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OPERATIONS IN FINANCIAL INSTITUTIONS - WHY IT’S MORE THAN JUST PROCESSES

OPERATIONS IN FINANCIAL INSTITUTIONS - WHY IT’S MORE THAN JUST PROCESSES. B60.2315.20 OPERATIONS IN FINANCIAL SERVICES. Spring 2002.

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OPERATIONS IN FINANCIAL INSTITUTIONS - WHY IT’S MORE THAN JUST PROCESSES

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  1. OPERATIONS IN FINANCIAL INSTITUTIONS - WHY IT’S MORE THAN JUST PROCESSES B60.2315.20 OPERATIONS IN FINANCIAL SERVICES Spring 2002 This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.

  2. NY-101613.103/020417YlpolSL1 THREE OPERATIONS-RELATED THEMES FOR FINANCIAL INSTITUTIONS • How to apply “manufacturing techniques” to reengineer and rethink the operations processes • How to use offshoring to redefine the traditional operations location and operating model • How to respond to industry planned next-day trade settlement (T+1) initiative

  3. NY-101613.103/020417YlpolSL1 THREE OPERATIONS-RELATED THEMES FOR FINANCIAL INSTITUTIONS • How to apply “manufacturing techniques” to reengineer and rethink the operations processes • How to use offshoring to redefine the traditional operations location and operating model • How to respond to industry planned next-day trade settlement (T+1) initiative

  4. A manufacturing approach based originally on the Toyota production system • Has since been adapted by leading manufacturing companies around the world including most of the automotive industry, General Electric, Allied Signal, Solectron, Alcoa and many more • Many of these techniques are starting to be applied in service industries, including financial services, driving quick and dramatic improvements in performance, often without the need for significant investment NY-101613.103/020417YlpolSL1 LEAN MANUFACTURING – GENESIS AND KEY PRINCIPLES • Key principles of lean manufacturing • A workforce that is “waste aware” and skilled in reducing/eliminating waste • Level production load from matching demand to capacity/supply • A just-in-time production process that produces only when needed and in quantities required • A process designed to deliver quality the first time using robust, ‘in-process’ mechanisms • An energized organization with the processes and capabilities to achieve continuous improvement year after year

  5. NY-101613.103/020417YlpolSL1 LEAN MANUFACTURING LEVERS TO ACHIEVING OPERATIONS EXCELLENCE • Specific improvement • Example • Main lever • Migrate to lower cost channels • Reduced channel cost in credit card company by 50% due to migrating inquiries from call center to Web • Optimize/manage complexity • Segmented volume based on customer profitability to maximize contribution margin • Manage demand at the source • Level load incoming demand to match supply • Created measures encouraging branch loan applications to arrive on an ongoing basis during the workday • Capture information and correct errors one time, accurately, at the source • Reduced labor costs 40% in check processing due to one-time, quick capture of information • Understand customer preferences/tradeoffs • Conducted customer interviews to optimize required decision time of loan application • Standardize and stabilize work processes • Reduced variability on incomplete application handling to a no tolerance approach which improved completion rate by 50% • Streamline critical path • Ordered appraisals on homes for equity loans earlier in the decision process • Optimize process, layout, and flow • Operations excellence • Build in quality • Created data entry forms that have restricted fields to reduce incoming errors • Create one-piece synchronized flow • Redesigned the underwriting process to a single piece, first-in/first-out flow which reduced turnaround time from hours to minutes • Organize around processes, not tasks • Created “end-to-end” accountability for performance not department/task-based accountability • Set clear process metrics • Created a performance scorecard including timeliness, service quality, and cost/productivity measures • Manage perfor-mance • Determine stretch targets • Designed stretch targets based on theoretical limits, not incremental performance • Tailor incentives and consequences to results • Tied process metrics to team-level performance and to team compensation

  6. NY-101613.103/020417YlpolSL1 MANAGE DEMAND: CHANGE SCHEDULES TO MATCH DEMAND Number of applications Fax demand Current schedule capacity New schedule capacity 140 120 100 80 60 40 20 0 7 AM 8 9 10 11 12 PM 1 2 3 4 5 6 7 8 9 10 11

