Faster trades to cost more than Y2K prep

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by Maria Trombly

(IDG) -- Industry experts figure it cost about $5 billion to prepare Wall Street information systems for the year 2000 date rollover.

But preparing for something called T+1 will cost even more.

The U.S. Securities and Exchange Commission (SEC) has urged the industry to clear and settle all trades within 24 hours - or T+1, which means "trade plus one day." It will require a major overhaul of brokerage information systems, which have been required to settle trades in three days, or T+3, since 1995.

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In essence, T+1 will force a switch from Wall Street's traditional batch processing systems to a real-time processing network that never crashes.

The conversion to T+1 will take until 2004 and will cost about $8 billion, according to Don Kittell, executive vice president of the Securities Industry Association (SIA) in New York and the organization's chief T+1 planner.

Y2K and other legacies

The good news is that Y2k-spurred upgrades - as well as the transition from T+5 to T+3 five years ago - have helped lay much of the groundwork for this next challenge.

But the T+1 conversion may be more complicated than the Y2k conversion, and it will require an even greater degree of cooperation among industry participants than Y2k did, Kittell said.

Although stock trades seem instantaneous to retail customers - one click, and the stock is in the portfolio - the actual behind-the-scenes processing requires several steps and several days.

Both the seller and the buyer must register the transaction with a central clearing organization, Depository Trust & Clearing Corp. (DTCC) in New York. Then the two accounts of the trade have to be reconciled, errors have to be ironed out and money has to change hands. In addition, there's the matter of handling the physical certificates.

Moving away from batch processing

Currently, the system works through overnight batch processes, usually run on legacy mainframes.

"This monolithic stream is the bane of our existence," said Richard Iturbe, a vice president at Goldman Sachs Group Inc. in New York. The entire industry will now have to move to continuous processing, he said. "To the extent that your systems can operate that way, you're ready for T+1," he noted.

This part of the conversion will cost the industry about $3.3 billion of the $8 billion total, according to a report by the SIA and Chicago-based Andersen Consulting.

And the problems of converting or replacing old systems were what forced the industry to push back the deadline by two years, said Larry Tabb, an analyst at Needham, Mass.-based TowerGroup. The T+1 conversion was originally planned to conclude in 2002.

Customer demand for real-time

San Francisco-based Charles Schwab & Co. has already started working on replacing its batch processing systems, according to Vincent Phillips, senior vice president of electronic brokerage technology. He said Schwab has already worked on more than half of its legacy systems, not just because of the coming T+1 conversion but also because of decimalization - and customer demand.

"Our customers want more and more and more real-time data," he said. People who were satisfied with day-old data a short while ago now get frustrated if their accounts aren't updated instantaneously, he said.

But replacing the legacy systems - though a big headache and major expense - will pale in comparison with the larger difficulty of getting all the players in the securities transaction chain to work together, said Tabb.

"[What] they're going to have to deal with is the political problem of getting everyone to agree on how it's going to work," he said.

One key link in the chain is DTCC, the clearinghouse for trade settlements. It not only has to upgrade all its internal processes but also all its links to the other industry players.

"We've been working on this for at least a year and a half or two," said Steve Letzler, a spokesman for the DTCC. Although Letzler couldn't confirm the numbers, the SIA said it expects DTCC to spend more than $100 million to prepare for T+1.

DTCC has begun to eliminate its overnight batch processing, moving to a multibatch system with Nasdaq Stock Market Inc. and five electronic communication networks. A multibatch system replaces one overnight process with a series of batch processes that run throughout the day.

In addition, DTCC has formed a real-time link with the New York Stock Exchange, which handles about 300,000 large trades daily.

"Eventually, we'll get to the other systems and get everyone to real time," Letzler said.

A step ahead

Another firm that planned ahead for T+1 conversion is The Bank of New York Co., which provides settlement services to more than half of the broker dealers in the U.S. CIO Kurt Woetzel said he's been getting ready since the move to T+3.

"Starting in 1995," he said, "any new applications that we built were engineered around the following factors: They reflect information in real time and process information [in] real time, and they're message-based, rather than moving files around."

Although there are still batch processes left, the critical systems - including those for delivering information to customers and taking transactional information from customers - are already running around-the-clock, he said.

The SIA will publish the technical standards for T+1 conversion by the end of next year, with full compliance expected to come by the middle of 2003.

Capsule Review: T+1 and Y2K

Unlike Y2k, which had the clear deadline of Jan. 1, T+1 is a voluntary industry effort so far. Its primary goal is to reduce the risk of a chain reaction of financial disasters, said Don Kittell, executive vice president of the Securities Industry Association (SIA).

Shorter settlement cycles lead to increased stability for the entire global banking system, said Deborah Williams, an analyst at Meridien Research Inc. in Newton, Mass.

Just as a bounced check can have a ripple effect when you've already written other checks based on those funds, large trading firms can have the same problem that ripples throughout the financial world, Williams said.

It isn't a hypothetical problem, either. In 1987, when a market downturn caused a few securities firms to go under, the five-day settlement period meant the problems rippled throughout the industry, causing other firms to fail. This spurred the move from T+5 to T+3, said Kittell.

If trades were settled instantaneously, the risk involved would be nonexistent. The SIA will, in fact, begin studying the feasibility of T+0 in the next year or two.

The U.S. securities industry is also facing competition from overseas. Hong Kong and Singapore already are at T+1, Kittell said, with Japan and Europe heading in that direction as well. By beginning the process now, the U.S. will maintain its leadership position, he said.

The switch to T+1 will also allow the industry to handle increased volume. The current batch processes are coming close to their capacity limits, Kittell said.

Yet another reason to switch to T+1 is that it will save industry participants money - about $2.7 billion per year, according to an SIA study - meaning that the overhaul will pay for itself in three years.

The savings will come from reduced manual processing, lower error rates and faster payments, the SIA said.

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