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Straight-through processing (STP) is an initiative used by financial companies to speed up the transaction process. This is performed by allowing information that has been electronically entered to be transferred from one party to another in the settlement process without manually re-entering the same pieces of information repeatedly over the entire sequence of events. The goal of STP is simple – reducing the time it takes to process a transaction will increase the likelihood that a contract or an agreement is settled on time.
STP was invented in the early 90s by James Karat in London to describe automated processing in the equity markets. It was also used around the same time by SWIFT, the banking cooperative, to describe automated processing in the payments arena.
While working with the London Stock Exchange (LSE) on the sequel project, and with the asset manager, LGT A/M, Mr. Karat cites the reason for developing the system as simple. The process before STP was very antiquated: sales traders would have to fill in a deal ticket, blue for buy and red for sell. The order was invariably scribbled and mostly unreadable. Upon receiving the order, the trader would execute on the market a usually incorrect investment. The runner picking up the ticket (in this case, Mr Karat) would input the order into the system to send out a contract note. For example, if the client wished to purchase 100,000 shares, but the trader only executed 10,000, the runner would send out the contract for 1,000. In those days, there was a T10 settlement so any errors were "fixable". However, with the new introduction of T5, the settlement arena changed, and STP was born. Mr. Karat realised that to reduce the exposure of risk, failed settlement, there could only be one "golden source" of information and that the onus was on the sales trader to be correct as he/she had the power to correct any discrepancies with the client directly.
The concept has also been transferred into other sectors including energy (oil, gas) trading and banking, and financial planning.
Currently, the entire trade lifecycle, from initiation to settlement, is a complex labyrinth of manual processes that take several days. Such processing for equities transactions is commonly referred to as T+2 (trade date plus two days) processing, as it usually takes two business days from the "trade" being executed to the trade being settled. This means investors who are selling a security must deliver the certificate within two business days, and investors who are buying securities must send payment within two business days. But this process comes with higher risks through the occurrence of unsettled trades. Market conditions fluctuate, meaning a two day window brings an inherent risk of unexpected losses that investors may be unable to pay for, or settle, their transactions.
Industry practitioners, particularly in the US, viewed STP as meaning "same-day" settlement or faster, ideally minutes or even seconds. The goal was to minimise settlement risk for the execution of a trade and its settlement and clearing to occur simultaneously. However, for this to be achieved, multiple market participants must realize high levels of STP. In particular, transaction data would need to be made available on a just-in-time basis, which is a considerably harder goal to achieve for the financial services community than the application of STP alone. After all, STP itself is merely an efficient use of computers for transaction processing.
Historically, STP solutions were needed to help financial market firms move to one-day trade settlement of equity transactions, as well as to meet the global demand resulting from the explosive growth of online trading. Now the concepts of STP are applied to reduce systemic and operational risk and to improve certainty of settlement and minimize operational costs.
There is often confusion within the trading world between STP and ECN (Electronic Communications Network). Although they are similar initiatives, ECN connects orders with those of other traders as well as man liquidity provides. An ECN is also typically a bigger pool of orders than a standard STP.
When fully realized, STP provides asset managers, brokers and dealers, custodians, banks and other financial services players with tremendous benefits, including greatly shortened processing cycles, reduced settlement risk, and lower operating costs. Some industry analysts believe that STP is not an achievable goal in the sense that firms are unlikely to find the cost/benefit to reach 100% automation. Instead, they promote the idea of improving levels of internal STP within a firm while encouraging groups of firms to work together to improve the quality of the automation of transaction information between themselves, either bilaterally or as a community of users (external STP). Other analysts, however, believe that STP will be achieved with the emergence of business process interoperability. As an aside, an enabler of STP is Straight-Through Quality, but this should not be considered a complete solution to STP, as it is just a tool in helping to achieve an STP implementation.
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