Modernizing the Back Office of Securities

FRAMINGHAM (03/13/2000) - After beating the Y2k bug, the securities industry faces a more complex problem. In processing securities transactions, neither the computer systems nor the business procedures they automate are up to the challenges of the 21st century. This can't be fixed merely by sending in programmers. The entire industry will have to change.

Securities trading has boomed in recent years. Thanks to computerization, more shares of stocks, bonds and mutual funds are traded faster than ever on exchanges around the world. Trading hours have expanded and global investing is more common.

The trouble is, the "back office" is approaching the point where it can no longer keep pace. The back office is where trades are settled by moving money and shares to the people who should get them, and where everyone's records are kept straight. Few outsiders know how crucial and complicated these operations are.

When a trade is executed on an exchange, all that happens is that a buyer is paired with a seller at an agreed-upon price. Many more steps are needed to complete the deal. Brokers, investment managers, custodians, depositories and others must all communicate to actually move the shares and money and update their books.

Much of this is now done in "batch." Computers crunch through huge piles of data after the close of the trading day, and a lot of human intervention is required as well. A typical back office has armies of people reading screens and printouts, verifying in-process trades and manually reconciling accounts.

The whole mess is a relic of, well, the 20th century. It has been tweaked and prodded, but now, the paradigm is breaking down. Goals like true around-the-clock trading and next-day settlement - often spoken of as being just around the corner - can't be reached by squeezing the current setup any further.

The industry moved from five- to three-day trade settlements by running computers faster and longer and throwing more people at the work. We can't get down to next-day settlement the same way. While trade volumes and workload grow, the time available shrinks because of extended trading hours and global trading.

Another concern is the growing likelihood of errors in processing. Companies "on the hook" for back-office errors - whether they be brokers, custodians, fund managers or others - could face fines or penalties for problems that impact investors. Some could lose market share or even be forced to exit the business.

The industry is aware of the crisis. The Global Straight-Through Processing Association, a consortium of leading industry participants, is designing new systems for real-time, computer-to-computer processing. This technology is essential, but only part of the solution.

In addition to replacing batch-oriented computer systems, the industry must also shed its reliance on batch-oriented business operations. These methods, by nature, result in logjams and errors, to be caught by a final review. Real-time continuous transaction processing is needed, with each transaction being booked, confirmed, reconciled and settled as it occurs. Quality control must be built into each step, not tacked on at the end by inspection.

The term back office reflects an obsolete mind-set, connoting a support function, something ancillary to the main show on the trading floor. It must be treated as what it is: a mission-critical production facility that turns out completed transactions.

Building the efficient, scalable transaction factory of the future won't be easy. A complete redesign must fully leverage the latest technologies, which have come a long way since current legacy mainframes were installed. Moreover, a single firm must get all the firms it communicates with during trade processing to go along.

But status quo is not an option. Sooner or later, some firms will move to the new paradigm - and those that cling too long to their dinosaur systems and operations will go the way of the dinosaur.

RICHARD FRANKLIN is a professor of MIS at the Katz Graduate School at the University of Pittsburgh, as well as a consultant and former IT executive in the financial services industry. Contact him at

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