  7. NY-101613.103/020417YlpolSL1 OPTIMIZE PROCESSES, LAYOUT AMD FLOW: LISTED EQUITIES TRADE FLOW A Automated Automated Eliminated Manual Sales/trading Exchange floor Middle Order Cash- Daily P&S Office Room iers P&L Messengers/data Sales/traders Block traders Booth Brokers entry operators 1. Enter order into A 8. Write down order (or print order from B) 4. Acknowledge order A A A 5. Write down order on pad 10. Pick up order at booth 2. Select block trader from pull-down menu 9. Beep $2 or house broker A Rejected by D 11. Execute order in crowd 3. Send order to trader through A 6. Decide exe-cution strategy Call order into D sales/trader Executed by D 7. Call order to floor/enter order into D 12. Call verbal to booth Client A A 15. Write down execution & check against pad 13. Deliver written to booth 14. Call back execution (or type into B) A A 16. Enter execution into A 20. Write floor execution report 21. Pick up floor reports and deliver for punching 17. Send/allocate execution to sales/trader 22. Type floor report into 18. Call execution to client A 19. Print house execution report A Systems A B C Rolesinvolved* • Sales/ traders • Assistant • Booth • House brokers • Key punch • traders clerks $2 brokers operators • Block traders • Runners *Support block desk and other products

  8. NY-101613.103/020417YlpolSL1 IMPACT FROM REDESIGNING LISTED EQUITIES TRADE FLOW • Description of opportunity • Trade flow involves over 70 steps, 40 of which are manual • Manual steps and the resulting errors requires hiring costly FTE and limits capacity • Large numbers of systems increasing the level of complexity and steps • Numerous reconciliations based on multiple sources of data entry Steps in trade flow process • Financial impact • 10% reduction in FTEs • Total steps • Manual steps -13% • Key success factors • Walking the process to see each activity first-hand • Willingness to redesign the process from scratch rather than generating changes to current system • Make sure the trade flow is right before introducing technology -33% • Assumptions • Service levels to customers would not decline • The majority of manual steps do not require complex decisions that cannot be automated • Before • After* • Before • After • Implementation time • 12-18 months * New design also reduced flow through 18% of remaining steps

  9. 5 Order documents for equity second decision 6 Receive documents from vendors 8 Mail back to branches 2 Print credit report 3 4,7 Underwriting 1 Receive fax NY-101613.103/020417YlpolSL1 OPTIMIZE PROCESSES, LAYOUT AMD FLOW: UNDERWRITING ACTIVITY From convoluted physical flow PC Order x x Denial PC Printer Printer x U/Ws x x 6 x PC Printer PC Printer PC PC x x x PC x 3 regional underwriting queues PC x PC Fax Fax Fax

  10. 4,7 Underwriting Order/receive docs Mail back to branches 3 5,6,8 2 Print credit report 1 Receive fax NY-101613.103/020417YlpolSL1 OPTIMIZE PROCESSES, LAYOUT AMD FLOW: NEW UNDERWRITING PROCESS “Production” flow Phone U/W X X Single queue X X X X PC PC 10 paces Printer Printer Processors Fax

  11. Increasedunderwriting capacity by 40% NY-101613.103/020417YlpolSL1 IMPACT OF REORGANIZING UNDERWRITING ACTIVITIES • Eliminated transportation time, increasing underwriting capacity by 6% • Moved all clerical work to processors, increasing underwriting capacity by 11% • Transitioned all first and second decisions to 4 underwriters (and reprioritize tasks), decreasing through-put time • Created ‘phone underwriter’s positions (for 2 staff members) to handle all communication and non-time-sensitive underwriting, allowing other underwriters to focus exclusively on first and second decisions

  12. 123 123 123 Date 123 Jane Doe 123 Main Street Anywhere, PA 11111 Date Pay to the Order of Date Pay to the Order of Date Any Bank Anywhere Pay to the Order of Dollars Any Bank Anywhere Any Bank Anywhere Pay to the Order of Dollars Any Bank Anywhere Dollars Dollars For For For For NY-101613.103/020417YlpolSL1 OPTIMIZE PROCESSES, LAYOUT AMD FLOW: CURRENT CHECK PROCESSING • Checks are transported from branches to centralized processing site • Each check is read by a proof operator who enters the amount which is MICR encoded onto the check • The checks are then run through a sorter equipped with a MICR reader and microfilm camera – data from each check is sent from the sorter to the bank’s IP servers • Checks are then prepped and put into trays

