Aligning Product Control Today

8/6/2019 Aligning Product Control Today

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Aligning Product Control Today

Copyright 2010 Microgen. All Rights Reserved

Microgen Microgen PlcMicrogen Aptitude Microgen Aptitude Limited

Microgen Aptitude - Patent Pending (Serial No: 1686466) & U.S. Patents Pending


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Agenda

What is Product Control?

The Finance Function

The Control Environment

The Trade

Valuation

Independent Pricing

Day 1 P&L

Daily P&L

Decomposition

Attribution

Estimation (Financial and Management Accounting)

Daily P&L Reporting Trading Systems?

Core Systems?

Balance Sheet

Where could we be....?Copyright 2010 Microgen. All Rights Reserved




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The role of Finance

The machinery of Finance

The Finance Engine in most organisations is huge and multi-faceted

All parts of this Engine are critical and if any component is missing the wholeceases to function on all levels

Roles and responsibilities of the Finance Function include the following:

Existence (Validity): Only valid or authorized transactions are processed (i.e., no

invalid transactions) Occurrence (Cutoff): Transactions occurred during the correct period or were

processed timely.

Completeness: All transactions are processed that should be (i.e., no omissions)

Valuation: Transactions are calculated using an appropriate methodology or arecomputationally accurate.

Rights & Obligations: Assets represent the rights of the company, and liabilities its

obligations, as of a given date.

Presentation & Disclosure (Classification): Components of financial statements (orother reporting) are properly classified (by type or account) and described.

Reasonableness: Transactions or results appears reasonable relative to other data ortrends.



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The role of Product Control

All finance roles and responsibilities source from a single starting point

If all aspects of the Trade are understood, captured and processed correctlythe entire Finance Function has a fighting chance of being able to achieve

its goals and objectives It is the responsibility of the Product Controller to ensure that all aspects

of the trade are understood, captured and process correctly.

The Product Controller is operating at the Coal Face

Without effective Product Control the Finance Function cannot operateeffectively

Product Control cannot succeed without an effective ControlEnvironment

The execution of a Trade





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5 aspects are required to support any level of control in any organisation:

1. Control Environment: sets the tone for the organisation and influences thecontrol consciousness of its people. This is the foundation stone for all otheraspects of control

2. Risk Assessment: the identification and analysis of relevant risks to the

achievement of objectives, forming a basis for how the risks should be managed

3. Information and Communication: systems or processes that support theidentification , capture, and exchange of information in a form and time framethat enable people to carry out their responsibilities

4. Control Activities: the policies and procedures that help ensure managementdirectives are carried out

5. Monitoring: processes used to assess the quality of internal controlperformance over time


Microgen Microgen PlcMicrogen Aptitude Microgen Aptitude LimitedMicrogen Aptitude - Patent Pending (Serial No: 1686466) & U.S. Patents Pending
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The IT environment often makes control challenging

Market Pricing/Valuation Model

Reconciliation Systems

Management Information/

Reporting

Deal Capture

Cash Settlement Systems

General Ledger

Copyright 2010 Microgen. All Rights ReservedMicrogen Microgen Plc

Microgen Aptitude Microgen Aptitude LimitedMicrogen Aptitude - Patent Pending (Serial No: 1686466) & U.S. Patents Pending


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Most trading organisations grow organically, adding products and complexity

through time, bringing further challenges

Multiple trading systems

Non-standardised settlement and valuation processes

Contrived solutions that jam trades into systems not intended to support them

Manual interventions and associated control risk




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The Trade




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The Trade

Understanding the Trade

The Product Controller must understand the trade and the economic intentbehind that trade

Critical for all Trades, whether Structured or Vanilla

The component based approach

By breaking trades down into their lowest level components, these components,

when combined into a pattern can describe the full lifecycle of the product

Common, low level components can be defined and managed in such a waythat they can be re-used across the full product set

Components can then be used to model transactions across multipletransactions types, trading systems and any upstream processes

The more complex the trade, the more appropriate a consistent componentbased approach becomes:

Modelling at the component level along with understanding associated behaviourpatterns allows support for an infinite number of distinct products with theconfidence of generating reliable results




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The Trade

Trade Completeness

The Product Controller must ensure that the trade is represented in the TradingSystem(s) according to its economic intent

Critical for trading structures where trades are split across multiple systems, forexample, a structure may span a Bond System, a Derivatives System and aStructured Option System.

Where booking Interventions have been made, the rationale behind theseinterventions must be clear, understood and documented

Clear Audit Trails must exist otherwise, as time moves on and memories fade,controls will be compromised

It is the responsibility of the Product Controller to ensure that the trade is

booked in such a way that it can be used reliably and predictably by all otherareas of the organisation


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The Trade Valuation




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The Trade: Valuation

The ability to value a Trade is critical. That valuation must reflect:

The economic reality of that trade

Current market conditions

Regulatory pronouncements at that point in time.

