Part 14
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Tarheel Consultancy Services Corporate Training and Consulting
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Part-14 Brokerage Operations Meso Issues
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Standard Securities Terminology
Trade Date
The date on which the two parties agree to trade or the date of trade execution
Operation
The type and direction of the trade
That is Buy or Sell Lend or Borrow
Quantity
The number of units of the security being exchanged 3
Terminology (Cont…)
Security
Counterparty
The party to whom we sell or lend or the party from whom we buy or borrow
Value Date or Contractual Settlement Date
The specific asset being exchanged
The intended date of delivery of securities by the seller and the payment of cash by the buyer
Cash Due
The cash value of the trade; the amount to
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Terminology (Cont…)
Required Location of Securities
The place where we wish the securities top reside
Cash to be paid from
From the buyer’s perspective the specific bank from which the payment is ought to be made
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Trade in Securities versus Trade in Goods
Major differences arise in the context of `Required Location of Securities’ and `Cash to be Paid From’.
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Location
A seller of goods will most probably take direct delivery of the goods purchased and store them in a local warehouse. Payment will be made by handing over a check to the seller. Similarly following a sale delivery of goods will be under the direct control of the seller and receipt of a check on account of a sale can be banked immediately. 7
Location (Cont…)
The securities industry is however a global industry
Traders in the world’s financial centers invest in securities that are normally delivered locally to the security’s place of issue.
For example a trader in New York may choose to invest in an Australian security.
He can always take delivery in New
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Location (Cont…)
However from an efficiency and cost perspective the trader will typically ask for delivery in the normal place of issue and delivery of the securities, in this case Sydney. The alternative is that securities would be delivered from Sydney to New York with lengthy delivery time frames and costs. Besides the seller is likely to demand payment before the securities leave his possession.
If the buyer were to agree he would be taking the risk of being without both securities and cash. Such risk would be unacceptable to most parties. 9
Location (Cont…)
In order to minimize the risk and to exchange securities and cash in the most efficient manner, most traders use local agents to exchange securities and cash on their behalf. These local agents are often referred to as Depots/Nostros or Custodians. We will use the term Custodians in this presentation to refer to such agents.
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Location (Cont…)
Securities are held within a custodian securities account – known as a DEPOT Account. Cash is held in a custodian cash account – known as a NOSTRO Account. Large traders employ the services of custodians around the globe.
Each custodian is responsible for exchanging securities and cash as a result of buying and selling by the trader. He is also responsible for holding the 11 securities and cash in safekeeping on behalf
Exchanging Securities and Cash
The exchanging of securities and cash is known as SETTLEMENT. The art of settlement is no different from buying and selling goods.
Most traders would be reluctant to pay the purchase price without taking delivery of the goods at the same time. Conversely sellers would not like to hand over title to the goods without 12
Exchanging…(Cont…)
The risk which is applicable to both parties is that at some point in time they may be in possession of neither asset.
Traders are very risk averse and try to avoid such situations.
The most efficient and risk free method of settlement is known as Delivery versus Payment or DvP, whereby simultaneous exchange of securities and cash is effected between the buyer 13 and seller through their respective
Exchanging…(Cont…)
Under DvP
The seller is not required to deliver securities till the buyer pays the cash And the buyer is not required to pay the cash until the seller delivers the securities thereby ensuring the both parties are protected.
The alternative to DvP is Free of Payment or FoP settlement.
In this case one or both parties will need to arrange delivery of securities or payment of cash prior to taking possession of the other 14 asset.
Control
It is important for a company to remain in control of its goods and cash.
For a securities trader this means monitoring within its books and records complete and up-to-date records of the following.
Trades: A complete record must be maintained of all executed trades Trading Positions: The net quantity15
Control (Cont…)
Open Trades: Trades which are yet to settle and are outstanding with counterparties. Settled Trades: Trades which have settled at a custodian and are no longer outstanding with a counterparty. Settled Positions: The net sum of all settled trades in each security and in each currency. In order to prove that the records are accurate each of the items should be 16
Control (Cont…)
Furthermore, a trader’s complete picture for an individual security can be reconciled internally by comparing
The trading position or `ownership’ position with the sum of `open’ trades and the settled position also know as the `location’ position. 17
Control (Cont…)
The advantage of performing an ownership versus location comparison is that it is intended to confirm that whatever quantity of goods that the trader owns as a result of trading – which is represented by the trading position is Held within the trader’s control at the custodian and/or Is due to be delivered to it by counterparties from whom it has purchased securities and/or Is due to be delivered by it to counterparties 18
Example
ALPHA a dealing firm undertakes the following three trades in IBM. Assume that there was no trading position prior to the first trade C’Pty
T.Dt.
V.Dt.
Op.
Qty.
T.Pos.
BETA
15Sep
25SEp
Buy
5,000
+5000
Gamma 1 Oct
10 Oct
Buy
8,000
+13,00 0
PHI
25 Oct
Sell
4,000
+9,000
15 Oct
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Example (Cont…)
The ownership versus location position of the shares at various points in time is as depicted below. The convention in these tables is: Within ownership
A positive trading position is represented by a + sign
Consequently within location
An open purchase due from a party will be shown with a – sign A settled purchase held at a custodian will be shown with a – sign An open sale due to a counterparty will be
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Table-1 IBM Shares on 1 Sep Ownership Location ALPHA +5000 -5000 BETA ________________ ___________ +5000 -5000 This shows the position immediately after the first trade. It shows that 5000 shares are owned by ALPHA and that these shares have not yet been delivered to the custodian by the counterparty as the value date is in the21
Table-1 (Cont…)
Up to and including the day prior to the value date the ownership versus location position will remain the same due to the fact that there were no more trades and nor has settlement occurred for the prior trades. When the first trade settles on 25 Sep the internal records will need 22
Table-2 IBM Shares on 25 Sep Location -5000 Custodian in London ________________ ___________ +5000 -5000 It shows that 5000 shares are owned by the trader and that the shares have been delivered to its 23 custodian in London.
Ownership ALPHA +5000
Table-3 Position on 1 Oct Location -5000 Custodian in London -8000 GAMMA ________________ ___________ +13,000 -13,000 This shows that as a result of the second trade the ownership position has increased – part of the position is held at the custodian and the balance at the counterparty GAMMA. 24
Ownership ALPHA +13,000
Table-4 Position on 10 Oct
Ownership ALPHA +13,000
________________ +13000
Location -13000 Custodian in London ___________ -13000
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Table-5 Position 0n 15 Oct
Ownership ALPHA +9000
PHI ________________ +9,000
Location -13000 Custodian in London +4000 ___________ -9,000
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Table-6 Position on 25 Oct
Ownership ALPHA +9000
Location -9000 Custodian
in London ________________ ___________ +9000 -9000 Due to the double-entry system of bookkeeping the ownership position will 27 always be equal to the location position.
Trade Flow for Individual Trades
Investor send order to an Agent Agent records the order and sends it to an STO (Securities Trading Organization) or an Exchange. The STO or Exchange executes the order and sends the advice of execution to the Agent. The Agent will record the execution and send an advice of execution to the investor. 28
Individual Investors
An individual may decide to operate one or more securities accounts. They may be used:
To distinguish between holdings in equities versus debt Or to hold international and domestic securities separately
This enables separate assessment of profitability in a way that suits
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Individual Investors (Cont…)
Similarly for cash accounts an individual may require an Income Account to be maintained to reflect receipts of dividends on equities and coupons on bonds, while having a separate Capital or Investment account over which the cost of purchases is debited and sale proceeds are credited.
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Institutional Investors
Institutions may trade using an Agent or without utilizing the services of an agent.
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Trade Flow if an Agent is Used
Investor send order to an Agent Agent records the order and sends it to an STO (Securities Trading Organization) or an Exchange. The STO or Exchange executes the order and sends the advice of execution to the Agent. The Agent will record the execution and send an advice of execution to the investor. 32
Trade Flow if an Agent is not Used
The investor sends the order to an STO. The STO
Records the order Executes the order Records execution It then sends an advice of execution to the Investor. 33
Institutional Investors (Cont…)
Following execution of a trade to buy or sell securities, institutional investors effect settlement of trades either by utilizing the services of a global custodian that has a network of sub-custodians in numerous financial centers around the globe, or by having direct relationships with custodians in the 34 relevant financial centers.
Institutional Investors (Cont…)
In those cases where a global custodian is used, following the execution of trade the institutional client will issue a settlement instruction to only one destination – Its Global Custodian The global custodian will in turn instruct the appropriate local custodian to carry out settlement. 35
Securities Trading Organization (STO)
The terms STO is a collective expression that describes those who reside within the market -
Namely traders and market makers who on their own behalf sell securities to or buy securities from -
-
-
Agents acting on behalf of individual or institutional investors Individuals (HNI) or institutional investors who have opted not to use an agent Other STOs such as traders and market 36 makers.
Methods of Trading
Trades take place in two ways. Method-A:
The STO receives the order from an agent
Executes the order Records the detail of the execution Communicates the details of the execution to the agent
The agent will apply commission to the trade and communicate the detail to the investor. The STO will normally not be aware of the identity of the investor
The STOs client in this case is the agent.
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Methods…(Cont…)
Method-B:
The STO receives an order directly from an investor
Executes it Records the details Communicates the execution details directly to the investor
The STOs client in this case is the investor. 38
STOs (Cont…)
Unlike arrangements made by some institutional investors to use global custodians, most STOs hold securities representing their positive trading positions with a diversified group of custodian. Each custodian will be located in the normal place of settlement of the security concerned. 39
STOs (Cont…)
Following purchases and sales of securities the STO will issue a settlement instruction to its relevant custodian to perform settlement on its behalf. Following settlement the resultant securities and cash positions will be updated by the custodian and reported to the STO who will then update its internal books and records in order to 40 maintain an accurate picture of
Departments Within an STO
The Front Office
The Middle Office
Sales Traders Repo Traders Trade Support
The Back Office
Settlement 41
Departments Independent of Divisions
These include
Static Data Reconciliation Compliance Accounting Risk Management Internal Audit Information Technology 42
The Front Office
It is a collective term used to describe those who are involved with trading and market making either directly or indirectly.
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Sales
Institutional traders are powerful organizations. They are the originators of a large number of trades with large cash values. When an institutional client has a direct relationship with an STO the STO can generate a large of revenue provided it offers service 44
Sales (Cont…)
In order to ensure that institutional clients are given high quality service sales people are typically deputed to act as a primary contact point between the client and the STO. These point men are also known as:
Account managers or
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Sales (Cont…)
The institutional client will place orders with the salesperson either over the phone or via an order management system to which it has been given access. The salesperson is responsible for the internal management of the order which involves forwarding the order to the trader or the 46
Sales (Cont…)
The trader or the market maker will decide whether or not to trade. The salesperson has no authority to execute a trade on behalf of an STO. If the trader or market maker agrees to the terms of the order, a trade will be executed between the STO and the client. 47
Sales (Cont…)
The trader will record the details of the trade and advise the salesperson. The salesperson will inform the client that the order has been executed. This will be followed by the issuance of a formal trade confirmation by the STO to the client via a medium of the client’s 48
Sales (Cont…)
The management of an STO requires a mechanism to judge the performance of a salesperson. Normally a method of Sales Credits is employed for this purpose. This is a percentage of the value of each trade
The greater the number of trades and the cash value of each trade the greater is the accumulated sales credit. 49
Sales (Cont…)
The accumulated sales credits are used to calculate the compensation payable to the salesperson. So it is in the salesperson’s interest to:
Generate as many orders as possible To maintain relationships with existing institutional clients And to bring more clients to trade 50
Traders
They execute trades with the following types of counterparty.
Institutional clients via their own internal salespersons Agents acting on behalf of individual and institutional clients Other STOs Other companies within the STOs group
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Traders (Cont…)
Traders involved with proprietary trading within an STO are responsible for the profitability of their particular trading portfolio
This is referred to as a Trading Book
A trading book may be operated
Either by an individual or By a small group of traders 52
Traders (Cont…)
Each book contains a number of individual securities in which the trader or market maker trades The trading book is the primary record of the traders current and historical trades and trading positions. 53
Trading Books
Trading books may be defined according to:
Individuals or groups of traders to whom securities have been assigned A group of securities to whom traders have been assigned Currency of securities to which traders have been assigned Trading strategies to which traders have been assigned 54
Trading Books (Cont…)
To enable the management to assess the profitability of its trading activity, the trading department typically contains a number of trading books Each trade that is executed is `owned’ by a specific trading book. Trades are recorded against the relevant trading book And the Profit and Loss (P&L) is calculated at the trading book level
From this the performance of an individual or group of traders can be ascertained. 55
Traders (Cont…)
Traders within an STO are normally required to take positions within predefined trading limits set by the management. The objective is to prevent an over enthusiastic trader from taking an excessively risky position. 56
Traders (Cont…)
When a trader receives an order to trade for example from a salesman on behalf of an institutional client, he will first assess the terms of the trade. If feels that the terms are reasonable he will execute the trade. 57
Traders (Cont…)
Following execution the details of the trade will be recorded The trader will the update the trading book so that subsequent tasks such as
Settlement P&L calculations
can begin. 58
Repo Traders
When an STO buys a security and thereby takes a positive trading position in that security, then once settlement has occurred the relevant custodian will be holding the securities in safe custody on behalf of the STO. Conversely the purchase cost will be represented by a debit on the STOs Nostro account at the 59
Repos (Cont…)
The rate of interest charged by a custodian to remain overdrawn on the Nostro account may not be as low as borrowing rates in the money market. Unless action is taken to minimize the overdraft cost the rate of interest payable will have a detrimental effect on the trader’s 60
Repos (Cont…)
The cheapest method of borrowing cash is for the borrower to place some form of security as collateral with the lender. Lenders will charge a high rate of interest if the risk of not being repaid is high which is the case with unsecured loans. However if cash is lent on a secured or collateralized basis the risk to the lender is much reduced since he can recover the cash by selling the 61 collateral.
Repos (Cont…)
An STO has potential collateral in the form of securities that it has purchased and which it is holding with the custodian. In order to minimize the overdraft cost at the custodian the STO may borrow cash on secured basis by delivering the securities as collateral to a lender. 62
Repos (Cont…)
Repo traders are employed by STOs to manage the flow of collateral and cash in order to minimize the cost of borrowing funds that are needed to finance a positive trading position. Transactions are effected on behalf of the STO with other STOs and institutional clients to borrow against simultaneous delivery of securities on an agreed value date , with the return of cash plus interest and the collateral 63
Middle Office
The middle office also known as Trade or Trader Support is typically responsible for a number of tasks relating to the servicing and support of its traders, market makers, and salesmen.
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Middle Office (Cont…)
The tasks of a middle office include:
The keying of trade details to trading systems (on behalf of the traders) thereby allowing the traders to focus on trading The agreement of trade details with counterparties The investigation of trade details discrepancies if any between the STO65
Middle Office (Cont…)
New counterparty and security setup within the internal systems Production of the daily P&L from the STO’s formal books and records Ensuring agreement with the traders’ view of the P&L Reconciliation of trading positions (that is the quantity of specific securities within each trading book) between the STO’s books and the records and the trading system. 66
Operations or the Back Office
The Settlement Department
Following the execution of a trade within the front office and the subsequent recording of the trade within the trading system, trade details are typically fed through an interface between the trading system and the settlement system. 67
Back Office (Cont…)
Having received details of the trade, the back office is typically responsible for the following actions
Capturing the details of the trade within the settlement system Capturing the trading positions within internal books and records Applying additional details to the trade 68 Applying custodian details to the
Back Office (Cont…)
Gaining agreement of the trade details with the counterparty Providing details of the trade to regulatory authorities Issuing a settlement instruction to the relevant custodian Ensuring that the trade settles on the value date Updating internal books and records as a result of settlement Operating a custodian service for clients 69 Ensuring that income due is properly
Capturing the Details of the Trade within the Settlement System
The back office normally maintains the formal books and records pertaining to securities trades and positions within an STO Trades are first recorded in the front office trading system
But the responsibility for updating the formal books and records lies with areas such as settlement and 70 accounting.
