Canada has set a global precedent with the introduction on Jan. 12 of the long-awaited trade matching rule, which takes effect across the country on April 1.

Trade-matching is the process by which the details and settlement instructions of an executed delivery against payment or a receipt against payment trade are reported, verified, confirmed and affirmed or otherwise agreed to among “trade-matching parties.”

The definition is contained in the Canadian Securities Administrators’ National Instrument 24-101: Institutional Trade Matching and Settlement. The goal of NI 24-101 is to achieve same-day settlement of institutional accounts — that is, agreement among the three parties (the investment manager/registered advisor as the buyer, the broker-dealer and the custodian) involved as to the terms of a trade on the same day it is executed.

This performance target will be phased in over the next three years, using a seven-step schedule that ultimately will see 95% of trades matched by a deadline of 11:59 p.m. on the same day.

The phase-in period begins with a matching deadline of noon the following day — T+1 — for the second and third quarters of 2007. During this initial period, there is no requirement that a certain percentage of trades must meet the matching deadline. Steps 2 and 3 add matching requirements of 80% and 90%, respectively, of trades. Step 4 shortens the timeline to 11:59 p.m. on the same day as the trade, with a 70% matching requirement. Steps 5, 6 and 7 strengthen the matching requirement to 80%, 90% and 95%, respectively.

Jane Davis, executive director of the Canadian Capital Markets Association, says NI 24-101 is the first regulatory enactment in Canada to bring together all three parties to an institutional trade.

“From an operational perspective,” she says, “the Canadian securities industry will be a global leader. This is especially important in a sector in which speed and operational risk management are important differentiators. At the end of the day, this helps us prepare for a straight-through processing environment.”

Davis also points out that NI 24-101 “compels the securities industry to focus on automation and connectivity to achieve the ultimate objective of same-day trade-matching for institutional trades.”

Tom White, head of the operations group for Merrill Lynch Canada Inc. , says for two years he was chairman of a CCMA working subcommittee with a mandate to accelerate institutional trade-date matching because implementation of the trade matching rule is so important. “Merrill Lynch has been working toward the requirements in NI 24-101 for the past two years,” he says, “so the organization will be in position to comply with it.”

He also notes there is more to be done from a technological perspective, which “can continue to be developed. In addition, education, both internally and externally, are definitely a requirement.”

The CSA first introduced the trade matching rule in 2004. Two years later, after many revisions, it was reissued with a request for comment from interested parties. Now, the rule has been released by the CSA and the provincial securities commissions in its final form, although specific documentation and reporting requirements do not start until Oct. 1.

Documentation requirements refer to the need for a “trade matching statement” or a “trade matching agreement” that confirms all trade-related parties have their processes and procedures in place before the trade is executed. Standard forms are being developed for use across the industry. The trade matching statement can be sent by e-mail or posted on the company’s Web site.

Reporting will be required when either a broker or an investment manager fails to achieve the target performance level. For example, during Q1 and Q2 of 2008 (the third step), 90% of trades must be matched by noon on T+1. In such cases, “exception reporting” will be necessary to explain the circumstances or causes that have contributed to the failure to meet the target, together with the specific steps planned to resolve delays in the future.

The CSA intends to review the exception reports to identify the weak performers. These parties can expect to be contacted directly by the appropriate securities commission or a self-regulatory organization such as the Investment Dealers Association of Canada.

For the purposes of NI 24-101, institutional trades are considered separately from retail trades, which are not affected by the trade matching rule.

@page_break@Davis points out that retail trades do not require this added level of sophistication because there are only two parties involved (the custodian and the broker would be the same entity) and because of retail trades’ simplicity: “You give me 100 shares and I’ll give you the correct amount of money.”

She sums up the impact on individual investors in this way: “This rule does not impact individual investors other than peripherally. As the industry automates, which this rule will accelerate, one would suspect that the cost of trading, once information-technology investment costs are recovered, would decline. So, there could be some savings for investors in the longer term.

“Of course, the savings in costs, if any, will depend on the external vendors and their respective fees,” Davis adds. “[Nevertheless], this rule deals with institutional investors and will make post-trade settlement more efficient, thus reducing risk and costs.”

In contrast to a typical retail trade, an institutional trade could deal with a million shares on behalf of several mutual funds. And there are the three participants. These added complexities inject a risk that the wrong number or class of shares could be applied.

“All kinds of details have to be checked to make sure it’s the right order,” says Davis. “What used to be done by fax or telephone can no longer be done manually. A lot of vendors provide linkages among the parties. Some are not well connected. The benefit of the rule is that it compels the whole industry to automate.” IE