Reconciliation Moves Into Fee Accounting

Once viewed strictly as a matter of matching up cash, positions and transactions, the middle-office task of reconciliation is quickly moving into the trade-execution and post-trade space.

The reasons are self-evident: not only are regulators demanding better control of operational risk, but C-level management are requiring more precise analysis of the bottom line for each unit.

“It’s all about managing business lines correctly,” says David Penney, executive vice president of strategy and innovation for Smartstream Technologies, based in London. “Every bank that uses brokers, or has other fees to manage, can see new operational efficiencies, increased accuracy and cost savings from paying accurate invoices. Interdealer brokers, in turn, benefit from these operational efficiencies through an easier payment process and all parties can experience improved reference data.”

Best known for its bread-and-butter licensed and managed reconciliation services for over two dozen of the world’s largest banks, Smartstream expanded its reach in the trade execution and post-trade market in 2011 through a managed fee reconciliation service. The new TLM Transaction Fees Invoice Management is already helping a large undisclosed investment bank handle invoices from 400 interdealer brokers, says Penney.

MYRIAD Group Technologies, also based in London, has opted to focus on the network fee market, where it believes the passage of the new European Alternative Fund Managers Directive (AIFMD) provides fertile ground for growth. Several global reconciliation experts contacted by FinOps Report agree, noting that European-headquartered financial firms appear to be ahead of their US and Asia-Pacific peers.  Under AIFMD, a bank tasked with the safekeeping of investor assets must not only segregate them from their own and others, but also comply with more cumbersome recordkeeping and oversight requirements.

“The legislation mandates global custodians performing depositary services to more closely monitor their sub-custody network and ensure no investor assets are lost,” explains Simon Shepherd, chief executive of MYRIAD, whose fee reconciliation platform is licensed by eight global custodians. “Custody costs are part of the equation and full transparency of running safely segregated accounts is an element of AIFMD.”

Costly Errors

Mistakes in matching up cash, positions and transactions between financial firms, their counterparties and service providers can easily lead to incorrect portfolio valuations, risk metrics, and regulatory reports. Likewise, errors in fee billings can translate to lower operating margins and ultimately higher charges to fund manager clients. Should internal units be used as service providers, the correct cost must be apportioned to the appropriate unit, so that charges are not accidentally borne by just one business line subsidizing others. If that takes place, financial firms can’t know which business lines are profitable and which are underperforming.

Fee discrepancies between firms and their internal units or external providers can often occur when the wrong fee schedules are used, when the economic details of the transaction are wrong; or the incorrect legal entity or instrument is recorded. Hence, an ancilliary benefit of fee reconciliation is likely to be improved data quality. Banks and broker-dealers are naturally loathe to publicly disclose their losses to slippage, so there are no confirmed figures. Reconciliation experts at several large global banks privately tell FinOps that slippage could easily be over US$10 million based on an estimated 10 percent error rate. That number may seem a bit high, yet even the industry average of between 2 percent and 5 percent, cited by a handful of senior-ranking operations experts, is pretty substantial.

Although it might stand to reason that large financial institutions with deep pockets would have automated systems to verify whether or not they are being charged the correct amounts by their executing brokers, clearing brokers and subcustodians, surprisingly that isn’t always the case. “Some are relying entirely on paper and pencil, while others are simply matching up that the number of transactions charged is accurate and then paying the bill, regardless of the fee,” warns Penney. “Clearly, this is not what is meant by a regulator in requiring that good operational controls are demonstrated.”

At the core of the fee or expense reconciliation services offered by Smartstream and MYRIAD Group Technologies is their ability to aggregate data from disparate applications — such as order management, trade execution, custody, and clearance and settlement — to match up the number of transactions involved and their economic details between the client, counterparty or service provider. In the case of subcustodian fees, the value of assets safekept must also be the same. Discrepancies are quickly flagged and resolved either by the client itself, as in the case of MYRIAD’s licensed software, or a dedicated staff provided by Smartstream through its Mumbai-based processing center.

The asset servicing arm of BNP Paribas Securities Services is using MYRIAD’s platform to electronically store important legal contracts including fee schedules and documents on relationships with subcustodians and other service providers such as international securities depositories Euroclear and Clearstream to help ensure the bank is paying the correct custody fees. BNP Paribas Securities Services was not available for further comment, but a case study approved by the bank cites Dominique Ansiaux, global head of network management, clearing and custody fees, as identifying three reasons MYRIAD’s platform was selected: the need to improve management controls on payable fees; the need to allocate fees correctly within the bank; and the need to improve reporting. “We have managed to reach our objectives; most of the highly detailed invoices are automatically integrated within the system and we are able to check the amount payable, and allocate and recharge costs precisely,” says Ansiaux.

Although MYRIAD has set its sights on the custodian bank market, Shepherd predicts that fund managers could also warm up to the need for network fee reconciliation. “Large traditional fund managers are already building their own network management capability, sometimes dressed up as vendor management or global provider strategy teams, but fundamentally, the principles remain the same,” he says. “They are looking to do so, because they want to be less reliant on global custodians; they want better visibility of their costs; and they want better control over who they work with. If this means going direct [without a custodian] in a number of jurisdictions, then so be it.”

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