Capturing…(Cont…)
The starting point for the settlement of trades and all subsequent activities is the capture of trade details within the settlement system. These days the formal books and records are very highly interlinked with software systems
Having been fed from the trading system trades are recorded in the settlement system (which forms a part of the STO’s formal books and records) automatically
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Information Example
Trade information that is normally fed by a trading system to a settlement system includes: Trading Book: Book A Trade Date: 20 April Trade Time: 11:25 Value Date: 23 April Operation: Buy Quantity: 500,000 Security: IBM Shares Price: USD 97.92 Counterparty XYZ, Zurich
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Updating Trading Positions With Internal Books and Records
The moment the details of a trade are captured within the settlement system, the trading positions for both securities and cash at a trading book level must be updated.
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Example
On 20 April, Trading Book A had an existing position of 1,000,000 IBM shares all of which were held at the custodian as the underlying trades had settled. The ownership versus location position is as follows. 74
Example (Cont…) IBM Shares on 20 April Ownership Location Trading +1,000,000 -1,000,000 Book A Custodian L, NYC _________ __________ + 1,000,000 -1,000,000
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Example (Cont…)
The following day Trading Book A purchased a further 1,000,000 shares from XYZ, Zurich. The trade was entered into the trading system and was fed to the settlement system where the capture of the trade resulted in the following ownership versus location position. 76
Example (Cont…) IBM Shares on 21 April Ownership Trading +2,000,000 Book A NYC
_________ + 2,000,000
Location -1,000,000 Custodian L, -1,000,000 XYZ, Zurich __________ -2,000,000
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Example (Cont…)
Equivalent entries for the relevant cash amounts would also need to be made.
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Updating…(Cont…)
Passing the entries in the STOs formal books and records provides a complete and updated view of the STO’s business. It also enables confirmation that the trading position agrees with the traders’ and market makers’ view of their position. The books and records show the STO’s view of the securities that are under its control ( at the custodian) and those that are not, as settlement is yet to occur
In this case for the 1,000,000 shares that are owed by XYZ
The equivalent cash entries would show the exact amount owed to XYZ for the STO’s
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Applying Additional Details to the Trade
Trading systems cater primarily for the needs of traders and do not typically provide all the information about a trade that is needed for complete operational processing by the back office. The typical trade information fed by a trading system and which is captured by the settlement system could be described as the `Trade 80
Applying…(Cont…)
The skeleton represents the minimum detail that a trader must provide for these items are variable and cannot be guessed by the settlement department. The exceptions are:
Trading Book, Trade Date and Value Date
In most cases it is possible to derive these details from the information
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Applying…(Cont…)
However for trades to settle successfully and for the operational activities to be completed, all trades require additional information to be attached, over and above what is contained in the skeleton. Examples Include:
Mandatory charges STO imposed charges
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Applying (Cont…)
Mandatory Charges: These include cash amounts that are imposed by law.
For example stamp duty at a fixed percentage rate is payable on the purchase of UK securities. The STO will charge the buyer the purchase cost inclusive of stamp duty, and must in turn pay the duty to the authorities. 83
Applying (Cont…)
STO Imposed Charges:
An STO will typically levy an administrative fee. This will be added to the purchase cost And will be deducted from the sales proceeds.
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Applying…(Cont…)
Accrued Interest:
When trading in an interest bearing bond the value of the interest payable by the issuer up to the value date is payable by the buyer to the seller in addition to the trade price.
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Applying Custodian Details to The Trade
In the past business was typically transacted by STOs only in their domestic securities markets. With the result that all trades settled with the same custodian in the home country.
Thus there was little or no choice as to where to settle the trade.
These days business is transacted worldwide.
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Thus it is necessary to decide which location
Applying…(Cont…)
Thus when a trade is input into a settlement system such as the purchase of 1,000,000 IBM shares, the system will derive the STO’s relevant custodian by a series of links.
For example the individual security (IBM) is linked to the nationality of the security (USA) which is linked to the relevant financial centre (NYC) which is linked to the relevant custodian. 87
Applying…(Cont…)
However it is important that the STO also derive the counterparty’s relevant custodian. With regard to an individual trade the STO’s custodian is required to act on the STO’s behalf only after the custodian has received a direct and specific communication from the STO. 88
Applying (Cont…)
The STO communicates with the custodian by issuing a settlement instruction directly to the custodian. The instruction tells the custodian to either receive or deliver:
A specific quantity For a specific security From/to a specific counterparty or its custodian On a specific value date Against a specific amount of cash
89
Applying (Cont…)
In order for the trade to settle settlement instructions must match between the two custodians. If a match is not made it could lead to a settlement failure and may lead to a monetary loss for the STO. For this reason timely and accurate calculation of both the STO’s and 90
Validating the Details of the Trade
Inaccurate recording of the details of a trade can lead to unnecessary costs and risks being taken by the STO. For instance settlement instruction matching between the two custodians must happen before settlement can occur. Therefore inaccurate trade recording either by the trader who enters trade details into the trading system or when writing the details of a trade or by middle or back office personnel inputting trades manually into the settlement system is likely to lead to a mismatch of settlement instructions. This can cause delays in settlement – that is, the trade fails to settle on the value date. 91
Validating… (Cont…)
Another example is where the STO’s counterparty to a trade is an institutional client who expects service of a high quality from the STO.
Part of the service provided by the STO is the issuance of a formal trade confirmation that lists all the details of the trade. If the information contained in a confirmation is inaccurate the STO 92
Validating…(Cont…)
In an attempt to prevent inaccurate information being sent to the outside world, the process of validating trade information is adopted by many STOs. Historically valuation used to be a manual task undertaken by those within the settlement department. 93
Validating…(Cont…)
In modern settlement systems rules can be written and then compared with individual trade details as each trade is received, resulting in the trade either passing or failing the internal check. Validation failures can then be investigated resulting in: Continued processing of the trade in its original state Or amendment of the trade details Followed by transmission of trade details to 94 the outside world.
Gaining Agreement to Trade Details With the Counterparty
Failure of the STO and its counterparty to agree on the details of the trade immediately after execution can result in monetary losses if the discrepancy remains unresolved as of the value date. Consequently it has become a standard practice in many markets to strive for trade agreement as 95
Gaining…(Cont…)
These days electronic trade matching mechanisms exist in some markets In other markets trade agreement is reached by the STO issuing an advice of trade confirmation known as a Trade Confirmation by a more conventional method such as paper or fax. 96
Gaining…(Cont…)
From the perspective of an STO there are two main reasons for wishing to achieve trade agreement and issuing a trade confirmation to the counterparty
Client service: Institutional clients are likely to require a formal written or electronic notification of trade details from the STO within a specified deadline following trade execution. 97
Gaining…(Cont…)
Risk Reduction: The issuance of a trade matching message by the STO provides the counterparty with the opportunity to agree or disagree with the details of the trade. It is in the STO’s interest to remove any doubt that the counterparty may have as soon as possible after trade execution.
For there is always the possibility that the counterparty disagrees with details such as price or quantity or it may even claim that it never sought to have the trade executed. The risk is that the trade may potentially have to amend or cancel a trade that was executed earlier.
98
Providing Details of the Trade to Regulatory Authorities
In many securities markets in order to enable the local regulator to monitor all trades executed by STOs, individual trade details must be sent to the regulator by a specified deadline typically during or at the end of the trade date. This is known as Transaction Reporting. 99
Providing…(Cont…)
Methods of achieving transaction reporting vary
In some markets the trade detail is conveyed to the regulator as an individual message serving no other purpose Or else it may be sent as a part of a trade matching message Or else it may be derived from the receipt by a Central Securities Depository of the STO’s settlement 100
Issuing a Settlement Instruction to the Relevant Custodian
Once the STO has determined which of its custodians to use for the settlement of an individual trade a settlement instruction must be issued by the STO to its custodian in order for settlement to occur. Custodians are required to remove securities or cash from the client’s account only after receipt of a 101
Issuing…(Cont…)
From an STO’s perspective there is a risk that its custodian may inadvertently act upon an instruction to remove securities or cash from its account when someone other than the STO has sent the instruction. However the responsibility of minimizing the possibility of fraud and error lies with both the 102
Issuing…(Cont…)
The STO and the custodian must agree on the method of communication of settlement instructions
The choices include electronic methods like SWIFT As well as less automated methods such as telex and fax. 103
Issuing…(Cont…)
The chosen method is very important as it will impact:
The ability to achieve STP The speed and accuracy with which a settlement instruction can be generated and transmitted to the custodian The deadline imposed by the custodian for the receipt of settlement instructions The type and extent of checking necessary by the custodian to prove the authenticity of the settlement instruction. 104
Issuing…(Cont…)
Irrespective of the method of transmitting the settlement instruction, the STO should seek from the custodian an acknowledgement of receipt of each individual instruction.
If the STO does not know whether the instruction has been received it takes the risk that the instruction has not 105 been received.
Issuing…(Cont…)
Where the custodian has not received the instruction the trade cannot settle and if the situation is not rectified on or before the value date settlement cannot occur on the value date.
Once the custodian has received a settlement instruction and is satisfied that it is authentic it must be matched with the 106 counterparty’s settlement
Ensuring that the Trade Settles on the Value Date
Settlement is due to occur on the value date. Settlement involves risk to both the parties unless measures are taken to prevent losses. If a seller delivers securities without receiving the sale proceeds at the same time or if a buyer pays cash without receiving securities at the same time, the risk is that receipt of the counter-
107
Ensuring…(Cont…)
The desired method of settlement is DvP meaning simultaneous exchange of securities for cash. Where securities have been sold and the trade is due to settle on a DvP basis the seller has a further risk; unless he is able to deliver the securities he will not receive cash at the earliest opportunity and hence will have a loss of interest. 108
Ensuring…(Cont…)
For example if 20MM USD is received a day late the loss of interest will be $2,500 assuming a rate of 5%. Settlement failures are normally caused by the seller not having the securities available for delivery on its value date. The first step in ensuring that the settlement occurs on the value date is to achieve a match of settlement instructions between the two custodians.
109
Ensuring…(Cont…)
Both parties to the trade should proactively seek the status of their settlement instruction from their respective custodian, and where unmatched, take immediate action to achieve a match. On the value date provided the settlement instructions have matched, settlement will occur if the seller has the securities and the buyer has the cash.
Should the seller be deficient in securities it may be possible to borrow securities in 110 order to settle the trade.
Updating Internal Books and Records as a Result of Settlement
Once settlement has occurred the STO’s custodian will advise the STO. In order to bring the STO’s internal books and records up to date to reflect the true position in the outside world, the appropriate trade within the STO’s settlement system must be identified and updated so as to reflect the 111
Updating…(Cont…)
The successfully updated settlement system will reveal that the trade is no longer awaiting settlement with the counterparty, and that in the case of a purchase by the STO securities have been credited to and cash has been debited from the STO’s account with the custodian and vice versa 112 for a sale.
Operating a Custodian Service for Clients
Following the execution of a trade STO’s typically expect to settle externally with counterparties that are STOs.
This means exchanging securities and cash between two custodians.
However where the counterparty to the trade is an institutional client the client may not have a custodian relationship to enable
113
Operating…(Cont…)
For client such as these the STO may offer to hold the client’s securities and possibly cash in safe custody. This means that when the STO sells securities to an institutional client:
He externally moves the securities to a segregated account from his own account at the custodian, while retaining control but not ownership of the securities Internally maintains records of the client’s securities holdings and possibly cash balances
The reverse flow must occur when the 114 STO buys securities.
Ensuring that Income Due is Received
Issuers of most securities pay income. Those who invest including STOs may or may not be entitled to these benefits. The first step in collection of the benefit is for the STO to become aware that the issuer is making a specific income payment.
Income on most bonds is predictable However income on equities is subject to announcement and the STO must check the information in order to minimize the risk of not receiving income to which it is entitled.115
Ensuring…(Cont…)
Secondly the STO must calculate whether it is in fact entitled to the income and if so must assess by whom the payment of income will be made and monitor the receivable amount till the payment is received. Where an STO offers safe custody service to clients, the STO is expected to collect income on 116
Independent Departments
Some departments are independent of divisions. These include:
Static Data Reconciliation Compliance Treasury Accounting Research Risk Management Internal Audit Information Technology
117
Static Data
Static Data or Standing Data is a term used within the securities industry to describe data that changes occasionally or not at all. The two principal components are:
Securities static data Counterparty static data
118
Static Data (Cont…)
The responsibilities of the static data department are the input of new and the update of changed securities and counterparty details to one or more systems such as the settlement systems and corporate action systems. If an STO wishes to achieve the highest possible automation of trade throughput known as STP, it must have complete confidence in the static data that is being input to the settlement system. 119
Static Data (Cont…)
STP is achievable if the two main types of data that are fed to the settlement system
Trade Data And Static Data
are both of high quality. Many components form security static data
For instance if the coupon rate on a bond is not correctly set up incorrect trade cash 120 values will result.
Static Data (Cont…)
Likewise static data relating to counterparties involves a number of attributes
For example the setting up of an incorrect counterparty postal address could result in an institutional client failing to receive a trade confirmation.
Where static data is not accurate monetary losses may be incurred by an STO through settling trades against incorrect cash values. If static data is incomplete delays in the throughput of trades are likely and this121 can result in a reduced service to
Reconciliation Department
An important process for any company is proving that its books and records are accurate meaning that
They are up-to-date Are complete And reflect reality
Reconciliation is achieved through the comparison of specific pieces of information within the STO’s books and records and between the STO’s records and the outside world. Frequent reconciliation is extremely important in order to minimize the number of 122 discrepancies requiring investigation.
Compliance Department
The compliance officers within an STO are responsible for ensuring that the various rules and regulations as laid down by the local regulatory authority are adhered to by the STO. This includes ensuring that: Only qualified personnel execute trades on the STO’s behalf Reporting of trade and positional information to the regulatory authorities is complete and effected 123 within the stated deadlines
Compliance (Cont…)
Methods of investigating trade disputes between the STO and its counterparties are carried out in a correct and thorough manner Measures are taken to prevent unlawful activities such as Insider Trading.
124
Treasury Department
The treasury department is responsible for obtaining funds as cheaply as possible in order to finance the trader’s positive trading positions. The treasury department typically has prior cash borrowing arrangements with other banks on a secured and unsecured basis. 125
Accounting Department
For any trading activity there is a need to keep formal accounting records of the company’s business including:
Asset – that is items of value to the owner Liabilities - any item actually or potentially owed to others Income such as
Interest on bank balances Commission earned Dividends and coupons Trading revenues
126
Research Department
The function of the research department is to analyze the performance of securities markets; companies; and individual securities in order to produce forecasts of performance. The information produced from such analysis is supplied to institutional clients. The research material is usually
127
Risk Management Department
The risk management department is responsible for assessing the STO’s risk which arises in a number of different ways. Trades:
Having executed a trade there is a risk that the counterparty may fail to honour its contractual obligation to settle the trade – the risk is that the profit will be lost if the trade is 128 cancelled. This is known as
Risk…(Cont…)
A different type of risk exists regarding the method of settlement of a trade If an STO agrees to settle a trade on an FOP basis and:
On a sale delivers securities before receiving cash Or on a purchase pays cash before receiving securities
there is a risk that the asset owed to the STO may be delayed or may never be 129 received at all.
