STP in Institutional Trading — Step 3: Settlement                 Brokers’ back office systems transmit allocated trades or blocks to CDS. Using CDS’ systems, Custodians review the trades and blocks, comparing them against their own records sent by the investment managers. Each allocated trade that matches the Custodian’s copy of the same trade is marked on CDS’ system for settlement. If an allocated trade does not match any on the Custodian’s records, it is “DK’d” (i.e., rejected as “Don’t Know this trade”). Sometimes allocated trades match in all “significant” details with minor inaccuracies (e.g., a minor variance on commission calculation). Such trades can be settled or “DK’d” at the discretion of the Custodian. In theory trades should all match, but the extensive use of manual processes introduces error at several points along the way. A certain percentage of rekeyed trades, allocations and settlement instructions are bound to contain human error. Beyond that, certain percentage of calculations (commission calculations, accrued interest calculations, etc.) calculated by independent systems are bound to disagree from time to time. The result is some trades go to the wrong custodian and some trades do not match. The problem with unmatched trades is the difficulty in tracking down the errors. There is little transparency in this process, which means that staff investigating errors often need to phone each of the parties in both processing streams to have them check physical records. This is a time-consuming process, itself having its own share of errors. Worst are the errors that do not appear right away. DK’d trades that aren’t acknowledged, trades settled accidentally that should have been fixed or DK’d, etc., create problems that may not surface for days or even months. Correcting such errors can be very costly, particularly where large accrued interest values are involved or major market price fluctuations have occurred, since error correction can require going into the market to make good a confirmed trade.

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