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.
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. |
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
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.