Risk (Cont…)
Positions:
An STO that holds a positive securities position for its own account takes the risk that the price of the securities may fall – this is known as Market Risk A settlement position at a custodian may be regarded as risky and the issuer of the bond or equity may go out of business 130
Risk (Cont…)
Additionally the custodian may go out of business and although the STO may be protected from financial loss of the assets that the custodian holds on its behalf
There is a chance that settlement of sales may be delayed and that consequently income due to the STO may be delayed.
131
Internal Audit Department
Some STOs have set up a function that is responsible for examining the books and records kept by the STO’s operational areas to ensure that adequate controls are in place. In addition the internal audit area ensures that an external auditor will ratify the STO’s practices of bookkeeping and reconciliation for132
Transaction Types
The following transaction types are typically used by STOs:
Principal Repo Securities lending and borrowing Trading book transfer Depot (custodian) transfer 133
Principal Transactions
A principal transaction represents either a purchase or a sale by an STO on a proprietary trading basis.
134
Example Principal Transaction
Trading Book – Book A Trade Date – 20 April Trade Time – 11:05 Value Date – 23 April Operation – Buy Quantity – 3,000,000 Security – Telstra Price – AUD 46.30 Counterparty – RST, Hong Kong 135
Example Characteristics
Movement of – Securities and cash Origin – Front Office Trading position affected – Yes External securities movement – Yes External cash movement – Yes No. of external counterparties – One Issue a trade confirmation – Yes 136
Repurchase Transactions Example
Trading Book – Repo Book D Trading Date – 20 April Trading Time – 11:05 Operation – Repo (deliver securities and receive cash) Cash Amount – USD 20,650,000 (to receive) Face value of securities – USD 20,000,000 (to deliver) Security – World Bank 6.75%, 15 Feb 2025 Price – 102.25 Counterparty – DEF, NYC Opening value date – 22 April (value date of cash receipt) Closing value date – 30 April (value date of cash repayment) Interest rate – 4.50%
137
Repurchase Agreement Characteristics
Movement of – Securities and cash Origin – Front Office Trading position affected – No External securities movement – Yes External cash movement – Yes No. of external counterparties – One Issue a trade confirmation – Yes Issue a settlement instruction – Yes (one for the opening value date and one for the closing value date) 138
Securities Lending and Borrowing Example Trading Book – Securities lending and borrowing book Trade Date – 20 April Trade Time – 11:05 Operation – Lend Face value of securities – GBP12,000,000 lent/borrowed Security lent/borrowed – IADB 6.2% 1st Dec 2015 139 Price of security lent borrowed – 98.625%
Example (Cont…)
Face value of collateral – GBP 12,500,000 Collateral – Denmark 6.5% 15 may 2020 Collateral Price – 99.10% Counterparty – JKL London Opening value date – 22 April (securities delivery) Closing value date – 28 April (securities return) Fee – 4.2% of market value 140
Characteristics
Movement of – Securities only or securities plus cash Origin – Front Office Trading position affected – No External securities movement – Yes External cash movement – Yes No. of external counterparties – One Trade confirmation – Yes Issue a settlement instruction – Yes (two for opening value date and two for the closing value date) 141
Securities Lending/Borrowing
This illustrates a securities lending transaction from the STO’s perspective where the STO’s securities have been lent and delivered to the counterparty against receipt of collateral on the opening value date. The lent securities are subsequently returned to the STO by the counterparty against delivery of the collateral on the closing value date. 142
Securities…(Cont…)
The lending of securities does not result in a change to the trader’s trading position, as from the trader’s perspective ownership is retained. As a safeguard to the lender of securities the borrower is required to provide collateral that has a market value greater than the market value of the lent securities; the collateral may be in the form of cash or securities. Settlement instructions need to be issued to the STO’s custodian with settlement occurring on a DvP basis. Securities lending transactions normally involve a minimum of one movement of securities and one movement of collateral at the same time on two separate occasions – the opening value date and the closing value date.
143
Trading Book Transfer
An STO’s traders trade on a principal basis with other STOs and institutional clients. Within some STOs two or more trading books within the same legal entity may be allowed to trade and hold positions in the same security. 144
Trading Book Transfer (Cont…)
Under these circumstances one trading book may agree to trade with another trading book - a counterparty that is internal to an STO. This trade will b executed at a price that is agreeable to both parties and the P&L of both books will be affected by the price at 145
Example
Selling Trading Book – Book A Buying Trading Book – Book B Trade Date – 20 April Trade Time – 11:05 Value Date – 20 April Quantity – 2,000,000 Security – ICI shares Price – GBP 3.80 146
Characteristics
Origin – Front Office Trading position affected – Yes (both books) External securities movement – No External cash movement – No No. of external counterparties – None Issue a confirmation – No 147
Depot (Custodian) Transfer Transactions
An individual STO typically appoints a custodian in each financial centre to settle transactions and hold securities. Normally an STO will hold securities with one custodian per financial centre. However certain securities may be held at more than one custodian. For example Italian government bonds can be settled in Milan, but are also able to be settled in the international clearing systems – Euroclear in Brussels and Clearstream in Luxembourg. On occasions an STo may need to switch 148
Example
From Depot – Custodian Q , Milan To Depot – Custodian S, Brussels Quantity – EUR 2,000,000 Security – Italy 6%, 1 Sep 2012 Value Date – 20 April
149
Characteristics
Movement of – Securities Only Origin – Back Office Trading position affected – No External securities movement – Yes at both custodians External cash movement – No No. of external counterparties – None Issue a trade confirmation – No Issue a settlement instruction – Yes (to both custodians) 150
Depot Transfers
In situations where the seller holds securities with one custodian and the buyer wishes to take delivery at a different custodian, there is normally a choice of effecting a cross-border settlement, or of effecting settlement within the same custodian as the buyer, following a depot transfer.
151
Cash Transaction Types
The following transaction types are typically used by STOs. Each of these involves cash.
Repo Unsecured lending and borrowing Nostro transfer Foreign exchange 152
Cash…(Cont…)
In general terms cash transaction types are used for the purpose of covering actual or projected overdrafts of cash at the STO’s custodian resulting from the settlement of purchases.
153
Repos
These may be viewed as a cash transaction type as well as a securities transaction type. Many repo transactions are executed by STOs from the perspective of the need to borrow cash, against which securities are given as collateral. 154
Unsecured Cash Borrowing and Lending
The settlement of a principal purchase will result in a debit of cash and usually a negative cash position on the STO’s nostro account with the custodian. As the rate of overdraft interest charged by the custodian may be out of line with market rates, an STO will reduce its costs if it can borrow cash more cheaply from 155
Unsecured…(Cont…)
In order to cover a cash overdraft at the custodian an STO may choose to borrow cash on an unsecured basis
This is analogous to a repo except that no collateral is provide. As a consequence the cost of borrowing will be higher.
Unsecured borrowing and lending transactions are typically executed 156
Example
Trade Date – 20 April Trade Time – 11:05 Operation – Borrow Currency – HKD Amount – 22,500,000 Counterparty – HSBC Start Date – 22 April Maturity Date – 29 April Interest Rate – 6.4% 157
Characteristics
Movement of – cash only Origin – Treasury department Trading position affected – No External cash movement – Yes No. of external counterparties – One Issue a Trade Confirmation – Yes Issue a settlement instruction – Yes (one for opening value date and one for closing value date) 158
Unsecured…(Cont…)
An unsecured cash borrowing transaction is executed on a Trade Date; The borrower is due to receive the cash on the start date He is due to repay the cash plus interest on the maturity date A trade confirmation is issued by the STO to its counterparty containing the details of its transaction including the bank and account number to which the159
Unsecured…(Cont…)
Typically a settlement instruction is required to be issued by the STO to its receiving bank, so that the bank is alerted to the impending receipt of funds This type of an instruction is known as a `pre-advice’ of funds. At maturity the STO must issue a settlement instruction to its bank requesting repayment of cash plus
160
Unsecured…(Cont…)
Most of the time the STO will have a positive securities trading position and consequently will need to borrow cash in order to fund the purchases of securities. On occasions however the cash value of settled trades may be greater than that of settled purchases resulting in a credit cash balance at the STO’s account161
Unsecured…(Cont…)
The interest rates given by custodians on credit cash balances is typically lower than what can be obtained in the money market, and in some cases may even be zero. An STO desiring a better rate of return has no option but to lend. 162
Nostro Transfer Transactions
When an STO has an overdraft or anticipated overdraft at a custodian as a result of settlement of trades and it wishes to cover the overdraft, one of the options open is to transfer cash from
Another account with the same custodian an account held at another bank
163
Example
From Nostro – Custodian S, Brussels To Nostro – Custodian H, Hong Kong Currency – HKD Amount – 37,800,000 Value Date – 25 April 164
Characteristics
Movement – Cash Only Origin – Treasury Department or Back Office Trading position affected – No External cash movement – Yes Number of external counterparties – None Issue a trade confirmation – No Issue a settlement instruction – Yes (to 165 both paying as well as receiving
Foreign Exchange Transactions
A further option for an STO to cover an overdraft is to execute a foreign exchange transaction. When an STO has a credit balance in a nostro account in one currency (say JPY) but has an overdraft in another currency (say USD), it can effect an FX transaction that sells the appropriate number of JPY in exchange for the required number166
Example
Trade Date – 20 April Trade Time – 11:10 Value Date – 22 April Selling Currency – JPY Selling amount – 2,000,000,000 Buying Currency – USD Rate – 124.075 Buying amount – 16,119,282.69 Counterparty – Bank Y From Nostro – Custodian E, Tokyo To Nostro – Custodian L, NYC
167
Characteristics
Movement of – cash only (2 currencies) Origin – Back Office or Treasury Department Trading position affected – No External cash movement – Yes Number of external counterparties – One Issue a trade confirmation – Yes Issue a settlement instruction – Yes 168 (both nostros)
Cross-Currency Securities Settlement
Cross-currency settlement typically occurs when an STO has executed a securities transaction with an institutional client who wishes to pay or receive cash in a currency other than the normal traded currency of the security. 169
Example
Most bonds are traded in the currency of issue; for example a bond issued in Euros that pays interest in Euros and which will repay the principal in Euros at maturity will be traded in Euros in the secondary market. If an STO trades that bond in a currency other than Euros, an FX position and consequent risk will be taken by the STO unless it takes action to negate the 170 risk.
Example (Cont…)
For example if an STO buys a bond denominated in Euros it is highly likely to pay for the purchase in Euros. If the STO subsequently sells the bond is will normally wish to receive payment in the same currency. However it is normal for an STO to execute trades with institutional clients who always wish to pay or receive in the same currency. 171
Example (Cont…)
For instance a pension fund based in Singapore may wish to pay or receive the cash associated with the bond transaction in SGD, regardless of the issue currency of the bond. Assume that the cash paid by the STO on the purchase of the bond was EUR 5,000,000 and that it sells the bond for EUR 5,001,000. The trading profit is EUR 1,000. However if the counterparty were the Singapore based pension fund that wishes to pay in SGD, the STO would request payment of the SGD equivalent of EUR 5,001,000 or SGD
7,600,000.
172
Example (Cont…)
To summarize the STO’s overall currency situation
The STO has an overdraft of EUR 5,000,000 from its purchase But it has a credit of SGD 7,600,000 from its sale If the STO were to allow this situation to continue the trading profit in Euros may increase or decrease depending on exchange rate fluctuations. Thus the profit/loss is at the mercy of exchange rate movements.
To remove the risk in this case the STO would
173
Security Forms
Historically issuers printed paper certificates to represent equity and debt issues.
The certificate was intended to provide proof of ownership.
For an individual issue, certificates were normally designated as being in either registered or bearer form. 174
Registered Securities
The holders of a registered security will have their name and address recorded on a register of holders, which is typically maintained by a registrar or transfer agent on behalf of the issuer. The register contains
The name of the holder The address of the holder The quantity of shares or bonds held The date of registration and of changes of holdings
The registrar is responsible for keeping the register updated following a sale. 175
Certificated Form
Some issues in registered form are represented by certificates also known as a Scrip, which are printed and sent to the registered holders. A registered certificate typically contains the following information
The name of the issuer The description of the issue including the par value The certificate number The date of registration (the date on which the register was updated with the information contained in the certificate) The number of shares The registered holder’s name and address, which clearly identified the owner.
176
Certificated Form (Cont…)
Registered securities held by an company such as an STO, agent, or custodian on behalf of an investor are likely to be registered in a nominee name for all clients. The nominee’s name will appear on the issuer’s register of holders and represent the holdings of the underlying clients.
This enables more efficient administration of 177 subsequent sales by clients and the
Uncertificated Form
The registered owner’s holdings in some securities, although issued originally in certificated form may subsequently be held electronically via a method known as book entry. In these cases holdings are maintained centrally within a Central Securities Depository (CSD) as this facilitates more efficient holding and faster transfer of ownership. The global trend is moving towards 178 electronic book entry holdings and
Uncertificated Form (Cont…)
Securities that have been transformed from certified form to book entry form are either
Dematerialized that is certificates have been replaced by book entry Or immobilized that is the certificates continue to exist and are held centrally in storage
The holders of an uncertificated security will have their name and address 179 recorded on the register of holders
Bearer Securities
The holders of a bearer security have no means of having their name and address recorded on a register of holders maintained by the issuer or by a registrar
For no such register exists.
180
Standard Certificated Form
For bearer securities proof of ownership is physical possession of the certificate Thus holding a bearer security is like owning a banknote
Proof of ownership without physical ownership is extremely difficult to establish
When a bearer security is first issued the issuer prints bearer certificates representing the entire issue in specific denominations
The certificates are issued to the investors via the lead manager and the relevant member of the underwriting syndicate. 181
Standard…(Cont…)
The nature of the securities requires the investor to safeguard them by holding them securely
Certificates could be held in safe custody by an STO, an agent, or a custodian.
Physical movement of such securities introduces the risk of theft or loss.
So it is common to have them held in 182 vaults by a custodian or a Central
Standard…(Cont…)
Failure to have the securities held in a safe place could result in financial loss to the investor if the securities are lost or stolen. The responsibility for making payment of interest and maturity proceeds lies with the issuer or its appointed agent.
But payments are not made automatically. The bearer or its custodian is responsible for initiating these payments by presenting coupons (for interest payments) and the bond itself for the maturity proceeds. 183
Information on a Bearer Bond Certificate
The name of the issuer The description of the issue
The annual interest rate as a percentage of face value The maturity date The total issue size
The certificate number The face value A sheet of coupons
184
Coupons
Each coupon represents one of a number of interest payments during the life of the bond Interest may be paid
Annually Semi-annually Quarterly Or even monthly 185
Coupons (Cont…)
Each coupon contains the following information
The certificate number of the bond to which the coupon relates The face value of the bond The interest rate or amount per coupon The specific interest payment date The coupon paying agent
186
Methods of Transfer of Registered and Bearer Securities
When securities are sold or transferred the method of transfer from seller to buyer is closely linked to the form of the security being sold, because there may or may not be a need to re-resister the security. 187
Transfer and Reregistration
This is applicable to registered securities in certificated form. When an investor sells registered securities in certificated form the holder is required to deliver the registered certificates to the buyer to effect settlement. The steps are as follows. 188
Transfer…(Cont…)
The seller is required to complete a securities transfer form (in some markets he has to endorse the reverse of the certificate)
This indicates that the registered holder authorizes the removal or reduction of his holding in the specific security.
