Wall Street goes digital to cut down on waste
By David Becker
Staff Writer, CNET News.com
June 10, 2003, 4:00 AM PT
It was an emblem of American capitalism, a scene that had become a Hollywood cliche: On the floor of the New York Stock Exchange, harried traders yelled furiously and waved slips of paper that represented the lifeblood of the securities industry.
Yet when Roger Burkhardt observed the frenetic activity, the exchange's chief technology officer saw business being done in slow motion.
So Burkhardt, who had spent 15 years at IBM, embarked on a campaign to modernize the financial institution. Today, the slips of paper have given way to handheld computers that connect wirelessly to a central trading system, confirming orders in seconds and instantly spotting discrepancies that previously would have gone undetected for at least a day.
"It's about passing information out sooner, identifying problems sooner, cutting down risks," Burkhardt says.
The catalyst for the stock exchange's historic move is an initiative called "straight-through processing," or STP--a far-reaching vision for making securities transactions completely electronic, eliminating the paper, phone and fax detours that can bog down orders. STP is being adopted by the entire financial services industry that is seeking ways to save money as it rides out the national economic slowdown.
Inefficiencies can cost the largest brokerages and investment banks hundreds of millions of dollars a year in wages, processing time and fumbled transactions. As a result, STP has been transformed from an abstract technology challenge to a business imperative.
"Firms are looking for ways to improve their bottom line, improve their portfolios," says John Panchery, managing director of the Securities Industry Association, the main financial services industry trade group. "The new marching orders are to concentrate on straight-through processing to create a much more efficient process."
U.S. securities companies are expected to invest $6.7 billion in STP projects over the next three years, according to research firm TowerGroup. Most expect the projects to pay for themselves within a year.
All this is welcome news to technology companies seeking opportunities to survive in the same stagnant economy. STP projects will range from the design of custom software for helping clearinghouses correct trade errors without a barrage of faxes and phone calls to a broad array of consultants who help rebuild essential parts of a brokerage's back-office operations.
"Something like 15 percent of trades today don't settle without some kind of problem," says David Littlewood, director of worldwide financial services for Sun Microsystems. "If you can reduce your 'exceptions' from 15 percent to 10 percent, you save a fairly quantifiable amount of employee time and money."
To understand the scope and depth of the challenge, it helps to examine the complex route a securities transaction must follow from initiation to settlement.
The initial and final stages of the process are already automated, with orders and confirmations routinely submitted and received electronically. The middle links, however, offer plenty of opportunities for the binary chain to break.
For example, if a trading partner doesn't immediately have the number of shares necessary for a transaction, it borrows them from a "loan vendor"--a company that specializes in making stock readily available to enable the completion of orders.
The first half of the process is straightforward, but the loan vendor can retrieve its shares only with faxes and phone calls.
"There's an enormous amount of change that needs to occur within the security settlement process," says Tom Shaw, director of straight-through processing for IBM Global Financial Markets. "The amount of manual reconciliation and processing that still takes place clearly doesn't allow for real-time clearance and settlement, which is the ultimate goal for most firms."
Transactions can also get stalled once they reach the clearinghouse, the operation run by banking specialists that transfers stock from seller to buyer. Whether the problem is currency fluctuations or improperly recorded data, solving it often involves a flurry of calls.
Dushyant Shahrawat, senior analyst at TowerGroup, says the STP changes will go a long way to solving such problems, and he points out a psychological shift in the securities business.
"I think the whole industry has gotten more sophisticated," Shahrawat says. "A few years ago, we looked at everything as a data problem--How do you move data back and forth? Then we focused on an application problem--How do you get these applications to work together? Now we're looking at the next level higher up, which is process integration. We're not looking at hardware or software; we're looking at how the thing gets done."
An evolution in the works
The original solution to such problems was to be the industry's version of China's Great Leap Forward. An initiative dubbed T+1, which stood for "trade date plus one," would have required all transactions to be settled in one day, as compared with the current three-day turnaround.
Last year, banks were cautiously making plans for T+1, and the Securities and Exchange Commission was on the verge of requiring it, but the flagging economy scuttled such talk. T+1 would have required an investment by U.S. securities companies of $8 billion, along with massive projects aimed at replacing the decades-old mainframe computers most major banks and brokerages use for overnight processing.
