2.the Life Cycle of a Trade
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Transcript of 2.the Life Cycle of a Trade
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The Market Participants Static Data Trade Execution & Trades Processing Trade Confirmation Trade Instruction Instruction/Agent Matching Trade Settlement Position/Inventory Management Reconciliation Clearing and Custody Corporate Actions
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The Market Participants
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◦ Brokers◦ Dealers◦ Investment Banks◦ Stock Exchanges◦ Agents◦ Securities Trading Organisations◦ Custodians◦ Clearing Banks◦ Regulators
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◦ Institutional Investors ◦ Mutual Funds ◦ Pension Funds◦ Insurance Companies◦ Hedge Funds◦ Charities◦ Individual Investors
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SecuritiesTradingHouse
Exchanges
INVESTORS
INV
ES
TOR
S
INVESTORS
AGENTS
AGENTS
AG
EN
TS
ISSUERS
ISSUERS
Securities
Securities
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A Market is an environment in which securities are bought and sold. Central to some market places is the Stock Exchange.◦ Trades executed over an Exchange are executed
“On-Exchange” or “Exchange Traded”.◦ Other trades are “OTC” (Over the Counter) or Non-
Exchange Traded.◦ Each securities market has an associated and
recognisable place to effect settlement. E.g. Bonds traded on the Shanghai Stock exchange are
settled in Chinaclear.
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Region Country Financial Centre
Stock Exchange
Europe UK London London Stock Exchange (LSE)London Metal ExchangeLondon International Financial Futures & Options Exchange (LIFFE)
Germany Frankfurt Deutsche BourseSpain Madrid Bolsa de Madrid
Asia Pacific
China Hong Kong Stock Exchange of Hong KongHong Kong Futures Exchange
China ShenzhenShanghai
Shenzhen Stock ExchangeShanghai Stock Exchange
Japan Tokyo Tokyo Stock ExchangeTokyo International Financial Futures Exchange (TIFFE)
Singapore Singapore Stock Exchange of SingaporeSingapore International Monetary Exchange (SIMEX)
Australia Sydney Australian Stock Exchange (ASX)America USA New York
ChicagoNew York Stock Exchange (NYSE)Chicago Stock Exchange
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◦ Salespeople.◦ Data Providers.◦ Registrars.◦ Coupon Paying Agents.◦ Trade Matching Services.◦ Settlement Instruction Communication Mechanisms.
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Organisations occasionally need to raise cash/capital to expand their businesses by:◦ Selling part ownership issuing shares or equity.◦ Borrowing cash from investors issuing debt in the form of
bonds.
Type of Issuer ExampleCorporations Bank of Ningbo
Sovereign Entities China
Local Governments City of London
Government Agencies Ministry of Finance, China
Supranational Organisations International Bank for Reconstruction & Development (World Bank – IBRD)
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Static Data
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Static Data is the common term to describe the store of information used to determine the appropriate actions required for successful processing of each trade.
Critical to Straight Through Processing(STP) For Example:◦ Trading Entities◦ Trading Books within each entity◦ Counterparties◦ Instruments ◦ Currencies◦ Prices
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◦ Where possible, financial institutions try and create a core of “Golden Source” static data to avoid data conflicts in inter-dependent systems.◦ Companies specialise in gathering and distributing
financial data to institutions Example:
Reuters, Bloomberg
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Incorrect static data causes many processing errors:◦ Delayed Confirmations.◦ Unmatched Transactions.◦ Settlement Failure.◦ Incorrect Fee calculations.◦ Incorrect Profit & Loss Calculation.◦ Poor Reporting (Regulatory & risk impact).◦ Increased cost per transaction due to reduced STP.
Incorrect static data leads to reduced service and dissatisfied customers.
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◦ Bad Static Data results in reduced service levels to clients due to processing hold-ups and possible trade failure.
◦ Bad Static Data impacts operational risk and increases the cost per trade processed.
◦ Bad Static Data contributes to poor internal & external reporting impacting risk & reputation.
◦ Static Data will continue to be an important dependency on the efficient processing of trades especially as the trade lifecycle window becomes smaller.
◦ STATIC DATA Must be populated correctly within all of the relevant
systems. Must be obtained from a credible source as timely as
possible.