The certificate plus the sign transfer form must be delivered together to the buyer against
189
Transfer…(Cont…)
The buyer’s name and address are added to the securities transfer form and the certificate and the transfer form are forwarded to the registrar. On the register, the registrar will effect
Removal of the seller’s holding Creation of the buyer’s holding
The registrar will cancel the seller’s certificate for it is no longer valid He will create the buyer’s certificate He will then send the buyer’s certificate to the buyer. 190
Book Entry without Reregistration
This mode of sale is applicable to bearer securities. STOs buying a bearer security typically request that their securities are delivered to a CSD where the STO is a participant and where other STOs are likely to require their securities to be delivered. 191
Book Entry…(Cont…)
Bearer securities are normally held by the CSD in secure storage. The CSD must maintain records of the total quantity of an individual security that it holds, and the quantity held by each participant. CSDs do not mormally maintain records of which of their participants are the owners of which specific securities.
That is just like banknotes that are held by a bank the certificates are co-mingled. Such holdings are said to be fungible. At times a CSD may offer to hold non-fungible certificates for participants. 192
Book Entry…(Cont…)
Sales and purchases of bearer bonds are executed as a minimum of and multiples of the smallest denomination. The seller is required to deliver the bearer certificates representing the quantity sold to the buying STO’s custodian. The steps involved in a transfer are 193
Book Entry…(Cont…)
Having executed a sale the selling STO will issue a settlement instruction directly to the relevant CSD to deliver the securities to the byer’s account, within the CSD, versus receipt of cash, on the value date. Having executed a purchase the buying STO issues a settlement instruction directly to the relevant CSD to receive securities from the seller versus 194 payment of cash on the value date.
Book Entry…(Cont…)
On value date the following will occur.
As a result of settlement the CSD will need to update its records of securities holdings for its participants.
The seller’s or its custodian’s account will be debited with the securities and credited with cash. The buyer’s or its custodian’s account will be credited with the securities and debited with cash.
The total of all the holdings for all the participants has not changed. There has been no physical movement of securities in the CSDs vaults.
International CSDs like Euroclear and Clearstream Banking operate in this manner.195
Book Entry with Reregistration
This is applicable to registered securities in uncertificated form and is also applicable to registered securities in certificated form where
The seller holds the securities in certificated form but the buyer requires them in uncertificated form. 196
Steps
The seller and buyer each input a settlement instruction directly to the CSD or via their custodian. The CSD will send an electronic message containing details of the change in holdings as a result of settlement, to the registrar. The register is updated electronically. The registrar will send an electronic message confirming that the register has been updated to the CSD.
197
Countries and Systems
The following systems are used for book-entry with re-registration. Australia – CHESS – Clearing house Electronic Subregister System Hong Kong – CCASS – Central Clearing and Settlement System Japan – JASDEC - Japan Securities Depository Center UK and Ireland – CREST USA – DTC – Depository Trust Company 198
Trade Cash Value Calculation
It is necessary to calculate trade cash values for all transaction types with the exception of depot transfers since these involve only a movement of securities.
This process is known as Figuration.
The need for accuracy and speed in calculating trade cash values is important
It prevents
Losses through the payment of too much cash on purchases and the receipt of too little cash on sales Mismatches of trade details with counterparties 199 Miscommunication of trade costs or sales
Cash Value (Cont…)
The responsibility for the calculation of trade cash values for operational purposes typically resides within the middle office (trade support area) or with the settlement department. The final cash amount of a trade is referred to as Net Settlement Value. Two sets of information are required to calculate the NSV
The Gross Cash Value (GCV) Any additional trade amounts
200
Gross Cash Value Calculations
The type of price at which securities are traded depends on whether the security is an equity or a bond. Equity:
A pension fund wishes to buy shares of PQR. The sale is for 100,000 shares at $54.75 per share. The gross cash value is USD 5,475,000 In equity markets the gross cash value is also known as the Gross Consideration. 201
GCV (Cont…) For bonds, depending on the nature of the bond there are different pricing conventions. Bonds are in general traded at a percentage price relative to the face value of the bond. For example take a purchase of 1,000,000,000 JGBs with a coupon of 3.60% at a price of 98.125%. The GCV is: 1,000,000,000x98.125 ________________________=981,250,000 JPY 202
GCV (Cont…)
The GCV of a bond trade is commonly known as `principal’ or `principal value’. Yield Prices: The price of a bond can also be expressed on a yield basis Fractional Prices: In the US market bonds trade in fractional increments of 32nds. Thus a price of 99-5 is equivalent to 99 + 5/32 = 99.15625% of the face 203 value.
Additional Trade Amounts
Additional trade amounts have to be added to the Gross Cash Value in order to arrive at the Net Settlement Value. These amounts include:
Compulsory trade amounts Optional trade amounts Internal trade amounts 204
Compulsory Trade Amounts
These can be defined as cash values that STOs are obligated to charge because of requirements by bodies such as:
Stock exchanges Regulators Income tax authorities
Types of compulsory trade amounts include:
Stamp duty Purchase and sales taxes Transaction levies Registration costs
205
Examples
Hong Kong: Stamp duty of 0.125% and transaction levy of 0.007% is payable on equity purchases and sales. India: Stamp duty is payable when registering physical securities and is not payable on dematerialized securities. In addition STT is payable. Ireland: Stamp duty of 1% is 206
Examples (Cont…)
Japan: Registrars may charge a fee for the registration of securities. UK: Stamp duty of 0.5% is payable on equity securities and PTM Levy (Panel on Takeovers and Mergers) at a fixed GBP 0.25 is payable on purchases and sales over GBP 10,000. USA: SEC fee of 1/300th of one percent is payable by sellers of 207
Compulsory…(Cont…)
Automation of these calculations can occur where the calculation details are held within an STO’s settlement system.
208
Optional Trade Amounts
Optional trade amounts are cash values that STOs choose to charge that will affect the NSV. Administration Fees:
An STO may choose to charge an additional amount to its counterparty where for instance an unusual method of settlement is desired such as the processing of physical 209 certificates.
Optional…(Cont…)
Commissions:
Agents such as brokers typically earn profits by charging their clients commissions on executed trades. But an STO may charge a commission to an institutional client even when it acts in the capacity of a principal.
Commissions depend on a number of factors. 210
Optional…(Cont…)
Factors:
The monetary value of trades – the greater the size and frequency of trading the lower will be the commissions The location of the market – STOs are likely to charge lower commissions if the investor wishes to trade in a security in which the STO usually trades. Costs of trading and settlement in rarely traded securities will typically be higher. Availability of the security – trades in popularly traded securities are likely to be charged a lower rate of commission. 211
Internal Trade Amounts
These are cash values that STOs will not charge to the counterparty and consequently will not affect the NSV. For internal purposes the STO may calculate such items as:
Sales credits – where the salesman has been responsible for the client’s order a percentage sales credit can 212 be applied and the cash amount
Internal…(Cont…)
Anticipated external costs – where an STO expects to be charged by an external entity on a per transaction basis such as the cost of
Processing of a settlement instruction by a custodian Transmitting a trade confirmation
Internal operating costs – The management of an STO may take the view that the trader should bear the internal operational cost of processing each transaction. In such cases the total cost of items such as office space, 213 systems costs, payroll etc. are divided by
Net Settlement Value
The NSV is the final cash amount of a trade which is to be paid by the buyer or received by a seller. It is derived by calculating the GCV and adding or subtracting any additional trade amounts.
214
Example-1
An STO has sold 1,000,000 shares at a price of GBP 2.46 to an institutional client. Calculation:
1,000,000 x 2.46 = GBP 2,460,000 Add commission GBP 1,500 Add stamp duty GBP 12,300 ADD PTM Levy GBP 0.25 NSV GBP 2,473,800.25
215
Example-2
An STO has purchased 1,000,000 shares at a price of GBP 2.46 Calculation:
1,000,000 x 2.46 GBP 2,460,000 Deduct commission GBP -1,500 Deduct PTM Levy GBP -0.25 NSV GBP 2,458,499.75 216
Example-3
An STO has purchased USD 30,000,000 of 5.25% bonds at a price of 103.65%. Calculation:
USD 30,000,000 x 103.65% USD 31,095,000 Add accrued interest (200 days) USD 875,000 NSV USD 31,970,000 217
Static Data
Static data is critical from the standpoint of achieving straightthrough processing or STP. What is static data?
It is a term used to describe a store of information that is used to determine the appropriate actions necessary to achieve successful processing of each trade. 218
Static Data (Cont…)
Static data is required not only by the settlement department. The following areas of operation also use such data:
Order management Equity, bond and repo trading Corporate actions Reconciliation Risk management
219
Static Data (Cont…)
The term `static data’ implies that the information does not change. The majority of static data items are static and not subject to change. However certain aspects of static data are subject to periodic change or updating. 220
Static Data (Cont…)
The challenge for an STO is t:
Gather the relevant data Store it securely Update it when necessary Utilize it appropriately
The STO has to ensure that for every trade only the appropriate information is attached to the trade from the entire store of data. 221
Static Data (Cont...)
Typically an STO holds a vast amount of static data.
Large STOs may be holding within their systems thousands of securities and hundreds of counterparties. It is essential to select the correct information in a timely fashion if delays and costs are to be avoided. 222
Static Data (Cont…)
In an automated environment when a trade has been executed and recorded into a trading system, the trade will be received by the settlement system will at that point in time typically contain only the essential trading information. 223
Static Data (Cont…)
For a principal trade such trading information includes:
Trading book Trade data Trade time Value date Operation Quantity Security Price Counterparty
224
Static Data (Cont…)
In order to process the trade in an operational sense the trade needs to be enriched with more information. Fully functional settlement systems not only hold the necessary static data but also have the capability to automatically enrich trades with the appropriate225
Trading Companies
In order to automate the processing of trades it is necessary doe static data to be held regarding the trading company’s (STO’s) own details. An STO may be required to process the business of more than one trading company.
So information that is specific to each trading company will require setting 226 up within the static data.
Trading Companies (Cont…)
The trading activity of each company must remain segregated and separately identifiable for regulatory purposes. Management would also require separate accounting and P&L for each company. 227
Counterparties
STOs need to hold static data relating to all their counterparties, to enable automated enrichment of trades and subsequent actions such as
Production of trade confirmations And settlement instructions containing the counterparty’s custodian details. 228
Trading Books
A trading book within an STO represents groups of traders who trade in individual securities within specific security groups. It is normal for each trading book to be set up within the STO’s static data, and to have individual securities or security groups attached. 229
Hierarchy of P&L Calculations All European Trading All European Equities All Italian Equities
All European Bonds
All Spanish Equities
All French Bonds
Textiles
Chemicals
Bonds 3-5 Years
Chemicals
Forestry
Bonds 6-9 Years
230
Currencies
A modern STO normally operates in a multi-currency environment executing and settling trades in numerous currencies. Consequently details of currencies need to be set up within the trading system to provide consistency in the currency related aspects of
Trade cash value calculation Recording trades and updating books and records Issuing confirmations to counterparties
231
Currencies (Cont…)
The International Organization for Standardization (ISO) have given three character codes for most currencies. It is also important for an STO to be aware of public holidays around the globe for if such information is overlooked it could cause monetary losses due to the inability to move cash amounts when required. Thus an important component of static data is the holiday dates for all 232 currencies.
Securities
In order to automate the processing of trades, STOs need to hold the description, attributes and characteristics of securities. This is important for:
Accurate trade cash value calculation Exact description of the security appearing on trade confirmation issued to counterparties. 233
Example of a Bond
Full name: XOX AG 8.25% bonds 1st June 2020 Short name: XOX 8.25% 1.6.20 Internal reference: BD00757339 External reference: ISIN XS1234567893 Issued currency: USD Issued quantity: USD 1,000,000,000 Security type: Bond Security group: Eurobond (USD) Coupon rate type: Fixed rate Coupon rate: 8.25% Coupon frequency: Annual Coupon payment dates; 1 June Primary value date: 1 June 2000 First coupon payment date: 1 June 2001 Maturity date: 1 June 2020 Maturity price: 100% Denomination values: USD 5,000 and USD 20,000 Default trading book: Trading book Y Credit rating: AA 234
Example of an Equity
Full name: CDE plc GBP 1.00 ordinary shares Short name: CDE Ord Internal reference: SH00463815 External reference: ISINGB98765433215 Issued currency: GBP Issued quantity: 100,000,000 Security type: Equity Security group: UK Equity Primary value date: 16 January 2000 Board lots: 500 shares Default trading book: Trading Book D
235
Securities Identification Code Numbers
In order to facilitate unambiguous identification of securities, each individual security is given a unique identification code number. The securities numbering convention that is used globally is ISIN ISIN – International Securities Identification Number 236 It is a 12 character code
Securities…(Cont…)
The first two characters are a country code relating to the country of the issuer The next 9 characters are the national securities identification numbers The last character is a check digit which verifies the code In addition to the ISIN code securities identification numbers 237
Countries and Codes Country Code Australia ASX Belgium SVM Canada CUSIP Germany WKN Japan Quick Switzerland Valoren UK Sedol USA CUSIP CUSIP stands for Committee on Uniform Securities Identification Procedures 238
Sources of Static Data
Counterparties:
When an STO trades with a counterparty for the first time it is usual for the STO and the counterparty to swap custodian details directly, for each market in which they may execute trades between themselves. Additionally the STO will need to gather all other appropriate pieces of information from the counterparty 239 such as the required medium of trade
Counterparties (Cont…)
Counterparty information should be considered as private information, whereas information on securities is publicly available. Consequently information such as the custodian used by a party for a particular kind of trade is unlikely to be freely available. 240
Counterparties (Cont…)
There is a reason why such information is considered to be private.
Openly publicizing the custodian is like publicizing one’s bank account or credit card details. The worry is that assets may be removed from an account without authorization by the account holder. 241
Counterparties (Cont…)
Historically the process of gathering such information was a manual exercise. These days such information is available electronically for subscribers to a service called `Alert’ provided by Omgeo. The advantage is that updation of an STOs counterparty static data can be automated thereby preventing errors.
242
Securities
For those STOs that trade around the globe, the details of securities in which they trade will be derived from many sources in numerous locations. The decision as to which method to employ regarding the gathering of accurate and timely security static data is typically a difficult one. 243
Securities (Cont…)
When a security is being brought to the market it is normal for the issuer to produce a prospectus or offer document. The information contained in the prospectus is publicly available. At this point the custodians and CSDs typically set up details of the issue in their own static data 244
Securities (Cont…)
Some STOs gather their securities related static data directly from the prospectus. Another option is to request the necessary information from a custodian or CSD. There are a number of companies who specialize in gathering and distributing securities static data to those who subscribe to such a service. They are known as security data 245
Data Vendors
Reuters Telekurs Standard & Poor’s JJ Kenny Bloomberg FT Interactive data Data is provided by electronic feed or via the Internet. 246
Efficient Management of Static Data
The best method of gathering, storing, and updating static data involves the use of an internal central repository of data. This reduces the risk of conflicting data in the various processing systems. The system works as follows. 247
Efficient…(Cont…)
Securities static data pertaining to securities and counterparties is obtained from a number of sources. The STO stores the static data internally and compares the information for any discrepancies. This process is known as Data Cleansing. The Central Static Data Repository then releases the data to the relevant internal systems.
248
Controlling Access
The effort and cost of setting up accurate static data makes the protection of the data very critical. In an environment where any member of the staff is allowed to change the data, mistakes may be made despite the best of intentions. 249
Controlling Access (Cont…)
Incorrect changes to the coupon rate – will lead to an incorrect cash value transaction. Wrong address of a counterparty – trade confirmations may not be received on time Wrong modifications to the counterparty’s custodian details – settlement instruction issued by the STO will not match the counterparty’s instruction.
250
Controlling Access (Cont…)
In order to prevent errors many STOs protect their static data by restricting access to staff. Any changes made by someone with access rights will ideally be verified by a colleague.
