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Best Practices in Reconcilation: 10 Steps to Improving Efficiency and Reducing Risk

A Practical Guide for Asset Managers

TABLE OF CONTENTS

[03] [04]

The Shifting Reconciliation Landscape The Automation Imperative

Opportunity Costs of Manual Reconciliation Breakdown of Costs and Risks

[06] [08]

The Automation Upside

Advantages of Automated Reconciliation: A Case Study

Best Reconciliation Workflow Model

Broker Reconciliation Custodian Reconciliation

[09] [10]

Automating Reconciliation: 10 Steps to Greater Efficiency Solution Alternatives

Homegrown Solution Vendor Application Hosted Solution

[11]

Meeting the Challenge and Seizing the Opportunity

About Advent Software Advent Straight Through Processing Solutions

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The Shifting Reconciliation Landscape

While the asset management industry has shown steady growth in recent years, market volatility continues to put pressure on profitability. And as recent history has shown, volatility is not the only factor that can roil the market and unsettle its participants. The subprime debt crisis and resulting credit crunch, the growing federal budget deficit, and the undeniable slowdown in the economy have all contributed to uncertainty in the financial markets. Asset managers cannot control the ups and downs of the markets or the external factors that impact them. What they can control are their own operating costs. In fact, increased operational efficiency is a firms best hedge against marketplace volatility and its impact on revenue and profitability. A period of uncertainty is the time when many firms examine their operations for opportunities to eliminate inefficiencies and reduce their exposure. One effective way to accomplish these goals is through a combination of automation of processes and the implementation of best practices in workflow. And, at many firms, the area most ripe for improved productivity is reconciliationan often overlooked back office function that offers relatively easy wins in the quest for greater efficiency and profitability. Plucking this low-hanging fruit today is one obvious way to position your firm to prosper in whatever market conditions the future may hold. This document explains why automated reconciliation is quickly evolving into a competitive necessity. It then details the costs and risks associated with manual reconciliation, the benefits you can expect from automation, and the best reconciliation workflow model. It also outlines a 10-point checklist on optimizing efficiency in reconciliation and weighs the pros and cons of alternative solutions-in house, third party, or web hosted. As you will see, the decision to automate reconciliation presents both a challenge and an opportunity for firms: a challenge to stay competitive and an opportunity to make dramatic improvements in efficiency and client service.

This communication is provided by Advent Software, Inc. for informational purposes only and should not be construed as, and does not constitute, legal advice on any matter whatsoever discussed herein.

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The Automation Imperative

A recent report by Aite Group* observes that transaction volumes today have grown exponentially compared to the projections of just a few years ago. At the same time, trades are increasing in complexity, fueled by the growing use of derivatives by both traditional and alternative investment managers. The report also notes the shifting role of reconciliation from a postevent process to part of the trade lifecycle. Firms now have a much narrower window of time in which to reconcile transactions, portfolios, and accounts. No longer can matching take 24 hours, the report notes. It is now a real-time process. Processing times that seemed impossible as recently as five years ago are now de facto standards. These key trendsmore (and more complex) transactions and less time to reconcile themare putting pressure on firms as they struggle to deal with the deluge of data. Technology vendors, according to Aite, have addressed the issue by creating automated systems capable of processing ever-increasing transactions per hour and multipoint matching. Yet many asset management firms continue to be hamstrung by creaky legacy systems that are straining under the pressure. Evolving compliance requirements are also driving the deployment of automated reconciliation and exception management systems. Automation reduces the risk of errors and enables a firm to better demonstrate compliance in its processes and procedures. In the near future, according to the report, regulators are likely to require risk management controls in every aspect of straight through processing. Firms that have not automated will be hard pressed to keep pace with tightening compliance requirements. The advance of technology has made real-time reconciliation an opportunity for firms to increase efficiency, cut costs, and reduce errors. And the quickening pace of the market and more demanding client expectations have made it a competitive necessity. As the Aite report concludes, financial firms will have to bring their reconciliation systems up to date, not only for the increased STP capabilities and cost reductions, but simply to maintain their operational state of being.

* Philip R. Silitschanu, Reconciliation Systems Vendor Comparison: Higher Volumes and Higher Efficiency, Aite Group, April 2008.

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Opportunity Costs of Manual Reconciliation

One can imagine equity trade settlement and reconciliation as a threelegged stool. The stability of that stool depends on effective two-way communication between the investment manager and brokers, the DTCC, and custodians. Yet all too often the trade and portfolio reconciliation process between a firm and its various trading partners is labor intensive, error prone, and costly. For example, in order to match trade allocations to the DTCC for confirmation, it is not uncommon to find organizations still printing confirms and sorting through them manually, a task that diverts staff time and attention from higher value activities. Likewise, reconciling and recording transactions with custodian banks and prime brokers are often unnecessary pain points. At month end, an investment manager must make sure its systems are up to date before generating and delivering client reports. This may involve an import of data from their custodians websites, or keying the information in manually. Then comes the process of reconciling their daily records with each of their custodians. Reconciling those external and internal data flows by manually ticking and tying each transaction is a time-consuming and tedious processespecially given that a typical investment manager may have 20 or more different custodiansand is liable to result in significant numbers of mistakes, and potentially even compliance issues.

