and regulatory impact. These risks can be mitigated through automation which can also improve overall settlement performance.

Enhancing the overall stability of the financial system by reducing the risk of systemic failures.
Settlement failures can have cascading effects on the broader financial system, leading to market volatility, liquidity shortages, and even systemic risks. By improving counterparty performance, market participants can reduce the risk of such failures and enhance the stability of the financial system.

Why do we care?

Counterparty performance will play a critical role in meeting the challenges of T+1. As has been discussed at length in industry forums, a trade can only be settled as fast as its worst performing counterparty. With Straight Through Processing (STP) being the route to T+1 compliance, a firm’s communication with their counterparties is a critical avenue to explore to enhance STP through upfront conversations on SSIs and static data, shape matching and global operating model dependencies. A subsequent approach to truly identify the root cause of settlement inefficiencies is to perform in-depth process reviews and data analysis on trade capture, trade matching and trade settlement. By utilising the data and analysis, the causal factors of process inefficiencies can be identified, including who the responsible party is.

What should you do?

Industry participants can improve their own processes, but it takes both sides of the trade to be maximally efficient. Regularly measuring and assessing your counterparties’ performance should be a standard process for your business; industry collaboration will be a vital aspect of readiness for T+1, not only in the US but globally, and that collaboration should be led by what a firms’ data says about where the challenges with their counterparties are. Analysing the counterparties who have the lowest matching rates and create the most touch points can help guide a strategic counterparty outreach approach. All of this is possible using data that’s currently available.

Strong counterparty performance helps to reduce settlement risks, improve STP, and facilitates increased levels of automation. Market participants can improve counterparty performance by adopting robust operational standards, ensuring transparency and reliability in their transactions, and actively monitoring and managing known settlement risks. By doing so, they can embrace the challenge of moving to a T+1 settlement cycle as an opportunity for operational evolution and be as ready as possible for the move in May 2024.