This is known as the `Four Eyes’ principle
Following a successful change details of the change should be traceable by keeping records of
The staff members The time and date of change And the items that were changed
251
1
Part-14 Brokerage Operations Meso Issues
2
Standard Securities Terminology
Trade Date
The date on which the two parties agree to trade or the date of trade execution
Operation
The type and direction of the trade
That is Buy or Sell Lend or Borrow
Quantity
The number of units of the security being exchanged 3
Terminology (Cont…)
Security
Counterparty
The party to whom we sell or lend or the party from whom we buy or borrow
Value Date or Contractual Settlement Date
The specific asset being exchanged
The intended date of delivery of securities by the seller and the payment of cash by the buyer
Cash Due
The cash value of the trade; the amount to
4
Terminology (Cont…)
Required Location of Securities
The place where we wish the securities top reside
Cash to be paid from
From the buyer’s perspective the specific bank from which the payment is ought to be made
5
Trade in Securities versus Trade in Goods
Major differences arise in the context of `Required Location of Securities’ and `Cash to be Paid From’.
6
Location
A seller of goods will most probably take direct delivery of the goods purchased and store them in a local warehouse. Payment will be made by handing over a check to the seller. Similarly following a sale delivery of goods will be under the direct control of the seller and receipt of a check on account of a sale can be banked immediately. 7
Location (Cont…)
The securities industry is however a global industry
Traders in the world’s financial centers invest in securities that are normally delivered locally to the security’s place of issue.
For example a trader in New York may choose to invest in an Australian security.
He can always take delivery in New
8
Location (Cont…)
However from an efficiency and cost perspective the trader will typically ask for delivery in the normal place of issue and delivery of the securities, in this case Sydney. The alternative is that securities would be delivered from Sydney to New York with lengthy delivery time frames and costs. Besides the seller is likely to demand payment before the securities leave his possession.
If the buyer were to agree he would be taking the risk of being without both securities and cash. Such risk would be unacceptable to most parties. 9
Location (Cont…)
In order to minimize the risk and to exchange securities and cash in the most efficient manner, most traders use local agents to exchange securities and cash on their behalf. These local agents are often referred to as Depots/Nostros or Custodians. We will use the term Custodians in this presentation to refer to such agents.
10
Location (Cont…)
Securities are held within a custodian securities account – known as a DEPOT Account. Cash is held in a custodian cash account – known as a NOSTRO Account. Large traders employ the services of custodians around the globe.
Each custodian is responsible for exchanging securities and cash as a result of buying and selling by the trader. He is also responsible for holding the 11 securities and cash in safekeeping on behalf
Exchanging Securities and Cash
The exchanging of securities and cash is known as SETTLEMENT. The art of settlement is no different from buying and selling goods.
Most traders would be reluctant to pay the purchase price without taking delivery of the goods at the same time. Conversely sellers would not like to hand over title to the goods without 12
Exchanging…(Cont…)
The risk which is applicable to both parties is that at some point in time they may be in possession of neither asset.
Traders are very risk averse and try to avoid such situations.
The most efficient and risk free method of settlement is known as Delivery versus Payment or DvP, whereby simultaneous exchange of securities and cash is effected between the buyer 13 and seller through their respective
Exchanging…(Cont…)
Under DvP
The seller is not required to deliver securities till the buyer pays the cash And the buyer is not required to pay the cash until the seller delivers the securities thereby ensuring the both parties are protected.
The alternative to DvP is Free of Payment or FoP settlement.
In this case one or both parties will need to arrange delivery of securities or payment of cash prior to taking possession of the other 14 asset.
Control
It is important for a company to remain in control of its goods and cash.
For a securities trader this means monitoring within its books and records complete and up-to-date records of the following.
Trades: A complete record must be maintained of all executed trades Trading Positions: The net quantity15
Control (Cont…)
Open Trades: Trades which are yet to settle and are outstanding with counterparties. Settled Trades: Trades which have settled at a custodian and are no longer outstanding with a counterparty. Settled Positions: The net sum of all settled trades in each security and in each currency. In order to prove that the records are accurate each of the items should be 16
Control (Cont…)
Furthermore, a trader’s complete picture for an individual security can be reconciled internally by comparing
The trading position or `ownership’ position with the sum of `open’ trades and the settled position also know as the `location’ position. 17
Control (Cont…)
The advantage of performing an ownership versus location comparison is that it is intended to confirm that whatever quantity of goods that the trader owns as a result of trading – which is represented by the trading position is Held within the trader’s control at the custodian and/or Is due to be delivered to it by counterparties from whom it has purchased securities and/or Is due to be delivered by it to counterparties 18
Example
ALPHA a dealing firm undertakes the following three trades in IBM. Assume that there was no trading position prior to the first trade C’Pty
T.Dt.
V.Dt.
Op.
Qty.
T.Pos.
BETA
15Sep
25SEp
Buy
5,000
+5000
Gamma 1 Oct
10 Oct
Buy
8,000
+13,00 0
PHI
25 Oct
Sell
4,000
+9,000
15 Oct
19
Example (Cont…)
The ownership versus location position of the shares at various points in time is as depicted below. The convention in these tables is: Within ownership
A positive trading position is represented by a + sign
Consequently within location
An open purchase due from a party will be shown with a – sign A settled purchase held at a custodian will be shown with a – sign An open sale due to a counterparty will be
20
Table-1 IBM Shares on 1 Sep Ownership Location ALPHA +5000 -5000 BETA ________________ ___________ +5000 -5000 This shows the position immediately after the first trade. It shows that 5000 shares are owned by ALPHA and that these shares have not yet been delivered to the custodian by the counterparty as the value date is in the21
Table-1 (Cont…)
Up to and including the day prior to the value date the ownership versus location position will remain the same due to the fact that there were no more trades and nor has settlement occurred for the prior trades. When the first trade settles on 25 Sep the internal records will need 22
Table-2 IBM Shares on 25 Sep Location -5000 Custodian in London ________________ ___________ +5000 -5000 It shows that 5000 shares are owned by the trader and that the shares have been delivered to its 23 custodian in London.
Ownership ALPHA +5000
Table-3 Position on 1 Oct Location -5000 Custodian in London -8000 GAMMA ________________ ___________ +13,000 -13,000 This shows that as a result of the second trade the ownership position has increased – part of the position is held at the custodian and the balance at the counterparty GAMMA. 24
Ownership ALPHA +13,000
Table-4 Position on 10 Oct
Ownership ALPHA +13,000
________________ +13000
Location -13000 Custodian in London ___________ -13000
25
Table-5 Position 0n 15 Oct
Ownership ALPHA +9000
PHI ________________ +9,000
Location -13000 Custodian in London +4000 ___________ -9,000
26
Table-6 Position on 25 Oct
Ownership ALPHA +9000
Location -9000 Custodian
in London ________________ ___________ +9000 -9000 Due to the double-entry system of bookkeeping the ownership position will 27 always be equal to the location position.
Trade Flow for Individual Trades
Investor send order to an Agent Agent records the order and sends it to an STO (Securities Trading Organization) or an Exchange. The STO or Exchange executes the order and sends the advice of execution to the Agent. The Agent will record the execution and send an advice of execution to the investor. 28
Individual Investors
An individual may decide to operate one or more securities accounts. They may be used:
To distinguish between holdings in equities versus debt Or to hold international and domestic securities separately
This enables separate assessment of profitability in a way that suits
29
Individual Investors (Cont…)
Similarly for cash accounts an individual may require an Income Account to be maintained to reflect receipts of dividends on equities and coupons on bonds, while having a separate Capital or Investment account over which the cost of purchases is debited and sale proceeds are credited.
30
Institutional Investors
Institutions may trade using an Agent or without utilizing the services of an agent.
31
Trade Flow if an Agent is Used
Investor send order to an Agent Agent records the order and sends it to an STO (Securities Trading Organization) or an Exchange. The STO or Exchange executes the order and sends the advice of execution to the Agent. The Agent will record the execution and send an advice of execution to the investor. 32
Trade Flow if an Agent is not Used
The investor sends the order to an STO. The STO
Records the order Executes the order Records execution It then sends an advice of execution to the Investor. 33
Institutional Investors (Cont…)
Following execution of a trade to buy or sell securities, institutional investors effect settlement of trades either by utilizing the services of a global custodian that has a network of sub-custodians in numerous financial centers around the globe, or by having direct relationships with custodians in the 34 relevant financial centers.
Institutional Investors (Cont…)
In those cases where a global custodian is used, following the execution of trade the institutional client will issue a settlement instruction to only one destination – Its Global Custodian The global custodian will in turn instruct the appropriate local custodian to carry out settlement. 35
Securities Trading Organization (STO)
The terms STO is a collective expression that describes those who reside within the market -
Namely traders and market makers who on their own behalf sell securities to or buy securities from -
-
-
Agents acting on behalf of individual or institutional investors Individuals (HNI) or institutional investors who have opted not to use an agent Other STOs such as traders and market 36 makers.
Methods of Trading
Trades take place in two ways. Method-A:
The STO receives the order from an agent
Executes the order Records the detail of the execution Communicates the details of the execution to the agent
The agent will apply commission to the trade and communicate the detail to the investor. The STO will normally not be aware of the identity of the investor
The STOs client in this case is the agent.
37
Methods…(Cont…)
Method-B:
The STO receives an order directly from an investor
Executes it Records the details Communicates the execution details directly to the investor
The STOs client in this case is the investor. 38
STOs (Cont…)
Unlike arrangements made by some institutional investors to use global custodians, most STOs hold securities representing their positive trading positions with a diversified group of custodian. Each custodian will be located in the normal place of settlement of the security concerned. 39
STOs (Cont…)
Following purchases and sales of securities the STO will issue a settlement instruction to its relevant custodian to perform settlement on its behalf. Following settlement the resultant securities and cash positions will be updated by the custodian and reported to the STO who will then update its internal books and records in order to 40 maintain an accurate picture of
Departments Within an STO
The Front Office
The Middle Office
Sales Traders Repo Traders Trade Support
The Back Office
Settlement 41
Departments Independent of Divisions
These include
Static Data Reconciliation Compliance Accounting Risk Management Internal Audit Information Technology 42
The Front Office
It is a collective term used to describe those who are involved with trading and market making either directly or indirectly.
43
Sales
Institutional traders are powerful organizations. They are the originators of a large number of trades with large cash values. When an institutional client has a direct relationship with an STO the STO can generate a large of revenue provided it offers service 44
Sales (Cont…)
In order to ensure that institutional clients are given high quality service sales people are typically deputed to act as a primary contact point between the client and the STO. These point men are also known as:
Account managers or
45
Sales (Cont…)
The institutional client will place orders with the salesperson either over the phone or via an order management system to which it has been given access. The salesperson is responsible for the internal management of the order which involves forwarding the order to the trader or the 46
Sales (Cont…)
The trader or the market maker will decide whether or not to trade. The salesperson has no authority to execute a trade on behalf of an STO. If the trader or market maker agrees to the terms of the order, a trade will be executed between the STO and the client. 47
Sales (Cont…)
The trader will record the details of the trade and advise the salesperson. The salesperson will inform the client that the order has been executed. This will be followed by the issuance of a formal trade confirmation by the STO to the client via a medium of the client’s 48
Sales (Cont…)
The management of an STO requires a mechanism to judge the performance of a salesperson. Normally a method of Sales Credits is employed for this purpose. This is a percentage of the value of each trade
The greater the number of trades and the cash value of each trade the greater is the accumulated sales credit. 49
Sales (Cont…)
The accumulated sales credits are used to calculate the compensation payable to the salesperson. So it is in the salesperson’s interest to:
Generate as many orders as possible To maintain relationships with existing institutional clients And to bring more clients to trade 50
Traders
They execute trades with the following types of counterparty.
Institutional clients via their own internal salespersons Agents acting on behalf of individual and institutional clients Other STOs Other companies within the STOs group
51
Traders (Cont…)
Traders involved with proprietary trading within an STO are responsible for the profitability of their particular trading portfolio
This is referred to as a Trading Book
A trading book may be operated
Either by an individual or By a small group of traders 52
Traders (Cont…)
Each book contains a number of individual securities in which the trader or market maker trades The trading book is the primary record of the traders current and historical trades and trading positions. 53
Trading Books
Trading books may be defined according to:
Individuals or groups of traders to whom securities have been assigned A group of securities to whom traders have been assigned Currency of securities to which traders have been assigned Trading strategies to which traders have been assigned 54
Trading Books (Cont…)
To enable the management to assess the profitability of its trading activity, the trading department typically contains a number of trading books Each trade that is executed is `owned’ by a specific trading book. Trades are recorded against the relevant trading book And the Profit and Loss (P&L) is calculated at the trading book level
From this the performance of an individual or group of traders can be ascertained. 55
Traders (Cont…)
Traders within an STO are normally required to take positions within predefined trading limits set by the management. The objective is to prevent an over enthusiastic trader from taking an excessively risky position. 56
Traders (Cont…)
When a trader receives an order to trade for example from a salesman on behalf of an institutional client, he will first assess the terms of the trade. If feels that the terms are reasonable he will execute the trade. 57
Traders (Cont…)
Following execution the details of the trade will be recorded The trader will the update the trading book so that subsequent tasks such as
Settlement P&L calculations
can begin. 58
Repo Traders
When an STO buys a security and thereby takes a positive trading position in that security, then once settlement has occurred the relevant custodian will be holding the securities in safe custody on behalf of the STO. Conversely the purchase cost will be represented by a debit on the STOs Nostro account at the 59
Repos (Cont…)
The rate of interest charged by a custodian to remain overdrawn on the Nostro account may not be as low as borrowing rates in the money market. Unless action is taken to minimize the overdraft cost the rate of interest payable will have a detrimental effect on the trader’s 60
Repos (Cont…)
The cheapest method of borrowing cash is for the borrower to place some form of security as collateral with the lender. Lenders will charge a high rate of interest if the risk of not being repaid is high which is the case with unsecured loans. However if cash is lent on a secured or collateralized basis the risk to the lender is much reduced since he can recover the cash by selling the 61 collateral.
Repos (Cont…)
An STO has potential collateral in the form of securities that it has purchased and which it is holding with the custodian. In order to minimize the overdraft cost at the custodian the STO may borrow cash on secured basis by delivering the securities as collateral to a lender. 62
Repos (Cont…)
Repo traders are employed by STOs to manage the flow of collateral and cash in order to minimize the cost of borrowing funds that are needed to finance a positive trading position. Transactions are effected on behalf of the STO with other STOs and institutional clients to borrow against simultaneous delivery of securities on an agreed value date , with the return of cash plus interest and the collateral 63
Middle Office
The middle office also known as Trade or Trader Support is typically responsible for a number of tasks relating to the servicing and support of its traders, market makers, and salesmen.
64
Middle Office (Cont…)
The tasks of a middle office include:
The keying of trade details to trading systems (on behalf of the traders) thereby allowing the traders to focus on trading The agreement of trade details with counterparties The investigation of trade details discrepancies if any between the STO65
Middle Office (Cont…)
New counterparty and security setup within the internal systems Production of the daily P&L from the STO’s formal books and records Ensuring agreement with the traders’ view of the P&L Reconciliation of trading positions (that is the quantity of specific securities within each trading book) between the STO’s books and the records and the trading system. 66
Operations or the Back Office
The Settlement Department
Following the execution of a trade within the front office and the subsequent recording of the trade within the trading system, trade details are typically fed through an interface between the trading system and the settlement system. 67
Back Office (Cont…)
Having received details of the trade, the back office is typically responsible for the following actions
Capturing the details of the trade within the settlement system Capturing the trading positions within internal books and records Applying additional details to the trade 68 Applying custodian details to the
Back Office (Cont…)
Gaining agreement of the trade details with the counterparty Providing details of the trade to regulatory authorities Issuing a settlement instruction to the relevant custodian Ensuring that the trade settles on the value date Updating internal books and records as a result of settlement Operating a custodian service for clients 69 Ensuring that income due is properly
Capturing the Details of the Trade within the Settlement System
The back office normally maintains the formal books and records pertaining to securities trades and positions within an STO Trades are first recorded in the front office trading system
But the responsibility for updating the formal books and records lies with areas such as settlement and 70 accounting.