  13. 123 123 123 Date 123 Jane Doe 123 Main Street Anywhere, PA 11111 Date Pay to the Order of Date Pay to the Order of Date Any Bank Anywhere Pay to the Order of Dollars Any Bank Anywhere Any Bank Anywhere Pay to the Order of Dollars Any Bank Anywhere Dollars Dollars For For For For NY-101613.103/020417YlpolSL1 OPTIMIZE PROCESSES, LAYOUT AMD FLOW: IMAGE TECHNOLOGY • Checks are transported from branches to centralized processing site • Checks are prepped and put into trays • Each check is run through a sorter equipped with a MICR reader and a digital camera which captures an image of the front and back of the check Jane Doe 123 Main Street Anywhere, PA 11111 123 Date • The images are then run through OCR software to determine the amount; the amount and other infor-mation on the check are sent to the bank’s server • For checks where the image cannot be read, a person at a terminal reviews the image and enters the amount

  14. -25% • -83% • Streamline critical path • Eliminate redundant activities to reduce time to get an entry through the process • Low investment required to move sorting equipment NY-101613.103/020417YlpolSL1 IMPACT OF NEW TECHNOLOGY ON CHECK PROCESSING • Operational lever • Time to get 1 entry through process • Selected changes • FTEs • Optimize/ manage complexity • Improve labor utilization by introducing cross-training and workcells • Build in quality • Reducing the number of touches will provide fewer opportunities or errors • Before new process • Since new process • Before new process • Since new process • Organize around processes, not tasks • Team-based accountability improves total system quality

  15. NY-101613.103/020417YlpolSL1 THREE OPERATIONS-RELATED THEMES FOR FINANCIAL INSTITUTIONS • How to apply “manufacturing techniques” to reengineer and rethink the operations processes • How to use offshoring to redefine the traditional operations location and operating model • How to respond to industry planned next-day trade settlement (T+1) initiative

  16. NY-101613.103/020417YlpolSL1 RECENT SIGNIFICANT REDUCTION IN INTERACTION COSTS • Advancing technology • Maturing markets • Easing regulation • Reduction in bandwidth costs • Supplier base – India • $ Billions, revenue • Strong financial incentives (Malaysia example) : • 100% tax exemption for 10 years • No VAT • Aggressive operating incentives (India example): • State-sponsored training in “soft and domain specific skills” • Privacy protection act to protect offshored customer data • SLA’s between state and telecom providers to ensure dedicated, high quality supply • $ Thousands PA for 2 Mbps fiber leased line*, half circuit CAGR 69% Mar 2000 • 85% drop in India as state monopoly faces competition from private satellite providers Mar 2001 Mar 2002E • Employment in offshoring industry – India • Thousands • Philippines CAGR 53% Mar 2000 • India • Ireland Mar 2001 • U.S.** Mar 2002E * Cost of international leased line for India; cost of long distance domestic leased line in the U.S.; costs are for January each year; for India, based on Mumbai or Cochin ** U.S. half circuit data is derived by dividing full circuit data by half Source: VSNL press releases; literature search; Lynx, Goldman Sachs estimates; McKinsey analysis

  17. . . . to globally placed links in the supply chain driving optimal value • System development • Credit decisioning • Call center • Customer research • Data entry • Objective • Remote servicing is the placement of operational units at globally optimal locations based on factor and interaction costs, timeliness, and quality of service • Key drivers for the banking sector • Centralizeable operations • Significant labor cost differentials • Manageable communication/monitoring costs • Available and reliable technology/infrastructure • Supportive regulatory and political environment NY-101613.103/020417YlpolSL1 REMOTE SERVICING HAS BECOME A LEVER FOR DRIVING PERFORMANCE • From physically co-located end-to-end operations . . .

  18. NY-101613.103/020417YlpolSL1 THREE DIMENSIONS OF BENEFITS FROM REMOTE SERVICING Cost • Dramatic reduction in cost (10-30%) • Increased flexibility permitting greater capacity/demand balancing • Improved transparency and predictability • Operational improvement Quality Time • More established processes and metrics for meeting higher performance standards • Access to basic and specialized skills • Minimized baggage of outdated infrastructure, e.g., software • 24 x 7 service • Faster turnaround times from learning curve benefits • Continuous production possible with effective synchronization