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Trade Execution & Trades Processing
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Str
aigh
t Thr
ough
Pro
cess
ing
(STP
)
Trade Execution
Trade Instruction
Trade Confirmation/Affirmation/Matching
Trade Processing
Trade Validation
Trade Capture
Trade Settlement
Instruction/Agent Matching
Fails & Fail Management
Trade Enrichment
Pos
ition
/Inve
ntor
y m
anag
emen
t
Cor
pora
te A
ctio
ns
Trad
e/P
ositi
on A
ccou
ntin
g
Sec
uriti
es L
endi
ng &
Bor
row
ing
Cas
h Fu
ndin
g
Rec
onci
liatio
ns
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◦ A legal contract between two ‘counterparties’. A seller and a buyer.◦ The SELLER must deliver the commodity he has sold
to the buyer.◦ The BUYER must pay the agreed purchase price on
the agreed value date.
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◦ Trading◦ Sales◦ Broking◦ Corporate Finance◦ Repo Desk
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◦ Speculate Profit from price move or increase in value of the
asset.◦ Accumulate Benefit from dividend on shares and interest on bonds.◦ Hedging: To speculate and accumulate. To reduce risk.
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◦ Trading Long◦ Trading Short◦ Arbitrage Trading◦ Hedging
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Trade execution tends to operate in one of three ways where sellers and buyers execute trades:◦ Trading Floor. Traditional method of trading – face to face on the
trading floor of a Stock Exchange.◦ Computerised Exchanges. Prevailing!◦ Telephone
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Furthermore Trades can be:◦ Quote Driven. Market Makers quote prices via computerised screens
showing the level at which they are prepared to buy and sell with the intention of attracting business.
◦ Order Driven. Orders from sellers are matched with buyers’ orders
electronically.
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Regardless of the trade execution/origin, all trades must be recorded formally by the market participant.◦ To update a trading position for a specific security within a
trading book.◦ To update average price of the current trading position to
enable the trader to calculate trading profit or loss.◦ To allow trade detail to be sent through to the Back Office
for trade processing and settlement.◦ As part of Market & Regulatory Reporting requirements.◦ To facilitate risk management.
Traders use complex trading systems to facilitate trading & position management, trade processing is usually done via Back Office processing systems.
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◦ Trading Book◦ Trade Date◦ Deal Time◦ Value Date◦ Operation (e.g. Buy/Sell)◦ Quantity◦ Instrument/Security◦ Price◦ Counterparty
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◦ Trade validation occurs to check if the trade information received in the Back office systems corresponds with the Front Office record.
◦ Trade validation includes the checking of constituent static data information:
◦ Examples include: Is the security recognised on the system? Is the Counterparty account recognised? Is the Trader allowed to trade on the trading book? Is the trading book valid to trade security x? Is the value date a valid settlement date in the location of
settlement? Are the securities restricted?
All detected errors must be investigated and corrected.
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◦ Trade enrichment exists to add specific trade data to the basic trade detail to allow downstream processing.
◦ This data is not usually held in Front Office Trading systems.
◦ This data can be added manually however in the STP environment the aim is to derive this automatically.
◦ Examples include: Calculation of cash values. Regulatory Reporting required. Trade Confirmation requirements. Selection of custodian details. Selection of Settlement Instructions and communication
method.
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Trade Confirmation
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◦ Trade Confirmation/Affirmation is an important process required to reduce the risk of the traders P&L(Profit &Loss).◦ Until the counterparty acknowledges the trade
detail the effect on the price or quantity of the trade is subject to change, impacting the traders book.◦ Trade agreement can be achieved through: Sending trade confirmations to the counterparty. Receiving trade confirmations from the counterparty. Trade or Contract Matching. Trade Affirmation.
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◦ Trade confirmations are generated using trade data and static information held on the counterparty account:
◦ Confirms can be sent or received via: Fax Telex SWIFT Email (in some markets)
◦ Generally trade confirmations are checked and any discrepancies are reported back to the counterparty if: Trade data differs (security, price, quantity, value date). Trade is not recognised.
