THE BUSINESS CASE FOR ADJUNCT BILLING IN CLEARING AND CUSTODY

November 2003

1 INTRODUCTION
Rating and Billing of clearing and custody services by clearing houses, exchanges and primary custodians has traditionally been a function of the clearing or custody platform itself. Equally, exchange members, sub-custodians and asset managers have not required details of these costs, happily allocating them to central overhead budgets. However, providers of custody and clearing services are starting to demand both flexible pricing and discounting of services whilst users are demanding more transparency and more control over the allocation of those costs.

Current developments in the sector suggest that these demands will be increasingly more difficult to satisfy without an adjunct rating and billing platform, independent of the development cycle of the clearing and custody platform itself, which tends to be lengthy and bespoke in nature.

Two key factors are now evident in the clearing and custody market:

Faster product introduction and consequently pricing thereof;

More dynamic pricing;

This document examines both the demands and advantages of a separate best of breed rating and billing engine in the clearing and custody market.

2 DRIVERS FOR BEST OF BREED BILLING IN CLEARING AND CUSTODY
Flexibility in both costing and billing of trading, custody and clearing services is been driven from two different sources: primary providers, such as:

Derivative, Equity and Commodity Exchanges;

Primary Clearing Houses, e.g. Crest, DTCC, LCH;

Primary Custodians;

and users of the above mentioned services who could be classified as secondary providers, such as: Banks and Custodians, e.g. BONY, State Street, etc;

Asset Managers;

Investment Banks;

Outsourced settlement service providers. Both these groups have similar functional requirements but from different perspectives.

2.1 UNBUNDLING OF CHARGES
As clearing moves closer towards the STP goal, institutions are demanding more transparency in the charging process. At the same time both exchanges and clearing houses are looking at models that are more usage based than flat fee based. This is designed to drive efficiency in the market by making secondary users pay for actual usage.

In the new model, an institution will pay for the actual constituents of the clearing process. In the case of a correctly entered trade, which is matched and settled “without touching the sides”, fees will be kept to a minimum. However when a trade requires several efforts to clear, through mismatching or poor input, then the additional usage of the platform will be charged accordingly.

Fixed Bargain Charge

Segmented Bargain Charge

A prime example of this is the recently announced changes to the Crest tariff, which were implemented on a separate rating and billing platform, transferring charging responsibility away from the Crest settlement engine.

The principal going forward is that each element of a transaction must be able to be priced and billed, either individually or collectively.

2.2 RAPID PRODUCT INTRODUCTION
Notwithstanding current volumes, exchanges are still driving towards the introduction of fungible cross border products, such as the introduction of single stock futures from NASDAQ to Euronext Liffe. Charging for both trading and clearing of these new products has to be introduced both rapidly and with the flexibility to react to demand.

Fundamental to the business case for separating the pricing process from the clearing or custody platform is the ability to develop products and product bundles independently and, of equal importance, rapidly. Often, product development can run ahead of the ability of internal software development paths, meaning delays in changes to product and pricing rules. Separating costing and billing processes from the main trading or settlement engine allows products to be developed without software changes thereby enabling innovation to be independent of the software development and release lifecycle.

2.3 DISCOUNTING
Primary provider tariffs are often slow to change and often subject to regulation. However the continuing consolidation in the secondary market for custody and clearing services will lead to further pressures on both sectors as they compete for business. Therefore, rules-based discounting is an increasing phenomenon. Providers need to discount both at the individual rate and at the total bill level, according to rules based on various parameters such as type of member or size of aggregate trade volume.

Example Rating and Billing Parameters

This demonstrates that through rules-derived pricing, based on parameters ranging from volume to market efficiency, pricing models can be adjusted at the individual event pricing level or for an aggregate charging period, i.e. at the billing level.

Whatever parameters are used for charging, the ability to introduce these pricing changes quickly is paramount, given the increasingly competitive environment. Reacting to market changes independently of clearing platform development cycles is critical.

2.4 VALUE ADDED SERVICES
Equally, primary providers, conscious of these pricing pressures, are eager to offer more value added products to counteract global clearing becoming a commodity. Many of these services are not specifically related to events taking place on the clearing platform itself. These value adds are principally designed to be ‘sticky’ in nature, as an incentive to customer loyalty.

For secondary providers this is also becoming the case, driven by large back office outsourcing deals where invoicing goes beyond clearing and custody to the passing through of primary costs on a cost plus basis.

2.5 SUPPORT FOR COMPLEX ACCOUNT HIERARCHIES AND USAGE ANALYSIS
Secondary providers of dealing, custody and clearing services are continuing to consolidate into global institutions with complex cross border corporate structures. Moreover, the current ‘squeeze the pips’ drive for efficiency in operations will lead to customers demanding more complex breakdowns of invoicing, not just from a branch perspective, but also by cost center base.

Whereas event records from an invoicing perspective have traditionally been seen as a means of generating bills and collecting revenue, the move to more element-based charging makes these records a powerful tool for analyzing not only those costs, but also where there may be areas of inefficiency in back office systems or processes.

In order to be able to provide these slice and dice facilities to customers, there are two core requirements of the billing platform:

The ability to create and manipulate complex sets of accounts and sub accounts at the billing level;

The ability to provide rated data to secondary customers in multiple formats, such as HTML and CSV, with multiple delivery mechanisms, such as the web and e-mail;

Output data can also be used on a consolidated basis as a revenue assurance mechanism, to audit trail platform usage against billed usage.

2.6 ACCOUNTS RECEIVABLES, PAYMENTS AND CREDIT CONTROL
As both account structures and output formats become more complex, so does the need to effectively manage the accounts receivables. Not only does the allocation of payments between sub accounts become more important, but also the tracking of collection’s against due dates for the purposes of credit control.

Equally, the consolidation of general ledger receivables and the ability to allocate events to the general ledger both in terms of revenue and cost is equally important.

In addition to events there is also the issue of raising miscellaneous charges for items such as training in an efficient manner, ensuring these payments are also collected against deliverables.

Given the above accounts management, effectively becomes a CRM function, in which case the accounts manager, needs to have clear visibility of payments against various billable accounts as well as the ability to drill down on both billed and unbilled data, through a user friendly interface or via an API to the organisation’s CRM system.

2.7 BUSINESS PROCESS MANAGEMENT
As accounts and the nature of the global account relationship become more complex it is important that not just the billing and collections process is monitored. The business processes in creating new members and the management of provisioning of services also need to be tracked.

The business processes of CRM are often closely linked to accounts and billing, as charges for services such as terminal installation often need to be recorded and raised prior to the new member actually generating trade. Moreover, the account manager needs to be sure that compliance and due diligence procedures have been followed prior to activation of the clearing account.

These are all arguments for these processes being linked directly to the billing platform, with visibility of these business processes through CRM.

3 CONCLUSION
The portfolio of products for both primary and secondary market participants will inevitably continue to grow, as will the complexity of rules from which those charges are derived. This presents both challenges and opportunities. However, both of these can be met though the application of an adjunct rating and billing application as part of the trading or clearing architecture of an organization.