  19. NY-101613.103/020417YlpolSL1 LOCATIONS USED TO REMOTE SERVICE DIFFERENT SERVICES • Ireland • Software development • Call centers • Shared services • India • Call centers • Data entry • Software development • Engineering design • Back-office operations • Caribbean • Data entry • Philippines • Software development • Call centers • Data entry • Ukraine • Software • Singapore • E-commerce hub • Shared/financial services • South Africa • Financial services Source: McKinsey analysis

  20. Oil • Packaged goods • Telecom • Retailing • Utilities • Automotive • Computer • Banking • Insurance • Pharma-ceuticals • Third-party engineering and design services • Electronics • Airlines • Aerospace • Chemicals • Steel • Equipment • Ship building • Hotels • Entertain-ment • Real estate brokerage • Software producer • Third-party call center providers NY-101613.103/020417YlpolSL1 LARGE OPPORTUNITIES IN BANKING AND INSURANCE Areas of greatest opportunity • High (300+) • U.S. cost base industry • US$ Billions • Medium (100-300) • Low (0-100) • Low (0-1%) • Medium (1-5%) • High (5%+) • Remote serviceable processes share of cost base Source: U.S. Census Bureau; team analysis

  21. Data entry Revenue accounting Claims processing (Tier 1) Application processing Call center Data entry Claims Processing • CRM • Accounting Claims processing Claims processing • Financial reconciliation • Statutory reporting • Bill payments • Risk analysis • Underwriting • Transaction processing Call center • Planning and forecasting NY-101613.103/020417YlpolSL1 INITIAL FOCUS ON LOWER END PROCESSING/DATA ENTRY ACTIVITIES Current activities Future activities • Support activities (IT, HR) • Asset management • New business processing • In-force transactions • Customer acquisition • ( ) Source: Press searches; GE Remote services case study

  22. ESTIMATES NY-101613.103/020417YlpolSL1 EARLY MOVERS ARE ALREADY SEEING BOTTOM-LINE IMPACT 2001 Forecasted savings (public statements) • Cost savings • $ Millions PA* • Current • employees • Main activities • 9,500 • Call center, mortgage and insurance, accounting, bill payment • 340 • 6 • 14 • 20 • Back-office processing, e.g., payments, account services, support • 300 • 2,050 • Trade finance, check processing, data entry, customer services, loans, bills, credit cards, cash management • 70 • 35 • 105 • 6 • 54 • 60 • Transaction processing, e.g., accounts opening, mortgage clearing • 300 • 17 • 18 • 35 • 730 • Data processing, accounts, check clearing • 16 • 54 • 70 • 800 • Accounting services, operating services, and call centers • 14 • 41 • 55 • 400 • Insurance claim processing, call center * Total pretax operating cost savings based on labor cost savings for main activities adjusted for higher other costs (e.g., telecommunication); not adjusted for startup inefficiencies Source: Literature search; industry interviews; team analysis

  23. Details • Started operations in 1998 and has facilities in Mumbai, Bangalore and other places in India • Citibank Overseas Investment Corporation owns 37.2% of the company • Process ~ 70 million transactions of varying nature and complexity • Currently cater to mainly low to medium end remote service activities • Transaction processing • GF: Mainly focussed on trade finance related activities (Query handling, record keeping, scrutiny, data entry, authorisation and ledger entry). Some cash management activities including payment settlement account reconciliation and ledger keeping • GCB: Still in piloting stage (for TIDE loans, bills processing and expense tracking, credit card interchange) • Provides insurance claims & processing services • Technology services – software verification & validation, web catalog and content management, data center management • Call Centers – call centers, eCRM, sales and collection services : handle ~20 million calls • Merged with Citicorp Credit Services and added call center capability ESTIMATE 2,700 Impact 370 150 50 Current Impact: $40 million revenues expected for FY02 1998* 2000 2001 1999 NY-101613.103/020417YlpolSL1 CITIGROUP EXAMPLE • Corporate philosophy/thinking • Plan to become biggest outsourcing centre within Citigroup. • Works for over 22 overseas units - current geographies covered are CEMIA (Eastern Europe, Africa, South Asia). US and UK operations recently announced plans to use India as source base • Ensure at least 10% of total business comes from third party sources • Operate as a cost centre. Billing is on a cost plus basis for services offered. Billing per employee currently is $25,000-30,000/year * Start of year Source: Press searches, Interviews, McKinsey analysis