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Trade Matching generally applies to mandatory electronic matching of trade details.◦ Both parties are required to input details to a
central matching facility.◦ Matching results (i.e. matched, unmatched) are
provided by the trade matching facility to both parties.◦ Examples include: Omgeo Central Trade Manager (CTM). TRAX (Internationally traded debt & securities). National Securities Clearing Corporation’s Trade
Matching Service. (NSCC)
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Trade Affirmation relates to the electronic matching of trade details typically between securities institutions and Institutional clients.◦ Trade details are input by the securities house and sent to a
trade affirmation facility.◦ The Trade affirmation central hub sends on the message.◦ The institutional client agrees (affirms) or disagrees and the
response is sent back to the securities house.◦ Both parties must subscribe to the service.◦ Examples include: Omgeo’s Oasys Global system. DTC ID (Institutional Delivery) – (US)
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Basic Principles◦ The longer a trade’s detail remains unchecked after
trade date, the greater the risk of price movement and P&L impact.◦ Trade confirmation/matching messages should be
issued as soon as possible after trade validation.◦ Timely and accurate confirmation generation is a
major client service consideration.◦ Prompt actioning of all confirmation discrepancies
reduces trade risk.
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Trade Instruction
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Settlement Instructions are used to communicate the movement of securities and cash to the custodian.◦ Trade Agreement confirms the commercial details
of the trade.◦ Settlement Instructions indicate the commercial
details of the trade AND the location and account details for the cash and security movements. (Settlement Details).
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Settlement Instructions tell the custodian/Agent to carry out precise commands such as:◦ The quantity of securities to be received or
delivered.◦ The net settlement value to be paid or received.◦ From whom securities will be received.◦ To whom payment must be made.◦ From whom payment will be received.◦ To whom securities must be delivered.◦ On which date to carry out these instructions.
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◦ Delivery versus Payment (DVP) The simultaneous exchange of cash and securities. A single settlement instruction is generated to tell the
custodian to deliver securities out against a cash receipt in.
◦ Receipt versus Payment (RVP) The simultaneous exchange of cash and securities. A single settlement instruction is generated to tell the
custodian to receive securities in against a payment of cash out.
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◦ Free of Payment (FOP) A non-simultaneous exchange of cash and securities. A settlement instruction is generated to instruct the
receipt or delivery of securities against nil cash. A second instruction is generated to instruct either a
cash payment or a pre-advice to expect a cash receipt against nil securities.
Higher level of risk therefore usually requires high level of authorisation.
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Modern methods of electronic instruction generation and transmission include the following characteristics:◦ Automatic generation of settlement instructions by
settlement systems.◦ Automatic transmission of settlement instructions
(individually or in batches).◦ Settlement instructions in standardised formats.◦ Secure transmission environment due to high levels of
message encryption.◦ High speed of transmission.◦ Predictable cost of transmission.◦ Enabler of Straight Through Processing (STP).
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S.W.I.F.T.◦ CREST◦ DTC◦ Euroclear◦ Clearstream◦ Agent Banks◦ Custodians
Proprietary Messaging◦ CREST◦ DTC◦ Euclid (for Euroclear)◦ Cedcom (for
Clearstream)
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Instruction/Agent Matching
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To reduce settlement risk by:◦ Increasing the chances of trade settlement on value
date.◦ Resolving differences between trades and
counterparties.◦ Enabling accurate funding of cash in nostro
accounts.◦ Managing stock inventory in depositories.
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Once Instructions have been received at the Custodian, the next lifecycle steps include:◦ Instruction Matching Custodian attempt to match the instruction to the
counterparty instruction.◦ Status Update Attachment of the current status of the instruction.
(matched/unmatched/unknown).◦ Unmatched Resolution Investigation and resolution of non-matching
instructions.◦ Trade Settlement Updating the current status within the securities
trading organisation’s books and records.
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SecuritiesTradingHouse
CounterpartySecurities
House Counterparty
CSD or ICSDInstruction
Comparison
2
1 1
4 4
3Status Status
SettlementInstruction
SettlementInstruction
StatusMatched orUnmatched
StatusMatched orUnmatched
1 Instructions sent in by Securities House and Counterparty.2 Instruction matching occurs.3 Status is recorded.4 Instruction Status (Matched/Unmatched) is sent back to both
parties.
