Understanding 'seamless' stock trading

INVESTING

The Indian stock market is ready to implement "straight-through processing" (STP), while the banking system under the auspices of the Reserve Bank of India (RBI) is ready to implement "real time gross settlement" (RTGS).

Both events are expected to have a major impact on the way that trading and settlements (including payments) take place on the stock markets now.

How do we define STP? Let us first try to look at what STP does. It does away with the need for manual intervention at every point right from the time that the investor puts in an order with the broker and right up to the settlement system "" which includes pay-in and pay-out of securities and of funds.

This kind of a system reduces the impact of risks by reducing trade fails based on advanced matching of trades between participants and by providing an electronic information flow that goes through seamlessly.

Let us try to simplify this further. When an investor places and order with the broker this information is keyed in manually by the broker into his system and transmitted to screen-based trading system of the exchange.

At the exchange level after the execution of the deal the transaction information is transmitted to the broker who generates the contract note for the client and so it goes on.

So now we have a definition - STP is seamless integration of trades in the securities market from initiation to settlement without manual intervention.

It maximises automation and reduces human errors, increases speed of operations and reduces failed trades. One obvious benefit of this is that everything happens in real time - or at least almost-real time basis.

Now lets us take an example. Mohan Natarajan, chief technology officer of Kotak Securities, has explained the concept in a typical contract note flow.

A fund house, say, decides to invest in one lakh shares of Reliance and this information is conveyed to the broker for dealing. The broker, in turn, confirms the order in single or multiple trades on the National Stock Exchange or the Bombay Stock Exchange.

Post-execution the broker would generate a contract note in his back-office system. This would be sent to the fund house by courier or hand delivery.

The fund house then verifies the contract note and has the discretion to either accept it or reject it. The acknowledgment is sent to the broker for accepting or rejecting the contract note.

If accepted, the fund house would generate the settlement instruction in his back office and sends it to the custodian for clearing the trades.

In the above example, what happens is that different systems are used - the fund house has its own system, the brokers has his own system and custodian would have its own system. If STP were used then a single system would be used for the entire process.

According to Natarajan, "global experience shows that a major disadvantage of using multiple systems is non-synchronization of data between different links in the processing chain."

The ideal STP solution should :

• Cover all products handled by an existing desk
• Be a truly integrated solution not requiring additional interfaces
• Price products in a consistent way in all phases of processing, and
• Maintain static data in a central location.

This can be extrapolated to the settlements system also, where funds flow from the banks to the clients without any manual intervention. But this is possible only if real time gross settlement is present.

An RTGS system is defined as a gross settlement system in which both processing and final settlement of funds transfer instructions can take place continuously (i.e. in real time). As it is a gross settlement system, transfers are settled individually, that is, without netting debits against credits.

As it is a real-time settlement system, the system effects final settlement continuously rather than periodically at pre­specified times provided that a sending bank has sufficient covering balances or credit.

Moreover, this settlement process is based on the real-time transfer of central bank money. An RTGS system can thus be characterised as a funds transfer system that is able to provide continuous intra-day finality for individual transfers.