Methods for valuing trades are in the spotlight as a result of the credit crisis

We dont know future changes to valuation methodology so, today, the focus must

centre around the following:

Ensuring that current valuation processes encompass all trades across all systems

Ensuring that all valuation methods, models and processes are consistent and are fullyunderstood and documented

Documentary evidence for valuations is available and is in a state which can be provided tothe regulators.

Processes and models to support multiple valuation methodologies simultaneously are inplace

All aspects of the valuation process are automated as far as possible


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Are current valuations reliable?

Regulatory developments focus on transaction information to help makeassessments as to whether the valuations for those trades can be verifiedindependently

Categories based upon the ease with which prices can be IFRS 7 requires tradesto be classified into broad obtained:

Level 1: Quoted Prices (unadjusted) in active markets for identical assets or liabilities

Level 2: Inputs other than quoted prices included within Level 1 that are observable forthe asset or liability, either directly (i.e. as prices) it indirectly (i.e. derived from prices)

Level 3: Inputs for the assets or liability that are not based upon observable market data(unobservable inputs)

Allows the focus on transactions based upon the ease and reliability with whichvaluations have been obtained




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Are current valuations tested against independently often enough?

Independent Price Verification (IPV) is a hot topic in the global market

place today

Product Controllers are being asked to focus increasingly upon:

Increased frequency of the IPV process, from quarterly to monthly, bi-monthly,weekly and (sometimes) daily.

Greater coverage of the product set

Global consistency in the processes and models used

Global consistency in the inputs used to generate valuations

Complete audit trails supporting the process end-to-end

More granular triggers for identifying valuation differences requiring investigation

Documentary evidence to support the investigation of those differences and anyfollow-up action taken.

These requirements are onerous. How can they be supported?


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The Product Controller needs tools to be able to support the many and

varied requirements associated with Trade Valuations:

IFRS 7 classifications must be integral to the systems used daily. Classificationsupport using spreadsheets does not allow systematic processes focussing ontransactions which will attract attention due to lack of price availability.

The quest for price consistency is leading to Global Rates and PricingRepositories

Increased frequency is driving attention towards solutions which support partialor full automation.

Reporting solutions must be able to capture valuation adjustments at the tradelevel arising out of the IPV process coupled with supporting audit trails




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The Trade: Day 1 P&L

Day 1 P&L is increasingly important as an indicator that something might be

wrong !

In normal market conditions, trades executed at market prices as at T0should not generate large positive or negative P&L as at T1

Large T1 P&L could indicate:

Abnormal trading conditions in relevant market

Incorrect / Incomplete trade booking leading to incomplete / incorrect valuation

Off-market trading

Incorrect / incomplete prices used to generate valuations

Trade is significant and should be flagged as such within Finance in general

Trader exploiting a market opportunity, an inexperienced counterparty for

example.

The Product Controller requires tools allowing the identification of thesetrades and their subsequent investigation within very tight timeframes




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The Trade: Day 1 P&L

Abnormal Day 1 P&L:

Identification

Systems supporting tolerances and limits which are time stamped andvariable by Product / Market / Currency etc

Investigation

Identification of market conditions as at Trade Execution

Analysis of components comprising P&L generated

The capture and recording of all investigations and conclusions drawn basedupon agreed processes and procedures

Intervention

Tools allowing the suspension of any P&L under investigation coupled with

subsequent release of suspended P&L once investigations are completed Routine amortisation of Day 1 P&L over the life of the trade where certain

conditions apply




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Daily P&L




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Daily P&L

Product Control is the first point in the process whereby P&L is analysed

and reported.

It is the responsibility of the Product Controllers to understand the driversbehind any P&L generated and hence to be able to judge whether P&L hasbeen generated in a manner which supports organisational goals andobjectives.

This is a weighty responsibility....

The Product Controllers need all the help they can get, particularly as theregulatory focus is increasingly demanding information at an increasinglygranular level.

Any P&L validly reported by Product Control should be relied upon byFinance throughout the organisation




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Daily P&L: Decomposition

It must be possible for a Product Controller to decompose any daily P&L in a numberof different ways simultaneously.

Trading Book

Market or Country

Currency

Trader

Source System

Strategy

Instrument Type

Counterparty

IFRS 7 classification

Significant Trades

Risk factors

Etc...

With the ability to slice and dice daily P&L it is then possible to start to focus onspecific focus areas, or on those which may indicate trends which require furtherinvestigation

The design must be increasingly focussed on maintaining P&L at the trade level withall dimensions as above retained on the record





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Daily P&L: Attribution

The ability to attribute P&L to quantifiable drivers is critical and is the only

way to validate any reported P&L in any sustainable way.