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Trade Settlement
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Trade settlement is the act of exchanging securities and cash between buyer and seller.◦ Value Date is the intended date of delivery and
payment also known as Contractual Settlement Date.◦ Actual Settlement Date applies to the actual date
the exchange took place.◦ Value Date and Settlement Date will be the same in
the majority of trade settlement cases.◦ A percentage of trades fail to settle on value date
and will settle on another date referred to as the actual settlement date.
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How to ensure trade settlement.◦ Ensure the seller holds the required level of securities at
the correct custodian. Some securities can settle at more than one location.
◦ Ensure the purchaser has sufficient cash to make the payment. The purchaser may aggregate balances over a number of
accounts, the total amount must cover the amount required. (Funding).
The purchaser may have a credit agreement with the custodian who will cover the cash shortfall. (Secured credit line/Overdraft).
The purchaser may have a collateral agreement whereby collateral is held in the account to offset any non return of funds. (Margin)
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◦ Full Settlement◦ Partial Settlement◦ Securities Only◦ Cash Only◦ Cross Currency Settlement◦ Net Settlement
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Timely settlement of trades is an important part of the Trade Lifecycle with implications across the following areas:◦ Inventory Management◦ Cash Management◦ Settlement Risk◦ Cost Management◦ Firm Reputation
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Position/Inventory Management
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Management of the stock holding is an integral part of trade settlement:◦ Inventory Management ensures: The correct amount of securities (nominal) are
available At the correct location (depot). At the correct time (on value date).
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If securities are unavailable we can consider the following:◦ Internal Book Transfer. Borrow securities from another firm account same depot.
◦ Realignment. Borrow securities from another firm account different depot.
◦ Stock Borrow Loan Trade. Borrow the securities from the market.
◦ Autoborrow. Borrow the securities from the custodian/central depository.
◦ Execute a Repurchase Agreement (Repo)◦ Do nothing and let the trade fail.
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Transmit Settlement Instruction
Match Settlement Instruction at Custodian
Settle at Custodian
Securities
Choices
Cash
Choices
Do NothingLend Repo Do NothingBorrow viaRepo
BorrowUnsecuredAutoBorrow
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◦ Allows investors to earn money by lending out their securities portfolio.◦ Allows investors who need to fulfil a trade but are
insufficient of securities to borrow and complete the delivery.◦ Reduces risk and impact from a Buy-In as a result
of failed delivery.◦ Facilitates receipt of cash funds which may reduce
overall borrowing requirement.◦ Reduces risk of interest claims.
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◦ Legal title to the lent securities passes from lender to borrower for the period of the loan.◦ Lender’s rights are protected with regard to most
Corporate Actions: Dividends on Equity. Coupon Payments on Bonds.◦ The Borrow typically provides collateral to the
lender (securities or cash) against non return of the loan.◦ The Lender receives income from the borrow
periodically.
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Service provided by large Custodians and Central Security Depositories:◦ Borrowers Borrow required securities automatically. Borrow certain types of security automatically i.e.
Spanish Bonds. Borrow upon request. Sometimes used as a last resort due to the cost.◦ Lenders. Lend all securities automatically. Lend certain types of security automatically. Lend upon request.
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◦ Once a trade has settled it is essential to update the firm internal books and records to ensure: The transaction is no longer shown as outstanding. The securities are shown as having been received in so
they can be sold on. The securities are shown as having been delivered out
so more can be purchased if required. The cash is showing as having being paid out and
additional cash can be borrowed if required. The cash is shown as having been received in so it can
be lent out to make interest. To retain full control of all assets and liabilities at all
times. And facilitate further trading.
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◦ Automated Updates Instruction statuses are sent in by the custodian (fully
settled, partially settled, failed etc). The Securities Trading House automatically loads this
information into the settlements systems. The system attempts to locate the relevant trade in its
internal books and records. Once found it records the status update against the
transaction. It will also automatically update the relevant security
positions and balances reflecting the delivery or receipts.◦ Manual Updates In some cases it may be necessary to settle trade manually
and a settlements specialist may manually record the update against the trade record.
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Timely and accurate reflection of trading activities enables the following:◦ Repo Trading. Accurate picture of open and settled trades and settled
securities and cash positions at each custodian.◦ Securities Lending & Borrowing. As with repo trading accurate information is required
to maximise revenues and minimise costs.◦ Credit Risk Assessment. Facilitates risk assessment with counterparties and
markets.◦ Corporate Action entitlement. Enables accurate calculation of entitlements and timely
receipt of proceeds.