Manager

tion ncilia Reco n dian icatio Custo Notif Bank n ciliatio e co n

Custo

Tradin g

dial R

Settlement & Broker Reconciliation

Trade Exec u Alloc tion ation

Confirmation Affirmation

n odia Cust

Brok

er

Trade Reconciliation Workflow requirements between the investment manager, broker, DTCC custodian

DTCC

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Breakdown of Costs and Risks

The bottom line is that wherever gaps occur in the automation chain there will be a resulting impact on your firms resources and risk profile. Such costs and risks may take the form of: Exposure to operational risk resulting from unmatched items Staff time that could be spent on more value-added functions Employee discontent and turnover from lower job satisfaction Poor client service and its impact on client and asset retention Account errors that mean portfolio managers dont have an accurate picture of how much cash or securities they have available with which to trade A month-end reconciliation cycle resulting in day-to-day investment decisions being based on old or inaccurate data A reporting fire-drill at the end of the period leading to a focus on getting the reports out the door rather than on getting them done correctly in a controlled and predictable manner A temptation to plug in data just to make it reconcile Lack of operational scalability to meet changes in business volumes and take advantage of growth opportunities Inaccurate performance numbers, which could raise compliance concerns

The Automation Upside

Replacing an error-prone, manual file-matching process that may have taken two or three weeks with a time-saving, automated environment offers significant advantages on numerous fronts. Increased Productivity. Firms will be able to realize greater productivity from their staff by assigning them to higher value functions in operations, client service, or other areas of the company. Or they may simply be able to reduce their operational cost since the employees previously engaged in manual ticking and tying are no longer needed. Greater Scalability. Because systems can handle the reconciliation process quicker and with fewer errors, there is not the same constraint on what a firms operations department can now support. As a result, it can increase the volumes it handles without having to add an equal amount of staff. Volume could come in the form of increased trading, new client acquisition, new lines of businessor whatever your business growth goals may be.

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Streamlined Reconciliation. In an automated daily reconciliation environment, month-end reconciliation doesnt have to be a burden; instead, it becomes just another day. Automation makes fast and daily reconciliation a reality. That means portfolios are always up-todate, enabling portfolio managers and traders to make better investment decisions (since they will be based on timely and reliable data), and minimize the firms risk exposure. Enhanced Compliance. An automated reconciliation system reduces the risk of errors, ensures a standardized procedure, and maintains accurate activity records and audit trails for SEC reporting. A firm that automates its processes is in a better position to demonstrate compliance when required. Improved Service. Providing investors with access to current and error-free information on their holdings is another tool in the battle to acquire and retain customers. Asset managers that excel in client service are often successful in retaining assets, even when their investment returns are less than stellar. Satisfied clients are also more likely to invest additional sums in that managers funds, and give positive referrals to family and friends.

Advantages of Automated Reconciliation: A Case Study

A $1 billion Chicago-based asset management firm had one person doing all its reconciliation manually at month end using paper custodial statements and some online tools. With about 850 accounts, this process took more than a week. Meanwhile, investment decisions were being made based on stale and potentially inaccurate data. And, if a manual error occurred, it might not come to light until well after month end, causing a ripple effect of problems in the meantime. The firm decided to implement straight through processing technology to automate the connections and integrate data between their systems and outside parties such as custodians, brokers, the DTCC and securities data providers. This enabled them automate their trading, settlement, and account reconciliation. Now, without having to increase staff, every account is reconciled daily, and the process that used to take more than a week takes about three hours. Exceptions are uncovered immediately. Portfolio managers and traders know that they are working with the most current, accurate data available. And by noon, clients can get accurate positions as of the previous days end.

Optimal client service

Improve trading

Reduce operational risk

Staff focus on value-added tasks

Realize cost savings

Scalabilityfoundation for growth

Automating the Reconciliation Environment Implementing a scalable solution that leads to outstanding client support.

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Best Reconciliation Workflow Model

The benefits of automating the reconciliation process speak for themselves. But what does the implementation of a best practices reconciliation environment actually entail? The first step is to identify the various stages needed in the reconciliation workflow. From there it will be possible to see that each operates efficiently, thus ensuring the whole process runs as smoothly as possible. Of course there is no one size fits all solution, since different firms have different needs. However, most firms implement some form of custodian reconciliation, as that is the last check before sending client reports. In addition, some firms are opting to have a greater level of scrutiny and thus choose to self-affirm, adding broker reconciliation to their workflow so they can catch and control issues farther upstream. Whatever the process you adopt, the SEC advises you fully understand your areas of risk so you can design your policies and procedures to limit exposure.

