Trade Reconciliation: A Comprehensive Guide

Transaction reconciliation ensures that an asset manager’s internal information aligns with brokers. It’s the first step in ensuring a smooth NAV setting process and avoiding settlement issues.

Trade reconciliation meaning

The trade reconciliation process involves comparing internal records against those of brokers or custodians. Trades can be initiated:

Internally, which is the most common case - for example, when a Portfolio Manager makes a change to a portfolio.
Externally, e.g., if FX-hedging is outsourced to the custodian.

Regardless of who initiated the trade, reconciliation compares multiple parties’ trade records - to ensure all parties share the same view of what has been traded and any associated fees.

When to perform trade-by-trade reconciliation

Every day (or in real-time intraday), the asset manager reports trade details to the custodian. A trade order management system (OMS) typically handles the transmission of this report. The OMS can be a stand-alone system or part of a broader investment management software (as with Limina).

The counterparty in the trade will also send its view of trades to the market. If the trades don’t match, trade settlement can fail.
Therefore, the ideal timing of reconciliation in the trade life cycle is before trade settlement.

Reconciliation diagram - light bg

Types of transaction data to reconcile

What to reconcile on each transaction:

What	Description	Why important
Trade quantity	Number of shares/units traded or the notional.	Avoiding disputes and ensuring correct cash, NAV and P&L recon.
Execution price	The quoted price of the transaction (dollars, cents, points, clean/dirty, etc).	Avoiding disputes and ensuring correct cash, NAV and P&L recon.
Commission	The calculated commission payments	Ensure correct application of the counterparty. Facilitate correct NAV and cash reconciliation
Other Fees & Taxes	These might include stamp duties, exchange fees, regulatory charges or other taxes.	Ensure correct application of the counterparty. Facilitate correct NAV and cash reconciliation
Allocation to Mandates or Funds	For orders traded on behalf of multiple funds/mandates, the order is allocated according to some algorithm to the correct portfolios.	Avoid settlement failures. Read more about fund reconciliation.

EXPLORE LIMINA'S RECONCILIATION

Importance of post-trade reconciliation

Trade reconciliation isn’t mandatory, so not all investment managers perform it. The primary reason to reconcile trades is to avoid trade settlement failures, which can be expensive and time-consuming.

The likelihood of trade failures increases with higher trade volumes, so it’s highly recommended to do trade reconciliation if you trade a lot. The markets you trade in also affect the consideration of reconciling transactions. In emerging markets, there tend to be more (and more complex) fees and taxes than in other markets – making trade details in these markets more challenging to get right. Some markets also penalise you if you have a trade that is failing.

An additional benefit of all types of recon is that it creates an audit trail. Good fund reconciliation software allows you to review which party had what information, what breaks there were, and what was done about it.

Catching trade breaks with reconciliation

It’s important to note that you will catch trade reconciliation breaks anyway – just later in position and cash reconciliation. For example, the cash reconciliation will show a break if you have a discrepancy in commission. Another example is position reconciliation, which will show incorrect quantity if the trade is incorrectly allocated.

It’s easy and fast to understand a break on the trade level - for example, a mismatch on commission is immediately apparent. That break would be caught in the cash reconciliation later (but more challenging to identify) even if trade rec isn’t conducted. But at that point, it might also be too late to avoid a settlement failure. It’s also more difficult to troubleshoot since all you see is a difference in cash balance without knowing where it’s coming from.

The role of trade confirmation and affirmation

You can delegate the reconciliation of trades to a matching platform. You and your broker submit your respective transaction information electronically to a platform. When the details match, the matching platform affirms the trade.

The main benefit of using a matching platform instead of reconciling with each broker is that you avoid the work of setting up connectivity and processes with each broker. Setting up individual recons was historically a very cumbersome process, but nowadays it’s much more straightforward thanks to new advances in connectivity software.

Challenges in Transaction Reconciliation

Data entry mistakes & double-entry

There is always a risk of human error when data is entered manually. We recommend letting software automatically import or generate data as often as possible. For example when raising orders, instead of entering a number of shares – enter just a target exposure and let the system calculate shares based on a limit price or the latest price in the market.

Your OMS should always automatically generate information such as fees and taxes according to the rules you’ve defined.

It’s also highly recommended never to enter data twice, for example, manually keying confirmation data into an accounting system. Straight-through Processing (STP) minimises the “fat fingers” risk, which is an operational risk.

Fast (or even automated) break resolutoin

Resolving trade breaks should be as fast as possible. For example, if the reason for the break is incorrect information in the OMS, it should be possible to amend the trade with one click or even automatic rules.

A prerequisite for this process to be as efficient as possible is that the OMS is part of your investment management system, not a stand-alone system. If it’s separate, then the amendment happens in one of them and needs to be synced to the other – adding risk for errors even if this sync is automated.

Complex transactions: OTC & FX

Common discrepancies are on fees or taxes, especially in emerging markets. It’s uncommon that quantity or price will differ (if quantity and price are filled automatically from the information received from the market).

Investment reconciliation can be more complex on OTC derivatives and foreign exchange (FX). This is because instrument information needs to be reconciled in addition to the execution and fee/tax details. Using an FX Swap as a trade reconciliation example, one maturity date and two FX rates must be reconciled and done on the correct decimal places. The currency pair and directions might also be a good idea to reconcile in case of data entry mistakes internally or at the counterparty.

False positives (flagging breaks that aren't breaks)

Ensuring that the OMS can generate the exact correct fees and taxes on trades is crucial, especially in emerging markets where decimals can matter. Once done, the next key is to ensure reconciliation tolerances are set up to match those of the custodian. If not, the system will flag false positives (breaks that aren’t actual breaks).

Such false trade reconciliation breaks are a waste of time for your team to review. Furthermore, false breaks increase the risk of errors since humans will go numb to the results and miss the actual breaches.

Exception-based workflows

You’ve achieved “exception-based workflows” when you have the above four components.

Exception-based workflows are an approach to automation where the software is responsible for the complete trade life cycle in case of no errors. If everything is ok, or can be managed within pre-set rules, no human is needed.

Only when a break can’t be automatically resolved will the software call for a human to help with the resolution.

These are exception-based workflows and the entire premise of Limina’s investment management system.

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Andreas Holtz

Experienced client relations professional with a proven track record of building and nurturing successful client relationships, bringing a strategic and customer-centric approach to every interaction.