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◦ Trade Date Positions◦ Value Date Position◦ Settlement Date Positions◦ Short Positions◦ Long Positions◦ Client Positions◦ Firm Positions
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Reconciliations
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◦ Reconciliations exist to check the accuracy of the firms books and records: Internally between systems and departments Externally where securities and cash are held.◦ A Reconciliation Break is a discrepancy between one
record and another.◦ All breaks should be investigated, accounted for
and corrected to ensure continued integrity.◦ Automation of reconciliation reporting facilitates
timely investigation and resolution of breaks on a daily basis.
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◦ Regulatory Requirement to show we are acting responsibly in the
market place. Trading within recommended guidelines. Maximum security holdings in certain Firm entities.◦ Managing Risk Understanding true trading position. Understanding true cash balances. Understanding failed trades.◦ Corporate Actions Calculating correct Corporate Action entitlement from
true security holding. Correctly reflect changes caused by Corporate Actions
to the relevant internal accounts held on all systems. (FO & BO)
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◦ Position Reconciliations. Report Position differences between trading systems
and trade processing systems. (FOBO Recs). Track cash balances held internally against external
Agents (Nostro Reconciliations). Track stock/security positions held internally against
external Custodians (Stock/Depot Reconciliations).◦ Trade Reconciliations. Report transaction differences between systems. Report open trades/instructions.◦ System Reconciliations. Report data differences between systems.
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Clearing and Custody
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ISSA* Definition of a Global Custodian◦ ‘‘A Global Custodian provides clients with multi-
currency custody, settlement and reporting services which extend beyond the Global Custodian’s and its clients’ base region and currency, and encompasses all classes of instruments.’’
* International Society of Securities Administrators
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Term Description ExampleCustodian An organisation that holds securities
and cash on its clients’ behalf and may effect trade settlement on its clients’ behalf.
Deutsche Bank Domestic Custody Services
Global Custodian As per custodian, but has a network of local (or sub-custodians) that hold securities and cash and effect trade settlement on behalf of the global custodian.
State StreetCitigroupBoNYParibas
Local Custodian A custodian that operates within a specific financial centre.
Credit Lyonnais ParisBanco Espirito Santo Lisboa
Sub-Custodian A custodian within a Global Custodian’s network of custodians.
Citibank MilanCitibank Madrid
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Term Description Examples
Central Securities Depository (CSD). National Central Securities Depository (NCSD)
An organisation that hold securities, normally in book entry form; usually the place of settlement, effected through book transfer. A CSD that handles domestic securities of the country in which it is located.
DTC (USA)CREST (UK & Eire)JASDEC (JPY)CCASS (HK)
International Central Securities Depository (ICSD)
A CSD that handles domestic and international securities. Only two organisations are recognised as ICDS’s.
Euroclear (Brussels)Clearstream (Luxembourg)
Settlement Agent An organisation that effects the exchange of securities and cash on behalf of its clients; resultant securities and cash balances may or may not be held.
Citibank MilanCitibank Madrid
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Corporate Actions
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Any action by an Issuer which may affect the investor:◦ The distribution of benefits to existing shareholders
or bondholders. Coupon Payments Cash Dividends Stock Dividends◦ A change in the structure of an existing security. Stock Split Bonus Shares◦ A notification that may or may not require a
response from the securities owner. Annual Meeting Voting Rights
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◦ Timely notification of each Corporate Action which may affect a position or outstanding trade.◦ Understanding the nature of each Corporate Action.◦ Timely execution of responses within deadlines.◦ Understanding the cost, benefit and impact of each
Corporate Action.◦ Ensuring the receipt of entitled assets.◦ Ensuring costs are charged at the appropriate time.
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◦ Calculating Tax on benefits.◦ Impact of failing trades on Corporate Actions.◦ Reliable Announcement (Static Data) feeds.◦ High instance of manual processing of many
Corporate Actions impacted by volume increase during Corporate Action season.◦ Correct allocation of Corporate Actions across all
trading and client positions in Trading and Settlement systems.◦ Correct reconciliation of Corporate Actions at
custodian (depots and nostro accounts).
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Securities Operations – A Guide to Trade & Position Management-by Michael Simmons