Capturing…(Cont…)
The starting point for the settlement of trades and all subsequent activities is the capture of trade details within the settlement system. These days the formal books and records are very highly interlinked with software systems
Having been fed from the trading system trades are recorded in the settlement system (which forms a part of the STO’s formal books and records) automatically
71
Information Example
Trade information that is normally fed by a trading system to a settlement system includes: Trading Book: Book A Trade Date: 20 April Trade Time: 11:25 Value Date: 23 April Operation: Buy Quantity: 500,000 Security: IBM Shares Price: USD 97.92 Counterparty XYZ, Zurich
72
Updating Trading Positions With Internal Books and Records
The moment the details of a trade are captured within the settlement system, the trading positions for both securities and cash at a trading book level must be updated.
73
Example
On 20 April, Trading Book A had an existing position of 1,000,000 IBM shares all of which were held at the custodian as the underlying trades had settled. The ownership versus location position is as follows. 74
Example (Cont…) IBM Shares on 20 April Ownership Location Trading +1,000,000 -1,000,000 Book A Custodian L, NYC _________ __________ + 1,000,000 -1,000,000
75
Example (Cont…)
The following day Trading Book A purchased a further 1,000,000 shares from XYZ, Zurich. The trade was entered into the trading system and was fed to the settlement system where the capture of the trade resulted in the following ownership versus location position. 76
Example (Cont…) IBM Shares on 21 April Ownership Trading +2,000,000 Book A NYC
_________ + 2,000,000
Location -1,000,000 Custodian L, -1,000,000 XYZ, Zurich __________ -2,000,000
77
Example (Cont…)
Equivalent entries for the relevant cash amounts would also need to be made.
78
Updating…(Cont…)
Passing the entries in the STOs formal books and records provides a complete and updated view of the STO’s business. It also enables confirmation that the trading position agrees with the traders’ and market makers’ view of their position. The books and records show the STO’s view of the securities that are under its control ( at the custodian) and those that are not, as settlement is yet to occur
In this case for the 1,000,000 shares that are owed by XYZ
The equivalent cash entries would show the exact amount owed to XYZ for the STO’s
79
Applying Additional Details to the Trade
Trading systems cater primarily for the needs of traders and do not typically provide all the information about a trade that is needed for complete operational processing by the back office. The typical trade information fed by a trading system and which is captured by the settlement system could be described as the `Trade 80
Applying…(Cont…)
The skeleton represents the minimum detail that a trader must provide for these items are variable and cannot be guessed by the settlement department. The exceptions are:
Trading Book, Trade Date and Value Date
In most cases it is possible to derive these details from the information
81
Applying…(Cont…)
However for trades to settle successfully and for the operational activities to be completed, all trades require additional information to be attached, over and above what is contained in the skeleton. Examples Include:
Mandatory charges STO imposed charges
82
Applying (Cont…)
Mandatory Charges: These include cash amounts that are imposed by law.
For example stamp duty at a fixed percentage rate is payable on the purchase of UK securities. The STO will charge the buyer the purchase cost inclusive of stamp duty, and must in turn pay the duty to the authorities. 83
Applying (Cont…)
STO Imposed Charges:
An STO will typically levy an administrative fee. This will be added to the purchase cost And will be deducted from the sales proceeds.
84
Applying…(Cont…)
Accrued Interest:
When trading in an interest bearing bond the value of the interest payable by the issuer up to the value date is payable by the buyer to the seller in addition to the trade price.
85
Applying Custodian Details to The Trade
In the past business was typically transacted by STOs only in their domestic securities markets. With the result that all trades settled with the same custodian in the home country.
Thus there was little or no choice as to where to settle the trade.
These days business is transacted worldwide.
86
Thus it is necessary to decide which location
Applying…(Cont…)
Thus when a trade is input into a settlement system such as the purchase of 1,000,000 IBM shares, the system will derive the STO’s relevant custodian by a series of links.
For example the individual security (IBM) is linked to the nationality of the security (USA) which is linked to the relevant financial centre (NYC) which is linked to the relevant custodian. 87
Applying…(Cont…)
However it is important that the STO also derive the counterparty’s relevant custodian. With regard to an individual trade the STO’s custodian is required to act on the STO’s behalf only after the custodian has received a direct and specific communication from the STO. 88
Applying (Cont…)
The STO communicates with the custodian by issuing a settlement instruction directly to the custodian. The instruction tells the custodian to either receive or deliver:
A specific quantity For a specific security From/to a specific counterparty or its custodian On a specific value date Against a specific amount of cash
89
Applying (Cont…)
In order for the trade to settle settlement instructions must match between the two custodians. If a match is not made it could lead to a settlement failure and may lead to a monetary loss for the STO. For this reason timely and accurate calculation of both the STO’s and 90
Validating the Details of the Trade
Inaccurate recording of the details of a trade can lead to unnecessary costs and risks being taken by the STO. For instance settlement instruction matching between the two custodians must happen before settlement can occur. Therefore inaccurate trade recording either by the trader who enters trade details into the trading system or when writing the details of a trade or by middle or back office personnel inputting trades manually into the settlement system is likely to lead to a mismatch of settlement instructions. This can cause delays in settlement – that is, the trade fails to settle on the value date. 91
Validating… (Cont…)
Another example is where the STO’s counterparty to a trade is an institutional client who expects service of a high quality from the STO.
Part of the service provided by the STO is the issuance of a formal trade confirmation that lists all the details of the trade. If the information contained in a confirmation is inaccurate the STO 92
Validating…(Cont…)
In an attempt to prevent inaccurate information being sent to the outside world, the process of validating trade information is adopted by many STOs. Historically valuation used to be a manual task undertaken by those within the settlement department. 93
Validating…(Cont…)
In modern settlement systems rules can be written and then compared with individual trade details as each trade is received, resulting in the trade either passing or failing the internal check. Validation failures can then be investigated resulting in: Continued processing of the trade in its original state Or amendment of the trade details Followed by transmission of trade details to 94 the outside world.
Gaining Agreement to Trade Details With the Counterparty
Failure of the STO and its counterparty to agree on the details of the trade immediately after execution can result in monetary losses if the discrepancy remains unresolved as of the value date. Consequently it has become a standard practice in many markets to strive for trade agreement as 95
Gaining…(Cont…)
These days electronic trade matching mechanisms exist in some markets In other markets trade agreement is reached by the STO issuing an advice of trade confirmation known as a Trade Confirmation by a more conventional method such as paper or fax. 96
Gaining…(Cont…)
From the perspective of an STO there are two main reasons for wishing to achieve trade agreement and issuing a trade confirmation to the counterparty
Client service: Institutional clients are likely to require a formal written or electronic notification of trade details from the STO within a specified deadline following trade execution. 97
Gaining…(Cont…)
Risk Reduction: The issuance of a trade matching message by the STO provides the counterparty with the opportunity to agree or disagree with the details of the trade. It is in the STO’s interest to remove any doubt that the counterparty may have as soon as possible after trade execution.
For there is always the possibility that the counterparty disagrees with details such as price or quantity or it may even claim that it never sought to have the trade executed. The risk is that the trade may potentially have to amend or cancel a trade that was executed earlier.
98
Providing Details of the Trade to Regulatory Authorities
In many securities markets in order to enable the local regulator to monitor all trades executed by STOs, individual trade details must be sent to the regulator by a specified deadline typically during or at the end of the trade date. This is known as Transaction Reporting. 99
Providing…(Cont…)
Methods of achieving transaction reporting vary
In some markets the trade detail is conveyed to the regulator as an individual message serving no other purpose Or else it may be sent as a part of a trade matching message Or else it may be derived from the receipt by a Central Securities Depository of the STO’s settlement 100
Issuing a Settlement Instruction to the Relevant Custodian
Once the STO has determined which of its custodians to use for the settlement of an individual trade a settlement instruction must be issued by the STO to its custodian in order for settlement to occur. Custodians are required to remove securities or cash from the client’s account only after receipt of a 101
Issuing…(Cont…)
From an STO’s perspective there is a risk that its custodian may inadvertently act upon an instruction to remove securities or cash from its account when someone other than the STO has sent the instruction. However the responsibility of minimizing the possibility of fraud and error lies with both the 102
Issuing…(Cont…)
The STO and the custodian must agree on the method of communication of settlement instructions
The choices include electronic methods like SWIFT As well as less automated methods such as telex and fax. 103
Issuing…(Cont…)
The chosen method is very important as it will impact:
The ability to achieve STP The speed and accuracy with which a settlement instruction can be generated and transmitted to the custodian The deadline imposed by the custodian for the receipt of settlement instructions The type and extent of checking necessary by the custodian to prove the authenticity of the settlement instruction. 104
Issuing…(Cont…)
Irrespective of the method of transmitting the settlement instruction, the STO should seek from the custodian an acknowledgement of receipt of each individual instruction.
If the STO does not know whether the instruction has been received it takes the risk that the instruction has not 105 been received.
Issuing…(Cont…)
Where the custodian has not received the instruction the trade cannot settle and if the situation is not rectified on or before the value date settlement cannot occur on the value date.
Once the custodian has received a settlement instruction and is satisfied that it is authentic it must be matched with the 106 counterparty’s settlement
Ensuring that the Trade Settles on the Value Date
Settlement is due to occur on the value date. Settlement involves risk to both the parties unless measures are taken to prevent losses. If a seller delivers securities without receiving the sale proceeds at the same time or if a buyer pays cash without receiving securities at the same time, the risk is that receipt of the counter-
107
Ensuring…(Cont…)
The desired method of settlement is DvP meaning simultaneous exchange of securities for cash. Where securities have been sold and the trade is due to settle on a DvP basis the seller has a further risk; unless he is able to deliver the securities he will not receive cash at the earliest opportunity and hence will have a loss of interest. 108
Ensuring…(Cont…)
For example if 20MM USD is received a day late the loss of interest will be $2,500 assuming a rate of 5%. Settlement failures are normally caused by the seller not having the securities available for delivery on its value date. The first step in ensuring that the settlement occurs on the value date is to achieve a match of settlement instructions between the two custodians.
109
Ensuring…(Cont…)
Both parties to the trade should proactively seek the status of their settlement instruction from their respective custodian, and where unmatched, take immediate action to achieve a match. On the value date provided the settlement instructions have matched, settlement will occur if the seller has the securities and the buyer has the cash.
Should the seller be deficient in securities it may be possible to borrow securities in 110 order to settle the trade.
Updating Internal Books and Records as a Result of Settlement
Once settlement has occurred the STO’s custodian will advise the STO. In order to bring the STO’s internal books and records up to date to reflect the true position in the outside world, the appropriate trade within the STO’s settlement system must be identified and updated so as to reflect the 111
Updating…(Cont…)
The successfully updated settlement system will reveal that the trade is no longer awaiting settlement with the counterparty, and that in the case of a purchase by the STO securities have been credited to and cash has been debited from the STO’s account with the custodian and vice versa 112 for a sale.
Operating a Custodian Service for Clients
Following the execution of a trade STO’s typically expect to settle externally with counterparties that are STOs.
This means exchanging securities and cash between two custodians.
However where the counterparty to the trade is an institutional client the client may not have a custodian relationship to enable
113
Operating…(Cont…)
For client such as these the STO may offer to hold the client’s securities and possibly cash in safe custody. This means that when the STO sells securities to an institutional client:
He externally moves the securities to a segregated account from his own account at the custodian, while retaining control but not ownership of the securities Internally maintains records of the client’s securities holdings and possibly cash balances
The reverse flow must occur when the 114 STO buys securities.
Ensuring that Income Due is Received
Issuers of most securities pay income. Those who invest including STOs may or may not be entitled to these benefits. The first step in collection of the benefit is for the STO to become aware that the issuer is making a specific income payment.
Income on most bonds is predictable However income on equities is subject to announcement and the STO must check the information in order to minimize the risk of not receiving income to which it is entitled.115
Ensuring…(Cont…)
Secondly the STO must calculate whether it is in fact entitled to the income and if so must assess by whom the payment of income will be made and monitor the receivable amount till the payment is received. Where an STO offers safe custody service to clients, the STO is expected to collect income on 116
Independent Departments
Some departments are independent of divisions. These include:
Static Data Reconciliation Compliance Treasury Accounting Research Risk Management Internal Audit Information Technology
117
Static Data
Static Data or Standing Data is a term used within the securities industry to describe data that changes occasionally or not at all. The two principal components are:
Securities static data Counterparty static data
118
Static Data (Cont…)
The responsibilities of the static data department are the input of new and the update of changed securities and counterparty details to one or more systems such as the settlement systems and corporate action systems. If an STO wishes to achieve the highest possible automation of trade throughput known as STP, it must have complete confidence in the static data that is being input to the settlement system. 119
Static Data (Cont…)
STP is achievable if the two main types of data that are fed to the settlement system
Trade Data And Static Data
are both of high quality. Many components form security static data
For instance if the coupon rate on a bond is not correctly set up incorrect trade cash 120 values will result.
Static Data (Cont…)
Likewise static data relating to counterparties involves a number of attributes
For example the setting up of an incorrect counterparty postal address could result in an institutional client failing to receive a trade confirmation.
Where static data is not accurate monetary losses may be incurred by an STO through settling trades against incorrect cash values. If static data is incomplete delays in the throughput of trades are likely and this121 can result in a reduced service to
Reconciliation Department
An important process for any company is proving that its books and records are accurate meaning that
They are up-to-date Are complete And reflect reality
Reconciliation is achieved through the comparison of specific pieces of information within the STO’s books and records and between the STO’s records and the outside world. Frequent reconciliation is extremely important in order to minimize the number of 122 discrepancies requiring investigation.
Compliance Department
The compliance officers within an STO are responsible for ensuring that the various rules and regulations as laid down by the local regulatory authority are adhered to by the STO. This includes ensuring that: Only qualified personnel execute trades on the STO’s behalf Reporting of trade and positional information to the regulatory authorities is complete and effected 123 within the stated deadlines
Compliance (Cont…)
Methods of investigating trade disputes between the STO and its counterparties are carried out in a correct and thorough manner Measures are taken to prevent unlawful activities such as Insider Trading.
124
Treasury Department
The treasury department is responsible for obtaining funds as cheaply as possible in order to finance the trader’s positive trading positions. The treasury department typically has prior cash borrowing arrangements with other banks on a secured and unsecured basis. 125
Accounting Department
For any trading activity there is a need to keep formal accounting records of the company’s business including:
Asset – that is items of value to the owner Liabilities - any item actually or potentially owed to others Income such as
Interest on bank balances Commission earned Dividends and coupons Trading revenues
126
Research Department
The function of the research department is to analyze the performance of securities markets; companies; and individual securities in order to produce forecasts of performance. The information produced from such analysis is supplied to institutional clients. The research material is usually
127
Risk Management Department
The risk management department is responsible for assessing the STO’s risk which arises in a number of different ways. Trades:
Having executed a trade there is a risk that the counterparty may fail to honour its contractual obligation to settle the trade – the risk is that the profit will be lost if the trade is 128 cancelled. This is known as
Risk…(Cont…)
A different type of risk exists regarding the method of settlement of a trade If an STO agrees to settle a trade on an FOP basis and:
On a sale delivers securities before receiving cash Or on a purchase pays cash before receiving securities
there is a risk that the asset owed to the STO may be delayed or may never be 129 received at all.