  24. Details • Started operations in 1994, first remote services effort in India • Located in Delhi - ~75,000 sq. ft. complex • ~800 FTEs; 100 of which are MBAs/CAs • Currently into low/medium and remote services activities. Mainly back-end batch processing • Accounts reconciliation • Accounts opening and closing • Cheque processing/other payment processing • Data processing • Expanding into call center operations Impact FTEs 1,500-2000 ESTIMATE Current Impact: $20 million/year** 800 700 500 1996* 1998 2000 2003(E) • “The new operations in India will include processing activities such as voice-based customer support, account & transaction processing and fraud and risk modelling” • Rajiv Ahuja, Amex's head of public affairs and communications for India and area countries NY-101613.103/020417YlpolSL1 AMERICAN EXPRESS EXAMPLE • Background/corporate philosophy • One of the three global financial resource centres (FRCs)of AMEX • 100% owned by AMEX. Caters only to AMEX internal requirements • Key geographies covered are Australia, New Zealand, Singapore, Japan, Hong Kong, Philippines • Future plans are to: • Expand into higher value added work such as planning and forecasting, account consolidations, risk modeling • Increase service lines especially in TRS for activities such as voice based customer support etc. * Start of year ** @$30000/FTE/year Source: Press searches, Interviews, McKinsey analysis

  25. Details • Started operations in 2000 - located in Hyderabad in an over 40,000 sq. ft. premises • Invested additional US$20million at the start of the year • Currently employs ~1,100 FTEs, mostly graduates • Has out performed UK banks on quality and productivity • Current activities include transaction processing, mainly in retail banking (processes are online but not real time) - Account opening/closing, standing instructions, monitoring inward clearing, mortgage processing • Recently announced plans to expand its operations to Bangalore ESTIMATE Impact 7,000 Impact$ million/year* 3,000 Current: 12 Expected : 120 1,100 2001 2002(E) 2003(E) NY-101613.103/020417YlpolSL1 HSBC EXAMPLE • Corporate philosophy/thinking • Created a separate 100% owned subsidiary (HDPI) of HSBC, UK to provide services • Provides support for select back office operations of UK and US bank operations • Caters to more than 17 business areas • Plans to • Expand into high-end retail banking processes and expand to wholesale banking processes, and other branches in Europe, and Australia • Reach 3000 FTEs by 2002 • Add another global processing center in Hyderabad • Invest additional $10 million * @$40000/FTE/year Source: Interviews, press searches, McKinsey analysis

  26. NY-101613.103/020417YlpolSL1 EXAMPLE PROCESS: END-TO-END LENDING Fully remote serviceable Partially remote serviceable • Origination • Servicing • Payout • Application to closing • Fund disburse-ment to coupon delivery • Description • Cost • Percent of total • Savings • Percent of cost • Initial customer contact • Data entry of applications • Underwriting/ credit decision- ing • Communication and upsell to applicant • Document preparation • Disbursements/ closing • 45-50 • 15-20 • Review of closing document for compliance • Booking of document to system • Funding • General ledger reconciliation • 25-30 • 6-10 • Scan and index of file • File management • Assist in internal and customer inquiries • Research of issues • 10-15 • 15-25 • Processing final payments • Releasing collateral • 5-15 • 20-25 Source: Team analysis

  27. . . . to a perspective of utility-like functions cutting across supply chains • Data entry • Recon-cilation • … • Strong candidates for remote servicing: • Data entry • Document prep. • Booking • Reconciliation/ compliance • Front-end collections • Call centers • Corporate center • Consumer lending • Commercial lending • From a perspective of product/service supply chains linked end-to-end . . . • Item processing • Trust services • Cash management NY-101613.103/020417YlpolSL1 FIRMS ADOPTING A “UTILITY” VIEW TO IDENTIFY OPPORTUNITIES

  28. NY-101613.103/020417YlpolSL1 POTENTIAL BARRIERS AND CONCERNS • General concerns • Perceived issue/risk • Reliability of telecom • Lower quality • Lower productivity • Cultural differences • High bandwidth costs • Unsustainable labor cost advantage • High government/ regional risk/ instability • Data protection • Operational complexity • Current status/method for management • Reliability has improved over the last 5 years – satellite now at about 99 percent; fiber at 95 percent • Significant further improvements are likely – addition of 14 TBps of international capacity; addition of 270,000 miles of domestic fiber • Players experiencing increases in quality due to lower turnover and higher skill level • Higher productivity and quality can be achieved through investment in training, compensation and labor pool rotations between on-shore and off-shore locations • Bandwidth costs have significantly declined due to deregulation and investment in capacity • Supply of talent in some locations ensures cost advantage will exist for 20-30 years • Unlikely given not harmful to domestic constituencies • Government supports action – e.g., U.S. and Indian government agreed to decouple information technology trade from politics • Can manage through multiple location operations (e.g., India and Philippines) • Early development of public relations strategy Infrastructure Service levels/ responsiveness Cost advantage Political/country Operations and community

