Back Offices Aren’t Modern

Posted by Jeff Carter
on October 31st, 2012

One of the reasons cited for exchanges in NYC being closed the last two days is the back office. The modern day back office of brokerage firms aren’t very modern. They haven’t embraced technology in the same manner that other back offices in other industries have. Automation is a slow process.

One of the reasons for that is custom. I first realized that with the crash of 1987. In the confusion the days after the Monday crash, one thing became crystal clear. Only the futures exchanges knew where all the money was, and whom to allocate trades to.

New Yorkers were pointing fingers trying to fix blame for the crash to the S&P 500 futures contract. The contract had been initiated in 1982, much to the chagrin of Wall Street. Then CME ($CME) chairman Jack Sandner threw down the gauntlet and refused to allow Chicago to be blamed for the crash. He asked the New York exchanges for their trade registers. CME and CBOT had every single penny accounted for, allocated, P+S’ed, cleared and settled. Every trader knew exactly where they stood and who had traded with whom. The next day. Tuesday. The finger pointing stopped and Greenspan eventually absconded the Chicago exchanges from any blame. As a matter of fact, since Chicago exchanges stayed open on Black Monday while NY posts were closed, they became the pressure relief valve for the entire marketplace.

new york stock exchange (Photo credit: derek7272)

The standard in the stock industry is trade date +3 for clearing and settlement. It’s been that way for years. Initially, it was because they lacked the automation to even attempt to try and clear things daily. Today, the reason they do that is they hold onto money and earn a little juice on it. When interest rates are higher than they are today, the brokerage firms goose their earnings by skimming a little off the top on clearing. Cataclysmic events have a way of shining light on the dark corners of inefficiencies in business. Hurricane Sandy was no exception.

The Chicago exchanges could have been open the last two days with no problem. They also have disaster teams ready to spring into action with four hours notice. They can operate as if nothing happened when their main systems are down. I cannot speak for New York Exchanges, but it seems like their back up plans are lacking.

However, there is no excuse for the brokerage industry. Why their back offices aren’t in a secure cloud accessible from anywhere in the world is beyond me. The only thing I can think of is that they like to earn a little juice, and there is no compelling reason to change. Barriers to entry are pretty high, especially after the passage of Dodd-Frank.

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