To understand STP, you need to understand the concepts of the front office, middle office, and back office. These are, role-wise, the segregation in a member’s office or trading institution’s office.
The front office is responsible for trading. In a broker’s office, the front office speaks to various customers and solicits business. The front-office staff is also responsible for managing orders and executing them.
The back-office staff is responsible for settling transactions. The back office ensures that all obligations toward the clearing corporation are met seamlessly and that the member receives its share during pay-out.
While this entire process is happening, the middle office monitors all limits and exposures, and thus risks that the firm is assuming. The middle office is also responsible for reporting, especially where corporate-level reporting is required.
Since a broker’s office is organized into front, middle, and back offices, solution providers structure their products in the same fashion in the form of modules. Although many vendors provide solutions for all three sections, it is not mandatory for a broker to buy all three modules from the same vendor. If a broker goes for different vendors, though, then they have an issue of inter-module communication. Most brokers want all the three modules to be integrated. If they are not, then data will have to be entered multiple times in these modules. To obviate from this problem, brokers rely on a concept called STP.
STP, as defined by the Securities Industry Association (SIA), is “...the process of seamlessly passing financial information to all parties involved in the transaction process, spanning the investment manager decision through to reconciliation and statement production, without manual handling or redundant processing in real time.”
Two types of STP exist: internal and external. In the case just discussed, internal STP is required because you need to connect modules installed in a broker’s office. But some other entities such as custodians, fund managers, and so on, play an equally important role in settlement. To achieve true STP, even these need to be connected to each other. Any attempt to connect such entities beyond the organization in pursuit of STP is called external STP.
The industry wants to put processes in place that will allow an order to flow right from deal entry to conversion to trade to affirmation and confirmation and finally through settlement and accounting without manual intervention. This is because the industry wants to move toward T+1 settlement. This means trades done on one day will get settled the next day. This is an ambitious plan because it will call for a lot of process change, technology change, and industry change. Applications will have to come together and orchestrate the entire business process.
STP provides a lot of benefits to industry participants:
- STP reduces settlement time. This essentially reduces risk because transactions will be settled faster and will be irrevocable. Settlements are said to be irrevocable when they are considered to be final and cannot be reversed. Reduced settlement time also means better utilization of capital.
- Less manual intervention will mean fewer operational risks and errors. It will also mean fewer costs.
- STP will force the entire industry to move toward standard communication protocols. This will mean standardized systems and fewer system development and maintenance costs. Interoperability will be a prerequisite for this to happen.
- Increased automation will lead to increased throughput in transaction processing, thereby enabling institutions to achieve greater transaction volumes.
Equity trading and STP by itself are vast subjects, and understanding every minute business detail in a single go is not possible; furthermore, the functioning of every stock exchange is different from one another (though the concepts are fairly standard).