  29. NY-101613.103/020417YlpolSL1 COMMON QUESTION: WHERE TO LOCATE? • Skills • Availability of frontline skills • basic/language • specialized (as appropriate) • Availability of senior management skill • Cost • Telecom/other infrastructure • Telecom bandwidth and reliability • Availability of IT service providers • Reliability of power sources • Regulatory environment • Mode of entry • Fiscal incentives • Operating area compliances • Attractiveness of a location for remote services • Political risk • Stable government • No domestic conflict • Legal enforcement • Bureaucratic transparency and limited corruption Source: Team analysis

  30. Subsidiary • Function provides competitive advantage • Skill exists internally • Immature supplier market • Growth business within strategy • Joint venture • Third-party contract • Mature supplier market • Function not critical to distinctiveness • Scale and skill advantages not in house • Need overflow capacity • Not part of mission/growth portfolio NY-101613.103/020417YlpolSL1 COMMON QUESTION: WHAT IS THE APPROPRIATE BUSINESS MODEL? • At scale • Size of operation • Significant sub-scale • High • Low • Degree of control desired

  31. NY-101613.103/020417YlpolSL1 THREE OPERATIONS-RELATED THEMES FOR FINANCIAL INSTITUTIONS • How to apply “manufacturing techniques” to reengineer and rethink the operations processes • How to use offshoring to redefine the traditional operations location and operating model • How to respond to industry planned next-day trade settlement (T+1) initiative

  32. Mandatory industry initiative to shorten settlement cycle from current 3 days after trade execution to 1 day • Impacts most commonly traded securities • Not only U.S.; Canada is also moving to T+1 NY-101613.103/020417YlpolSL1 WHAT PRODUCTS ARE COVERED BY THE T+1 INITIATIVE? • Included in T+1 effort Source: Streetside Fixed Income Working Group (The Bond Market Association, SIA)

  33. Projected reduction in settlement exposure from T+1 settlement$ Billions 1999 2000 ‘01 ‘02 ‘03 2004 Average daily number of institutional trades not affirmed prior to settlement 41,000 CAGR = 36% * 12,000 1995 1999 NY-101613.103/020417YlpolSL1 WHAT ARE THE BENEFITS OF MOVING TO T+1? * Average daily transactions grew from 150M to 350M in the same period, a CAGR of 24% Source: SIA; T+1 Business Case

  34. NY-101613.103/020417YlpolSL1 ACHIEVING T+1 WILL REQUIRE OVER-COMING SIGNIFICANT LIMITATIONS OF CURRENT PROCESSING ENVIRONMENT

  35. NY-101613.103/020417YlpolSL1 SOLUTIONS PROPOSED BY INDUSTRY (SIA) TO THESE CHALLENGES

  36. NY-101613.103/020417YlpolSL1 MODULE 1: CREATE NEW MATCHING UTILITIES • From . . . • . . . to • Allocations • Investment manager • Confirm • Broker/dealer • Investment manager • Broker/dealer • Matching utility (central point of reference) • Confirm • Confirm • Affirm • Confirm • Custodian • Custodian • Affirm • Depository • Depository

  37. Total T+1 investment by participant type • $ Billions • Annual cost savings opportunity by participant type • $ Billions • Institutional brokers/dealers • Brokers/dealers • Retail brokers/dealers • Asset manager • Asset managers • Custodian • Custodians • Corres. clearers • Infrastructure service providers • Depository • Exchange • Total • Matching utility • Total NY-101613.103/020417YlpolSL1 SIA ESTIMATES OF T+1 INVESTMENTS AND COST SAVINGS • Majority of T+1 investment and benefits fall on market participants, particularly broker-dealers, who also gain vast majority of cost savings • Payback period of 3 years expected with a 28% IRR on total investment • 99% of total investment “within four walls” focusing on internal changes (e.g., IT infrastructure and applications) • Similarly, 78% of investment focused on two of ten building blocks: internal STP and standardizing reference data and protocols Note: Based on surveys; interviews; and industry data. Over 200 surveys were sent to different industry institutions across participant types. More detailed investment surveys were sent to targeted brokers/dealers, asset managers, and custodians to provide a better estimation of T+1 investments Source: SIA T+1 Business Case