There are multiple ways to attribute P&L and all must be available to theProduct Controller in a timely fashion.

In addition to tools highlighting P&L attribution, there must also be meansavailable to record the results of any analysis in such a way that otherfinance users can access the information for internal or regulatory purposes

The following are the most commons ways of measuring P&L attribution:




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Method 1: P&L analysed by Trading Activity

Day 1 Standard Trading

Funding

FX Revaluations

Cancelled and Amended Trades

Focuses on the activity within the trading book on any particular day

Requires information from numerous sources presented in a manner whichallows the Product Controller to focus immediately upon areas of interest.

Day 1 P&L should be analysed as explained earlier

Additional focus on Cancelled and Amended causing significant P&Lmovements




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Method 1: P&L analysed by Risk-based Activity

Day 1 Standard Trading

Greeks; Delta, Gamma, Theta

Focuses on the P&L generated in the book as a result of exposure to certainrisk based characteristics. This method of P&L analysis is a very powerful

P&L validation tool

Requires an understanding of how shift in the curve impact the mixture oftransactions within a particular book




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Daily P&L Reporting




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Daily P&L: Reporting

Sourcing Daily P&L: Trading Systems?

Advantages

Quicker as all the information is already there

Information is timely

More likely to agree to traders estimates

Core finance systems only require monthly updates for non-cash balances

Should support the measurement of FX exposure and may include Funding costs

Disadvantages

Not used for reporting in Finance therefore how useful is Trading system P&L

Does not reconcile P&L to core systems

Trade adjustments are difficult, if not impossible to capture therefore these are typicallyspreadsheet adjustments with their consequent lack of audit trails

Reconciliation issues between Trading Systems and Core finance systems may not beidentified intra-month therefore, due to month end time pressures, may not beinvestigated fully

Full monthly P&L still needs to be reconciled in core systems therefore increases timerequired for month end processing


Microgen Aptitude Microgen Aptitude LimitedMicro en A titude - Patent Pendin Serial No: 1686466 & U.S. Patents Pendin


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Daily P&L: Reporting

Advantages

Daily P&L is fully reflected in core finance systems intra-monthReduces workload at month end as only the final days P&L requires reconciliation plus

some additional monthly tasks.

There is time for P&L analysis as Monthly P&L is largely reconciled

Reconciliation items arise during the month when there is more time to investigate

Trade adjustments can be supported within core systems and will therefore be audit

trailedFunding and FX exposure information is available on a daily basis across businessareas contributing significantly to business decisions as to how to manage these keybusiness areas

Disadvantages

Requires core finance systems to be updated daily for items other than cash leading toprocessing overhead

May take longer to produce as core system reconciliations are a dependency

Processes to measure and manage FX exposure are required on a daily basis

Funding information is also required in core systems on a daily basis which, again, canadd to the processing overhead


Microgen Aptitude Microgen Aptitude LimitedMicro en A titude - Patent Pendin Serial No: 1686466 & U.S. Patents Pendin


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Balance Sheet




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Balance Sheet

Core system reconciliations will be required for Daily P&L reporting

Balance Sheet substantiation is required throughout all organisations on anincreasingly frequent basis and is attracting increasing regulatory focus

Reconciliations can also support Balance Sheet substantiation on a daily

basis. This brings its own additional benefits including... Internal Deal control and the ability to manage differences in valuation or timing

on a global basis

Cross-business funding requirements

If Core Systems are used for Daily P&L reporting...

... P&L is simply the difference between 2 dated Balance Sheets....

Daily Balance Sheet reconciliation is a logical extension to process




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Where could we be....?



D il P&L R i i C S


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Daily P&L: Reporting using Core Systems

With the focus moving away from fragmented, system focused, largely

manual environments, we have Product Control moving towards a rolewhich is increasingly intellectual.

The emphasis moves from number crunching towards analysis

The profile of Product Control within Finance will increase significantly asthe level of analytical contribution is allowed to rise.

Product Control increases in value to the organisation

Product Controllers become more involved in key business decisions and inplanning and strategy

Everybody Wins!



C l i
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Conclusion


The Finance Function


The Trade

Valuation

Independent Pricing

Day 1 P&L Daily P&L

Decomposition

Attribution

Estimation

Daily P&L Reporting Trading Systems?

Core Systems?

Balance Sheet

Where could we be....?Copyright 2010 Microgen. All Rights Reserved

Microgen Microgen Plc



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Thank you

and

Any Questions


Microgen Aptitude Microgen Aptitude Limited

Aligning Product Control Today

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