"The main problem with T+1...was as much technological as it was financial," says Damon Kovelsky, an analyst with the Financial Insights arm of research firm IDC. "The money just wasn't there. And the other thing was that the old technology still worked. When you present the argument to replace your COBOL mainframe, it hard to do that when everything is working fine."
The combined effect of Wall Street's precipitous decline and new security concerns after the New York terrorist attacks put T+1 on a back shelf. Nevertheless, the work that went into the program served as a skeleton for the more restrained STP campaign.
The Securities Industry Association came up with seven goals to be achieved within the next few years, including eliminating of paper stock certificates, standardizing electronic payments and streamlining the stock loan process.
Before the industry can achieve its many objectives, however, it must first decide on a common language to conduct business. To clear the logjam, companies are looking toward XML, the dominant language in Web services, to provide a common vehicle for exchanging financial data.
"The whole trade-settlement process is bogged down in this how-do-we-describe-what-we're-doing question," says Ronald Schmelzer, an analyst with research firm ZapThink. "They're all moving to XML representations of these data formats because it's the best hope for achieving consistency."
Banks and brokers can use an XML program to ensure that each transaction comes with a correct set of consistently formatted data but doesn't expose any secrets. Conversely, XML can send data to define what the other party does get to see--a critical issue in an industry where profits often hinge on knowing something the other person doesn't.
The language will likely replace SWIFT, the proprietary messaging format that financial services companies have been using for the last few years, because XML-based systems can incorporate transactions and other services into the communications system.
"This area has been a black hole for years," says Gabe David, managing director of the Global Capital Markets Group at software and services company Electronic Data Systems. "SWIFT worked well when you had five days to settle and everything was on paper. Now you need something where you can actually get work done as well as exchange messages."
Weeding out the "exceptions"
The industry will also be looking at "exceptions processing systems"--software, hardware and related processes that automatically address transaction problems. Major companies such as Sun Microsystems and Hewlett-Packard include these systems in their STP packages, often relying on software from specialists such as Sungard.
"There are products going out in the market now that address the exceptions process quite well," Sun's Littlewood says, noting that his company uses an application from specialist software maker CaseMetrics for that purpose. "You want to process every trade straight through and just manage the exceptions, and the right software will let you do that very precisely."
In the competition for STP business, bigger doesn't necessarily mean better. Although some financial houses may favor large companies with vast outsourcing operations, such as IBM, many prefer to keep things in-house.
"Anyone who touches the back end is going to get whatever business there is," IDC's Kovelsky says. "IBM is getting a nice chunk of it; Radiance is getting a nice chunk; your back-office software providers are getting part of the money. But you can only outsource so much. There are certain things firms just don't want someone else controlling."
Tower's Shahrawat agreed. "I don't think institutions are clamoring to hear Accenture's or EDS' ideas in this space--they're trying to fix the problems themselves," he says. "Firms have been hearing pitches like that for a long time, and sometimes they've been sold a bill of goods."
Most industry observers expect the leading brokers and investment banks to have STP systems in place within two or three years, but industrywide acceptance is a different matter. Many of those companies involved in the securities trading process won't have the resources or incentive to revamp their systems.
Firms that primarily buy equities, such as mutual fund administrators, have little incentive to invest in an area that won't do anything to improve returns. And smaller brokers and banks are unlikely to be able to afford the massive technologies required for the overhaul.
Yet, for the true benefits of electronic processing to be realized, every player in the process needs to be plugged in.
"I think there's going to be a dichotomy," EDS' David says. "There's going to be the big guys moving at a faster pace because they see it to their advantage, and the small guys either catching up or being marginalized."
For Burkhardt and the New York Stock Exchange, the move to STP was never a question. The NYSE simply had to adopt more efficient systems to handle rapidly increasing trade volumes while abiding by centuries-old rules that limit the number of traders allowed on the exchange floor.
"We are in a rather unique situation where we have a population of traders that's limited by constitution," Burkhardt says. "That's kind of good thing for us, because it forces us to be increasingly efficient."
Without STP, Burkhardt adds "we'd be dead."  Back to intro 
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