Risk (Cont…)
Positions:
An STO that holds a positive securities position for its own account takes the risk that the price of the securities may fall – this is known as Market Risk A settlement position at a custodian may be regarded as risky and the issuer of the bond or equity may go out of business 130
Risk (Cont…)
Additionally the custodian may go out of business and although the STO may be protected from financial loss of the assets that the custodian holds on its behalf
There is a chance that settlement of sales may be delayed and that consequently income due to the STO may be delayed.
131
Internal Audit Department
Some STOs have set up a function that is responsible for examining the books and records kept by the STO’s operational areas to ensure that adequate controls are in place. In addition the internal audit area ensures that an external auditor will ratify the STO’s practices of bookkeeping and reconciliation for132
Transaction Types
The following transaction types are typically used by STOs:
Principal Repo Securities lending and borrowing Trading book transfer Depot (custodian) transfer 133
Principal Transactions
A principal transaction represents either a purchase or a sale by an STO on a proprietary trading basis.
134
Example Principal Transaction
Trading Book – Book A Trade Date – 20 April Trade Time – 11:05 Value Date – 23 April Operation – Buy Quantity – 3,000,000 Security – Telstra Price – AUD 46.30 Counterparty – RST, Hong Kong 135
Example Characteristics
Movement of – Securities and cash Origin – Front Office Trading position affected – Yes External securities movement – Yes External cash movement – Yes No. of external counterparties – One Issue a trade confirmation – Yes 136
Repurchase Transactions Example
Trading Book – Repo Book D Trading Date – 20 April Trading Time – 11:05 Operation – Repo (deliver securities and receive cash) Cash Amount – USD 20,650,000 (to receive) Face value of securities – USD 20,000,000 (to deliver) Security – World Bank 6.75%, 15 Feb 2025 Price – 102.25 Counterparty – DEF, NYC Opening value date – 22 April (value date of cash receipt) Closing value date – 30 April (value date of cash repayment) Interest rate – 4.50%
137
Repurchase Agreement Characteristics
Movement of – Securities and cash Origin – Front Office Trading position affected – No External securities movement – Yes External cash movement – Yes No. of external counterparties – One Issue a trade confirmation – Yes Issue a settlement instruction – Yes (one for the opening value date and one for the closing value date) 138
Securities Lending and Borrowing Example Trading Book – Securities lending and borrowing book Trade Date – 20 April Trade Time – 11:05 Operation – Lend Face value of securities – GBP12,000,000 lent/borrowed Security lent/borrowed – IADB 6.2% 1st Dec 2015 139 Price of security lent borrowed – 98.625%
Example (Cont…)
Face value of collateral – GBP 12,500,000 Collateral – Denmark 6.5% 15 may 2020 Collateral Price – 99.10% Counterparty – JKL London Opening value date – 22 April (securities delivery) Closing value date – 28 April (securities return) Fee – 4.2% of market value 140
Characteristics
Movement of – Securities only or securities plus cash Origin – Front Office Trading position affected – No External securities movement – Yes External cash movement – Yes No. of external counterparties – One Trade confirmation – Yes Issue a settlement instruction – Yes (two for opening value date and two for the closing value date) 141
Securities Lending/Borrowing
This illustrates a securities lending transaction from the STO’s perspective where the STO’s securities have been lent and delivered to the counterparty against receipt of collateral on the opening value date. The lent securities are subsequently returned to the STO by the counterparty against delivery of the collateral on the closing value date. 142
Securities…(Cont…)
The lending of securities does not result in a change to the trader’s trading position, as from the trader’s perspective ownership is retained. As a safeguard to the lender of securities the borrower is required to provide collateral that has a market value greater than the market value of the lent securities; the collateral may be in the form of cash or securities. Settlement instructions need to be issued to the STO’s custodian with settlement occurring on a DvP basis. Securities lending transactions normally involve a minimum of one movement of securities and one movement of collateral at the same time on two separate occasions – the opening value date and the closing value date.
143
Trading Book Transfer
An STO’s traders trade on a principal basis with other STOs and institutional clients. Within some STOs two or more trading books within the same legal entity may be allowed to trade and hold positions in the same security. 144
Trading Book Transfer (Cont…)
Under these circumstances one trading book may agree to trade with another trading book - a counterparty that is internal to an STO. This trade will b executed at a price that is agreeable to both parties and the P&L of both books will be affected by the price at 145
Example
Selling Trading Book – Book A Buying Trading Book – Book B Trade Date – 20 April Trade Time – 11:05 Value Date – 20 April Quantity – 2,000,000 Security – ICI shares Price – GBP 3.80 146
Characteristics
Origin – Front Office Trading position affected – Yes (both books) External securities movement – No External cash movement – No No. of external counterparties – None Issue a confirmation – No 147
Depot (Custodian) Transfer Transactions
An individual STO typically appoints a custodian in each financial centre to settle transactions and hold securities. Normally an STO will hold securities with one custodian per financial centre. However certain securities may be held at more than one custodian. For example Italian government bonds can be settled in Milan, but are also able to be settled in the international clearing systems – Euroclear in Brussels and Clearstream in Luxembourg. On occasions an STo may need to switch 148
Example
From Depot – Custodian Q , Milan To Depot – Custodian S, Brussels Quantity – EUR 2,000,000 Security – Italy 6%, 1 Sep 2012 Value Date – 20 April
149
Characteristics
Movement of – Securities Only Origin – Back Office Trading position affected – No External securities movement – Yes at both custodians External cash movement – No No. of external counterparties – None Issue a trade confirmation – No Issue a settlement instruction – Yes (to both custodians) 150
Depot Transfers
In situations where the seller holds securities with one custodian and the buyer wishes to take delivery at a different custodian, there is normally a choice of effecting a cross-border settlement, or of effecting settlement within the same custodian as the buyer, following a depot transfer.
151
Cash Transaction Types
The following transaction types are typically used by STOs. Each of these involves cash.
Repo Unsecured lending and borrowing Nostro transfer Foreign exchange 152
Cash…(Cont…)
In general terms cash transaction types are used for the purpose of covering actual or projected overdrafts of cash at the STO’s custodian resulting from the settlement of purchases.
153
Repos
These may be viewed as a cash transaction type as well as a securities transaction type. Many repo transactions are executed by STOs from the perspective of the need to borrow cash, against which securities are given as collateral. 154
Unsecured Cash Borrowing and Lending
The settlement of a principal purchase will result in a debit of cash and usually a negative cash position on the STO’s nostro account with the custodian. As the rate of overdraft interest charged by the custodian may be out of line with market rates, an STO will reduce its costs if it can borrow cash more cheaply from 155
Unsecured…(Cont…)
In order to cover a cash overdraft at the custodian an STO may choose to borrow cash on an unsecured basis
This is analogous to a repo except that no collateral is provide. As a consequence the cost of borrowing will be higher.
Unsecured borrowing and lending transactions are typically executed 156
Example
Trade Date – 20 April Trade Time – 11:05 Operation – Borrow Currency – HKD Amount – 22,500,000 Counterparty – HSBC Start Date – 22 April Maturity Date – 29 April Interest Rate – 6.4% 157
Characteristics
Movement of – cash only Origin – Treasury department Trading position affected – No External cash movement – Yes No. of external counterparties – One Issue a Trade Confirmation – Yes Issue a settlement instruction – Yes (one for opening value date and one for closing value date) 158
Unsecured…(Cont…)
An unsecured cash borrowing transaction is executed on a Trade Date; The borrower is due to receive the cash on the start date He is due to repay the cash plus interest on the maturity date A trade confirmation is issued by the STO to its counterparty containing the details of its transaction including the bank and account number to which the159
Unsecured…(Cont…)
Typically a settlement instruction is required to be issued by the STO to its receiving bank, so that the bank is alerted to the impending receipt of funds This type of an instruction is known as a `pre-advice’ of funds. At maturity the STO must issue a settlement instruction to its bank requesting repayment of cash plus
160
Unsecured…(Cont…)
Most of the time the STO will have a positive securities trading position and consequently will need to borrow cash in order to fund the purchases of securities. On occasions however the cash value of settled trades may be greater than that of settled purchases resulting in a credit cash balance at the STO’s account161
Unsecured…(Cont…)
The interest rates given by custodians on credit cash balances is typically lower than what can be obtained in the money market, and in some cases may even be zero. An STO desiring a better rate of return has no option but to lend. 162
Nostro Transfer Transactions
When an STO has an overdraft or anticipated overdraft at a custodian as a result of settlement of trades and it wishes to cover the overdraft, one of the options open is to transfer cash from
Another account with the same custodian an account held at another bank
163
Example
From Nostro – Custodian S, Brussels To Nostro – Custodian H, Hong Kong Currency – HKD Amount – 37,800,000 Value Date – 25 April 164
Characteristics
Movement – Cash Only Origin – Treasury Department or Back Office Trading position affected – No External cash movement – Yes Number of external counterparties – None Issue a trade confirmation – No Issue a settlement instruction – Yes (to 165 both paying as well as receiving
Foreign Exchange Transactions
A further option for an STO to cover an overdraft is to execute a foreign exchange transaction. When an STO has a credit balance in a nostro account in one currency (say JPY) but has an overdraft in another currency (say USD), it can effect an FX transaction that sells the appropriate number of JPY in exchange for the required number166
Example
Trade Date – 20 April Trade Time – 11:10 Value Date – 22 April Selling Currency – JPY Selling amount – 2,000,000,000 Buying Currency – USD Rate – 124.075 Buying amount – 16,119,282.69 Counterparty – Bank Y From Nostro – Custodian E, Tokyo To Nostro – Custodian L, NYC
167
Characteristics
Movement of – cash only (2 currencies) Origin – Back Office or Treasury Department Trading position affected – No External cash movement – Yes Number of external counterparties – One Issue a trade confirmation – Yes Issue a settlement instruction – Yes 168 (both nostros)
Cross-Currency Securities Settlement
Cross-currency settlement typically occurs when an STO has executed a securities transaction with an institutional client who wishes to pay or receive cash in a currency other than the normal traded currency of the security. 169
Example
Most bonds are traded in the currency of issue; for example a bond issued in Euros that pays interest in Euros and which will repay the principal in Euros at maturity will be traded in Euros in the secondary market. If an STO trades that bond in a currency other than Euros, an FX position and consequent risk will be taken by the STO unless it takes action to negate the 170 risk.
Example (Cont…)
For example if an STO buys a bond denominated in Euros it is highly likely to pay for the purchase in Euros. If the STO subsequently sells the bond is will normally wish to receive payment in the same currency. However it is normal for an STO to execute trades with institutional clients who always wish to pay or receive in the same currency. 171
Example (Cont…)
For instance a pension fund based in Singapore may wish to pay or receive the cash associated with the bond transaction in SGD, regardless of the issue currency of the bond. Assume that the cash paid by the STO on the purchase of the bond was EUR 5,000,000 and that it sells the bond for EUR 5,001,000. The trading profit is EUR 1,000. However if the counterparty were the Singapore based pension fund that wishes to pay in SGD, the STO would request payment of the SGD equivalent of EUR 5,001,000 or SGD
7,600,000.
172
Example (Cont…)
To summarize the STO’s overall currency situation
The STO has an overdraft of EUR 5,000,000 from its purchase But it has a credit of SGD 7,600,000 from its sale If the STO were to allow this situation to continue the trading profit in Euros may increase or decrease depending on exchange rate fluctuations. Thus the profit/loss is at the mercy of exchange rate movements.
To remove the risk in this case the STO would
173
Security Forms
Historically issuers printed paper certificates to represent equity and debt issues.
The certificate was intended to provide proof of ownership.
For an individual issue, certificates were normally designated as being in either registered or bearer form. 174
Registered Securities
The holders of a registered security will have their name and address recorded on a register of holders, which is typically maintained by a registrar or transfer agent on behalf of the issuer. The register contains
The name of the holder The address of the holder The quantity of shares or bonds held The date of registration and of changes of holdings
The registrar is responsible for keeping the register updated following a sale. 175
Certificated Form
Some issues in registered form are represented by certificates also known as a Scrip, which are printed and sent to the registered holders. A registered certificate typically contains the following information
The name of the issuer The description of the issue including the par value The certificate number The date of registration (the date on which the register was updated with the information contained in the certificate) The number of shares The registered holder’s name and address, which clearly identified the owner.
176
Certificated Form (Cont…)
Registered securities held by an company such as an STO, agent, or custodian on behalf of an investor are likely to be registered in a nominee name for all clients. The nominee’s name will appear on the issuer’s register of holders and represent the holdings of the underlying clients.
This enables more efficient administration of 177 subsequent sales by clients and the
Uncertificated Form
The registered owner’s holdings in some securities, although issued originally in certificated form may subsequently be held electronically via a method known as book entry. In these cases holdings are maintained centrally within a Central Securities Depository (CSD) as this facilitates more efficient holding and faster transfer of ownership. The global trend is moving towards 178 electronic book entry holdings and
Uncertificated Form (Cont…)
Securities that have been transformed from certified form to book entry form are either
Dematerialized that is certificates have been replaced by book entry Or immobilized that is the certificates continue to exist and are held centrally in storage
The holders of an uncertificated security will have their name and address 179 recorded on the register of holders
Bearer Securities
The holders of a bearer security have no means of having their name and address recorded on a register of holders maintained by the issuer or by a registrar
For no such register exists.
180
Standard Certificated Form
For bearer securities proof of ownership is physical possession of the certificate Thus holding a bearer security is like owning a banknote
Proof of ownership without physical ownership is extremely difficult to establish
When a bearer security is first issued the issuer prints bearer certificates representing the entire issue in specific denominations
The certificates are issued to the investors via the lead manager and the relevant member of the underwriting syndicate. 181
Standard…(Cont…)
The nature of the securities requires the investor to safeguard them by holding them securely
Certificates could be held in safe custody by an STO, an agent, or a custodian.
Physical movement of such securities introduces the risk of theft or loss.
So it is common to have them held in 182 vaults by a custodian or a Central
Standard…(Cont…)
Failure to have the securities held in a safe place could result in financial loss to the investor if the securities are lost or stolen. The responsibility for making payment of interest and maturity proceeds lies with the issuer or its appointed agent.
But payments are not made automatically. The bearer or its custodian is responsible for initiating these payments by presenting coupons (for interest payments) and the bond itself for the maturity proceeds. 183
Information on a Bearer Bond Certificate
The name of the issuer The description of the issue
The annual interest rate as a percentage of face value The maturity date The total issue size
The certificate number The face value A sheet of coupons
184
Coupons
Each coupon represents one of a number of interest payments during the life of the bond Interest may be paid
Annually Semi-annually Quarterly Or even monthly 185
Coupons (Cont…)
Each coupon contains the following information
The certificate number of the bond to which the coupon relates The face value of the bond The interest rate or amount per coupon The specific interest payment date The coupon paying agent
186
Methods of Transfer of Registered and Bearer Securities
When securities are sold or transferred the method of transfer from seller to buyer is closely linked to the form of the security being sold, because there may or may not be a need to re-resister the security. 187
Transfer and Reregistration
This is applicable to registered securities in certificated form. When an investor sells registered securities in certificated form the holder is required to deliver the registered certificates to the buyer to effect settlement. The steps are as follows. 188
Transfer…(Cont…)
The seller is required to complete a securities transfer form (in some markets he has to endorse the reverse of the certificate)
This indicates that the registered holder authorizes the removal or reduction of his holding in the specific security.