  38. NY-101613.103/020417YlpolSL1 ECONOMICS OF T+1 BY PARTICIPANT $ Millions • Estimated T+1 investment for large participant • Payback period • Years • Comments • B/O operations major cost for brokers/dealers and requires significant investment for T+1 • Brokers/dealers making majority of investment, but receiving largest benefit • Investment likely for large brokers/dealers given short payback period and business importance of B/O capabilities • For medium and small brokers/dealers, however, outsourcing B/O more attractive due to economies of scale in investment • Brokers/ • dealers • $60-100 • BO operations small portion of costs and not perceived as core activity • T+1 likely viewed as compliance event • Although investment per company less than brokers/dealers or custodians, relative savings even less resulting in longer payback period • Despite little economics incentive for asset managers, industry needs their cooperation to move to T+1 • Asset • managers • 40 • B/O operations important cost area and key business capability for custodian requiring large T+1 investment per participant • Significant investment and benefits shared by small number of players with short payback period • Large role in institutional trades combined with better risk management provide strong incentives to make investments required by T+1 • Custodians • 60 Source: SIA T+1 Business Case

  39. NY-101613.103/020417YlpolSL1 T+1 IMPLICATIONS FOR BROKER-DEALERS • Approach to back-office partnering • Joint • Individual • Option 3 • Share common tasks and resources for T+1 • Option 1 • Implement changes to meet T+1 compliance requirements • T+1 as compliance event • Approach to back-office redesign • Option 4 • Share/create a single back office processing platform • Option 2 • Leverage and extend T+1 changes to broader redesign program • T+1 as catalyst for broader design

  40. Achieve basic STP as a means to accelerate trade processing • Redesign institutional trade processing • Eliminate paper confirmations • Build links to electronic matching utilities • Modify internal processes to meet compressed deadlines • Consolidate systems supporting different products (front and middle offices) • Comply with accelerated submission deadlines • Move to real-time feeds to CDS system • Implement new industry communication standards • Change traditional back-office operating model • Extended automation (e.g., non-trade-processing activities) • Automate pre-balancing dividend activities • Eliminate duplicative work across departments • Integrate reconciliation activities performed in Operations and Accounting in consolidated group • Create central repository that contains all information and documents related to each account • Realign organization • Reorganize departments along end-to-end processes instead of functional silos • Shift input of account opening and information upstream to F/O departments and potentially customers NY-101613.103/020417YlpolSL1 POTENTIAL INDIVIDUAL APPROACHES FOR BROKER-DEALERS • Individual changes (no JV) • Option 1 • Implement changes required to stay in business after T+1 • T+1 as compliance event • Approach to back-office redesign • Option 2 • Leverage and extend T+1 changes to broader redesign program • T+1 as catalyst for broader design

  41. Leverage overlapping activities • Build similar applications together • Standardized communications protocols • Common interfaces with shared vendors and service providers • Share common resources • T+1 program design, logistics, and management office (PMO) • Test scripts • Combine processing systems and functions • Segregate functions that could be performed more efficiently in a joint effort • Trade processing activities relating to clearance and settlement • Support functions such as Dividend • Merge systems into predominantly one of the existing IT platforms • Establish common interfaces to industry-wide utilities • Institutional trade matching • Fixed Income real-time matching • Create common reference data systems • Change traditional back-office operating model • Extended automation (e.g., non-trade-processing activities) • Eliminate duplicative work across departments • Realign organization NY-101613.103/020417YlpolSL1 POTENTIAL JOINT APPROACHES FOR BROKER-DEALERS • Approach • Individual • Joint • Option 1 • Implement changes required to stay in business after T+1 • Option 3 • Share common tasks and resources for T+1 • T+1 as compliance event • Approach to back-office redesign • Option 2 • Leverage and extend T+1 changes to broader redesign program • Option 4 • Share/create a single back office processing platform • T+1 as catalyst for broader design

  42. NY-101613.103/020417YlpolSL1 POTENTIAL END GAMES

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