Broker Reconciliation
Match trade allocations to broker record (i.e. DTCC confirm) Identify and address exceptions Affirm matched trades (if an affirming party) Update internal systems

Custodian Reconciliation
Data From: Brokers | DTCC | Clearing Firm | Custodians | Others FIX | Proprietary | Swift | XML | Others

Collect daily transaction and position data from custodians Compare custodian transactions with those from primary source maintained in the portfolio management system Determine reconciliation action for unmatched exceptions

Communication Translation Reconciliation Order Management Portfolio Management

Reports

Automated Reconciliation and Reporting Process

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Automating Reconciliation: 10 Steps to Greater Efficiency

Once you have decided to adopt a best practices approach to reconciliation, the next step is to introduce appropriate technology to automate each step of the workflow puzzle. Implementing an effective reconciliation environment requires a solution that can capture, validate, match, and reconcile data between your portfolios and a wide range of external parties. And when breaks occur, the solution will assist the exception management process in as automated a fashion as possible. Some key capabilities to look for when considering what reconciliation IT framework to implement are: 1. Access to two unique sources of account activity Primary: Internal source (e.g. data held in your order management system) Secondary: External source (e.g. custodial data aggregation service, DTCC, custodian website) 2. Centralized electronic data collection from widest possible universe of custodians/prime brokers, with daily connectivity Immediate transaction amendment capability, enabling staffers to add/replace data, and track exceptions Automation of rudimentary or recurring steps of data collection/ processing, enabling the user to focus only on exception management Exception-based matching process with user-defined tolerances Ability to mark and set aside pending items to work with later (i.e. if reconciling right after a re-org or if the custodian is late in reporting) Capacity to identify root cause of an exception, and/or aggregate similar exceptions for long-term resolution Data normalization/translation tools to deal with the multiplicity of file types Production of easy-to-read, high quality reports

3.

4.

5. 6.

7.

8.

9.

10. Audit trail support to record all actions taken during the reconciliation process

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Solution Alternatives
How do you achieve this robust and comprehensive automated reconciliation infrastructure? Three broad choices are available: Homegrown solution Vendor application Hosted solution Depending on the needs and capabilities of your firm, any of these options could be viable. But before making that decision there are various pluses and minuses to consider, summarized in the table below.

Solution Alternatives
Description
Homegrown Solution Typically an Excel spreadsheet, or simple Microsoft Access configuration

Pros
Hands-on control of reconciliation process No separate licensing fee Potential for customization

Cons
Development time and cost Ongoing maintenance Limited functionality Scalability constraints Must configure separate point-to-point interfaces to retrieve data Licensing fee Reliance on vendor support Implementation time

Vendor Application

Onsite installation of specialist reconciliation system from an independent software provider

Robust functionality Leverage vendor expertise System maintenance provided Access to functionality upgrades Access to a network of data providers Rapid implementation Vendor manages all connectivity Freedom to focus on core portfolio management competencies Future investments/upgrades are responsibility of provider

Hosted Solution

Remote access to specialist reconciliation system maintained by an independent software provider at an offsite location

One-size-fits-all proposition Lack of control/accountability concerns Hosting fee could drive up operation costs

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Whatever solution you decide upon, make sure it: Connects you with data that is reliable and comprehensive enough to meet your reporting needs Integrates with your portfolio management and trading systems Gives you a level of control that you feel comfortable with Allows you to focus more on the tasks that you deem important

Meeting the Challenge and Seizing the Opportunity

In the face of soaring trade volumes, increasingly complex transactions, and the mounting pressure for faster reconciliation, investment management firms today face both a challenge and an opportunity. The challenge is to meet the growing market demand for accurate, real-time reconciliation regardless of volume levels. The opportunity is to increase efficiency, eliminate error-prone manual intervention, and reduce the labor and infrastructure costs associated with reconciliation. Fortunately, technological solutions exist that enable a firm to both meet the challenge and seize the opportunity. Introducing automated processes wherever possible across an enterprises operationswith all the advantages automation brings in terms of cost reduction, error minimization, and scalabilityis one of the most effective ways for industry participants to gird themselves for whatever changes and challenges lie ahead. While automation in itself may be no guarantee of success, a scalable and repeatable process will provide the foundation for stability and growthand a measure of protection against market uncertainty.

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About Advent Software

Advent Software, Inc., a global firm, has provided trusted solutions to the worlds leading financial professionals since 1983. Firms in more than 50 countries rely on Advent technology to run their missioncritical operations. Advents quality software, data, services, and tools enable financial professionals to improve service and communication to their clients, allowing them to grow their business while controlling costs. Advent is the only financial services software company to be awarded the Service Capability and Performance certification for its service and support organizations.

Advent Straight Through Processing Solutions

Advents STP solutions integrate Advent software applications with investment managers mission critical counterparties: brokers, the DTCC, custodians, data sources, and other systems. The key benefits of STP integration are: Lower costs and fewer errors for trade execution, settlement and reconciliation processes Increased choice when selecting counterparties and service providers Integrated data from industry-leading sources of security information

Find out more: www.advent.com

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