Driving Business Success: The Importance of Post-Trade Operations for Front Office Excellence

Alex Knight, Head of EMEA at Baton Systems explains how the impact of efficient post-trade processes can be felt across a business in terms of both increased revenue and reduced costs, delivering better market access and enhancing customer service.

In recent years the FX market has focused its investments on the automation of the front office, with the spotlight on managing market risk and liquidity distribution. That focus now needs to turn to post-trade processes which, in many cases, still require a surprisingly high degree of manual intervention.

It is a common misconception that the front, middle and back offices are three entirely disparate functions within a business. It’s often thought that back-office activity is only distantly connected to what goes on at the front end. In reality, though, front office performance is heavily dependent on everything that happens after a trade is executed. Operational constraints have a significant impact on the ability of a business to serve new and existing customers and to access (and provide) market liquidity freely across all potential locations.

Post-trade processes impact not only potential revenues but also costs, whether directly attributable or charged by way of allocation. Efficient post-trade operations play a crucial role in ensuring smooth settlement and reducing settlement risk. In particular, the introduction of  T+1 settlement for US and Canadian securities in 2024 will create a clear division between market participants (on both the buy-side and the sell-side)  who have invested in post trade processes, and those that have not.

FX settlement: what the industry needs

The FX industry needs a set of configurable processes which are, at the same time, safe, fast, highly automated, scalable, and low cost and which allow for real-time and deliberate control.

To reinforce this need, the industry is now counting down to a large increase in the volume of same-day settlement trades due to the forthcoming shortening of the securities settlement cycles. Existing systems and processes will come under more and more pressure. A significant amount of flow that has hitherto been handled on a PvP basis will require an alternative solution. Without this, investor clients will lose access to valuable market liquidity and the risk of settlement fails will increase materially.

Customer-facing functions know how frustrating it is to be limited in the way that you can service particular clients (you might even be unable to service them at all) because you cannot guarantee the automated safe settlement that your credit team insists upon. The same applies if you are a trader – your access to liquidity can be constrained by settlement limits. So not only does the bank lose out directly on revenue, but your customers also suffer by not getting access to the liquidity that they need.

Because of the bilateral and fractured nature of FX trading and settlement there are almost limitless combinations of post-trade preferences in operation across different pairs of counterparties, currencies, and products. Some parties like to net; some only like to net up to a certain time or for a certain currency pair or a certain product; others don’t like to net at all (although best practice is clearly to net as much as possible). Some parties prefer split settlements to best manage liquidity, but this can lead to challenges when reconciling payments. Many of the relationships which exist between banks have specific elements which operations teams often cater to using non-standard applications like spreadsheets and macros so that they can be managed accordingly.

Although the FX Global Code promotes netting as an industry good practice, a surprising amount of business is still settled without netting, meaning that both settlement risk and funding costs are higher than they need to be. Our research at Baton Systems across a number of existing and prospective clients has found that there is about 35% room for improvement to reduce settlement risk and funding costs simply through the implementation of more netting across more counterparties. Of course, this helps to mitigate the risks associated with settlement, but it certainly doesn’t eliminate them in its own right.

The ability to do this in an automated, scalable, and configurable way, without imposing an additional burden on operations teams, undoubtedly represents a big win for the business as a whole.

Without safe settlement processes, netting only solves part of the challenge

Baton Systems is known to the FX industry as the only live provider of PvP services other than the legacy incumbent and is well regarded in the FX market for its contribution to safe, riskless settlement across a range of currencies, including the offshore Renminbi (CNH) which was added in 2022 – the first time the world’s fifth most traded currency has been settled using a PvP safe settlement mechanism. In addition, Baton is recognised as the only solution for the automated netting and PvP settlement of short-dated trades, including those that miss the cut-off times for other processes.

Our Core-FX™ solution allows configuration by counterparty, currency pair, and product for each settlement participant. Users can schedule and predict settlement events on, or for, each value date, allowing them to manage and optimise their use of funding. The exchange of ownership is simultaneous and instantaneous while the entire settlement process takes a matter of minutes. The solution supports the netting, splitting, and safe settlement of transactions on demand, meaning that value today trades can be (and frequently are) settled in a fast, transparent, and efficient manner.

Baton has also been very successful in the area of controlled settlements. Our Core-Payments workflows provide our customer banks with the real-time reconciliation of settlement data at the counterparty level. Combining this with configurable rules ensures that each payment that is released will not give rise to a situation where there is too much settlement risk against that counterparty or, indeed, too much stress on the bank’s funding position in that currency. It also allows for the real-time identification of potential or actual fails (when a currency cut-off time has been reached but the payment has not been made/received).

Settlement is generally thought of as the last mile of the lifecycle of an FX trade. But, as we have seen, efficient post-trade processes have a major influence on decisions that the front office needs to make to win and service clients effectively and make a business successful. The mechanics of the settlement are only the start. At Baton we integrate interoperable workflows and controls in an automated and configurable manner all the way from matching through to on-demand settlement, delivering scale, control, and increased opportunity to FX businesses and their counterparties.