The certificate plus the sign transfer form must be delivered together to the buyer against
189
Transfer…(Cont…)
The buyer’s name and address are added to the securities transfer form and the certificate and the transfer form are forwarded to the registrar. On the register, the registrar will effect
Removal of the seller’s holding Creation of the buyer’s holding
The registrar will cancel the seller’s certificate for it is no longer valid He will create the buyer’s certificate He will then send the buyer’s certificate to the buyer. 190
Book Entry without Reregistration
This mode of sale is applicable to bearer securities. STOs buying a bearer security typically request that their securities are delivered to a CSD where the STO is a participant and where other STOs are likely to require their securities to be delivered. 191
Book Entry…(Cont…)
Bearer securities are normally held by the CSD in secure storage. The CSD must maintain records of the total quantity of an individual security that it holds, and the quantity held by each participant. CSDs do not mormally maintain records of which of their participants are the owners of which specific securities.
That is just like banknotes that are held by a bank the certificates are co-mingled. Such holdings are said to be fungible. At times a CSD may offer to hold non-fungible certificates for participants. 192
Book Entry…(Cont…)
Sales and purchases of bearer bonds are executed as a minimum of and multiples of the smallest denomination. The seller is required to deliver the bearer certificates representing the quantity sold to the buying STO’s custodian. The steps involved in a transfer are 193
Book Entry…(Cont…)
Having executed a sale the selling STO will issue a settlement instruction directly to the relevant CSD to deliver the securities to the byer’s account, within the CSD, versus receipt of cash, on the value date. Having executed a purchase the buying STO issues a settlement instruction directly to the relevant CSD to receive securities from the seller versus 194 payment of cash on the value date.
Book Entry…(Cont…)
On value date the following will occur.
As a result of settlement the CSD will need to update its records of securities holdings for its participants.
The seller’s or its custodian’s account will be debited with the securities and credited with cash. The buyer’s or its custodian’s account will be credited with the securities and debited with cash.
The total of all the holdings for all the participants has not changed. There has been no physical movement of securities in the CSDs vaults.
International CSDs like Euroclear and Clearstream Banking operate in this manner.195
Book Entry with Reregistration
This is applicable to registered securities in uncertificated form and is also applicable to registered securities in certificated form where
The seller holds the securities in certificated form but the buyer requires them in uncertificated form. 196
Steps
The seller and buyer each input a settlement instruction directly to the CSD or via their custodian. The CSD will send an electronic message containing details of the change in holdings as a result of settlement, to the registrar. The register is updated electronically. The registrar will send an electronic message confirming that the register has been updated to the CSD.
197
Countries and Systems
The following systems are used for book-entry with re-registration. Australia – CHESS – Clearing house Electronic Subregister System Hong Kong – CCASS – Central Clearing and Settlement System Japan – JASDEC - Japan Securities Depository Center UK and Ireland – CREST USA – DTC – Depository Trust Company 198
Trade Cash Value Calculation
It is necessary to calculate trade cash values for all transaction types with the exception of depot transfers since these involve only a movement of securities.
This process is known as Figuration.
The need for accuracy and speed in calculating trade cash values is important
It prevents
Losses through the payment of too much cash on purchases and the receipt of too little cash on sales Mismatches of trade details with counterparties 199 Miscommunication of trade costs or sales
Cash Value (Cont…)
The responsibility for the calculation of trade cash values for operational purposes typically resides within the middle office (trade support area) or with the settlement department. The final cash amount of a trade is referred to as Net Settlement Value. Two sets of information are required to calculate the NSV
The Gross Cash Value (GCV) Any additional trade amounts
200
Gross Cash Value Calculations
The type of price at which securities are traded depends on whether the security is an equity or a bond. Equity:
A pension fund wishes to buy shares of PQR. The sale is for 100,000 shares at $54.75 per share. The gross cash value is USD 5,475,000 In equity markets the gross cash value is also known as the Gross Consideration. 201
GCV (Cont…) For bonds, depending on the nature of the bond there are different pricing conventions. Bonds are in general traded at a percentage price relative to the face value of the bond. For example take a purchase of 1,000,000,000 JGBs with a coupon of 3.60% at a price of 98.125%. The GCV is: 1,000,000,000x98.125 ________________________=981,250,000 JPY 202
GCV (Cont…)
The GCV of a bond trade is commonly known as `principal’ or `principal value’. Yield Prices: The price of a bond can also be expressed on a yield basis Fractional Prices: In the US market bonds trade in fractional increments of 32nds. Thus a price of 99-5 is equivalent to 99 + 5/32 = 99.15625% of the face 203 value.
Additional Trade Amounts
Additional trade amounts have to be added to the Gross Cash Value in order to arrive at the Net Settlement Value. These amounts include:
Compulsory trade amounts Optional trade amounts Internal trade amounts 204
Compulsory Trade Amounts
These can be defined as cash values that STOs are obligated to charge because of requirements by bodies such as:
Stock exchanges Regulators Income tax authorities
Types of compulsory trade amounts include:
Stamp duty Purchase and sales taxes Transaction levies Registration costs
205
Examples
Hong Kong: Stamp duty of 0.125% and transaction levy of 0.007% is payable on equity purchases and sales. India: Stamp duty is payable when registering physical securities and is not payable on dematerialized securities. In addition STT is payable. Ireland: Stamp duty of 1% is 206
Examples (Cont…)
Japan: Registrars may charge a fee for the registration of securities. UK: Stamp duty of 0.5% is payable on equity securities and PTM Levy (Panel on Takeovers and Mergers) at a fixed GBP 0.25 is payable on purchases and sales over GBP 10,000. USA: SEC fee of 1/300th of one percent is payable by sellers of 207
Compulsory…(Cont…)
Automation of these calculations can occur where the calculation details are held within an STO’s settlement system.
208
Optional Trade Amounts
Optional trade amounts are cash values that STOs choose to charge that will affect the NSV. Administration Fees:
An STO may choose to charge an additional amount to its counterparty where for instance an unusual method of settlement is desired such as the processing of physical 209 certificates.
Optional…(Cont…)
Commissions:
Agents such as brokers typically earn profits by charging their clients commissions on executed trades. But an STO may charge a commission to an institutional client even when it acts in the capacity of a principal.
Commissions depend on a number of factors. 210
Optional…(Cont…)
Factors:
The monetary value of trades – the greater the size and frequency of trading the lower will be the commissions The location of the market – STOs are likely to charge lower commissions if the investor wishes to trade in a security in which the STO usually trades. Costs of trading and settlement in rarely traded securities will typically be higher. Availability of the security – trades in popularly traded securities are likely to be charged a lower rate of commission. 211
Internal Trade Amounts
These are cash values that STOs will not charge to the counterparty and consequently will not affect the NSV. For internal purposes the STO may calculate such items as:
Sales credits – where the salesman has been responsible for the client’s order a percentage sales credit can 212 be applied and the cash amount
Internal…(Cont…)
Anticipated external costs – where an STO expects to be charged by an external entity on a per transaction basis such as the cost of
Processing of a settlement instruction by a custodian Transmitting a trade confirmation
Internal operating costs – The management of an STO may take the view that the trader should bear the internal operational cost of processing each transaction. In such cases the total cost of items such as office space, 213 systems costs, payroll etc. are divided by
Net Settlement Value
The NSV is the final cash amount of a trade which is to be paid by the buyer or received by a seller. It is derived by calculating the GCV and adding or subtracting any additional trade amounts.
214
Example-1
An STO has sold 1,000,000 shares at a price of GBP 2.46 to an institutional client. Calculation:
1,000,000 x 2.46 = GBP 2,460,000 Add commission GBP 1,500 Add stamp duty GBP 12,300 ADD PTM Levy GBP 0.25 NSV GBP 2,473,800.25
215
Example-2
An STO has purchased 1,000,000 shares at a price of GBP 2.46 Calculation:
1,000,000 x 2.46 GBP 2,460,000 Deduct commission GBP -1,500 Deduct PTM Levy GBP -0.25 NSV GBP 2,458,499.75 216
Example-3
An STO has purchased USD 30,000,000 of 5.25% bonds at a price of 103.65%. Calculation:
USD 30,000,000 x 103.65% USD 31,095,000 Add accrued interest (200 days) USD 875,000 NSV USD 31,970,000 217
Static Data
Static data is critical from the standpoint of achieving straightthrough processing or STP. What is static data?
It is a term used to describe a store of information that is used to determine the appropriate actions necessary to achieve successful processing of each trade. 218
Static Data (Cont…)
Static data is required not only by the settlement department. The following areas of operation also use such data:
Order management Equity, bond and repo trading Corporate actions Reconciliation Risk management
219
Static Data (Cont…)
The term `static data’ implies that the information does not change. The majority of static data items are static and not subject to change. However certain aspects of static data are subject to periodic change or updating. 220
Static Data (Cont…)
The challenge for an STO is t:
Gather the relevant data Store it securely Update it when necessary Utilize it appropriately
The STO has to ensure that for every trade only the appropriate information is attached to the trade from the entire store of data. 221
Static Data (Cont...)
Typically an STO holds a vast amount of static data.
Large STOs may be holding within their systems thousands of securities and hundreds of counterparties. It is essential to select the correct information in a timely fashion if delays and costs are to be avoided. 222
Static Data (Cont…)
In an automated environment when a trade has been executed and recorded into a trading system, the trade will be received by the settlement system will at that point in time typically contain only the essential trading information. 223
Static Data (Cont…)
For a principal trade such trading information includes:
Trading book Trade data Trade time Value date Operation Quantity Security Price Counterparty
224
Static Data (Cont…)
In order to process the trade in an operational sense the trade needs to be enriched with more information. Fully functional settlement systems not only hold the necessary static data but also have the capability to automatically enrich trades with the appropriate225
Trading Companies
In order to automate the processing of trades it is necessary doe static data to be held regarding the trading company’s (STO’s) own details. An STO may be required to process the business of more than one trading company.
So information that is specific to each trading company will require setting 226 up within the static data.
Trading Companies (Cont…)
The trading activity of each company must remain segregated and separately identifiable for regulatory purposes. Management would also require separate accounting and P&L for each company. 227
Counterparties
STOs need to hold static data relating to all their counterparties, to enable automated enrichment of trades and subsequent actions such as
Production of trade confirmations And settlement instructions containing the counterparty’s custodian details. 228
Trading Books
A trading book within an STO represents groups of traders who trade in individual securities within specific security groups. It is normal for each trading book to be set up within the STO’s static data, and to have individual securities or security groups attached. 229
Hierarchy of P&L Calculations All European Trading All European Equities All Italian Equities
All European Bonds
All Spanish Equities
All French Bonds
Textiles
Chemicals
Bonds 3-5 Years
Chemicals
Forestry
Bonds 6-9 Years
230
Currencies
A modern STO normally operates in a multi-currency environment executing and settling trades in numerous currencies. Consequently details of currencies need to be set up within the trading system to provide consistency in the currency related aspects of
Trade cash value calculation Recording trades and updating books and records Issuing confirmations to counterparties
231
Currencies (Cont…)
The International Organization for Standardization (ISO) have given three character codes for most currencies. It is also important for an STO to be aware of public holidays around the globe for if such information is overlooked it could cause monetary losses due to the inability to move cash amounts when required. Thus an important component of static data is the holiday dates for all 232 currencies.
Securities
In order to automate the processing of trades, STOs need to hold the description, attributes and characteristics of securities. This is important for:
Accurate trade cash value calculation Exact description of the security appearing on trade confirmation issued to counterparties. 233
Example of a Bond
Full name: XOX AG 8.25% bonds 1st June 2020 Short name: XOX 8.25% 1.6.20 Internal reference: BD00757339 External reference: ISIN XS1234567893 Issued currency: USD Issued quantity: USD 1,000,000,000 Security type: Bond Security group: Eurobond (USD) Coupon rate type: Fixed rate Coupon rate: 8.25% Coupon frequency: Annual Coupon payment dates; 1 June Primary value date: 1 June 2000 First coupon payment date: 1 June 2001 Maturity date: 1 June 2020 Maturity price: 100% Denomination values: USD 5,000 and USD 20,000 Default trading book: Trading book Y Credit rating: AA 234
Example of an Equity
Full name: CDE plc GBP 1.00 ordinary shares Short name: CDE Ord Internal reference: SH00463815 External reference: ISINGB98765433215 Issued currency: GBP Issued quantity: 100,000,000 Security type: Equity Security group: UK Equity Primary value date: 16 January 2000 Board lots: 500 shares Default trading book: Trading Book D
235
Securities Identification Code Numbers
In order to facilitate unambiguous identification of securities, each individual security is given a unique identification code number. The securities numbering convention that is used globally is ISIN ISIN – International Securities Identification Number 236 It is a 12 character code
Securities…(Cont…)
The first two characters are a country code relating to the country of the issuer The next 9 characters are the national securities identification numbers The last character is a check digit which verifies the code In addition to the ISIN code securities identification numbers 237
Countries and Codes Country Code Australia ASX Belgium SVM Canada CUSIP Germany WKN Japan Quick Switzerland Valoren UK Sedol USA CUSIP CUSIP stands for Committee on Uniform Securities Identification Procedures 238
Sources of Static Data
Counterparties:
When an STO trades with a counterparty for the first time it is usual for the STO and the counterparty to swap custodian details directly, for each market in which they may execute trades between themselves. Additionally the STO will need to gather all other appropriate pieces of information from the counterparty 239 such as the required medium of trade
Counterparties (Cont…)
Counterparty information should be considered as private information, whereas information on securities is publicly available. Consequently information such as the custodian used by a party for a particular kind of trade is unlikely to be freely available. 240
Counterparties (Cont…)
There is a reason why such information is considered to be private.
Openly publicizing the custodian is like publicizing one’s bank account or credit card details. The worry is that assets may be removed from an account without authorization by the account holder. 241
Counterparties (Cont…)
Historically the process of gathering such information was a manual exercise. These days such information is available electronically for subscribers to a service called `Alert’ provided by Omgeo. The advantage is that updation of an STOs counterparty static data can be automated thereby preventing errors.
242
Securities
For those STOs that trade around the globe, the details of securities in which they trade will be derived from many sources in numerous locations. The decision as to which method to employ regarding the gathering of accurate and timely security static data is typically a difficult one. 243
Securities (Cont…)
When a security is being brought to the market it is normal for the issuer to produce a prospectus or offer document. The information contained in the prospectus is publicly available. At this point the custodians and CSDs typically set up details of the issue in their own static data 244
Securities (Cont…)
Some STOs gather their securities related static data directly from the prospectus. Another option is to request the necessary information from a custodian or CSD. There are a number of companies who specialize in gathering and distributing securities static data to those who subscribe to such a service. They are known as security data 245
Data Vendors
Reuters Telekurs Standard & Poor’s JJ Kenny Bloomberg FT Interactive data Data is provided by electronic feed or via the Internet. 246
Efficient Management of Static Data
The best method of gathering, storing, and updating static data involves the use of an internal central repository of data. This reduces the risk of conflicting data in the various processing systems. The system works as follows. 247
Efficient…(Cont…)
Securities static data pertaining to securities and counterparties is obtained from a number of sources. The STO stores the static data internally and compares the information for any discrepancies. This process is known as Data Cleansing. The Central Static Data Repository then releases the data to the relevant internal systems.
248
Controlling Access
The effort and cost of setting up accurate static data makes the protection of the data very critical. In an environment where any member of the staff is allowed to change the data, mistakes may be made despite the best of intentions. 249
Controlling Access (Cont…)
Incorrect changes to the coupon rate – will lead to an incorrect cash value transaction. Wrong address of a counterparty – trade confirmations may not be received on time Wrong modifications to the counterparty’s custodian details – settlement instruction issued by the STO will not match the counterparty’s instruction.
250
Controlling Access (Cont…)
In order to prevent errors many STOs protect their static data by restricting access to staff. Any changes made by someone with access rights will ideally be verified by a colleague.
This is known as the `Four Eyes’ principle
Following a successful change details of the change should be traceable by keeping records of
The staff members The time and date of change And the items that were changed
251
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