The Market Participants Static Data Trade Execution & Trades Processing Trade Confirmation Trade Instruction Instruction/Agent Matching Trade Settlement Position/Inventory Management Reconciliation Clearing and Custody Corporate Actions

The Market Participants

◦ Brokers◦ Dealers◦ Investment Banks◦ Stock Exchanges◦ Agents◦ Securities Trading Organisations◦ Custodians◦ Clearing Banks◦ Regulators

◦ Institutional Investors ◦ Mutual Funds ◦ Pension Funds◦ Insurance Companies◦ Hedge Funds◦ Charities◦ Individual Investors

SecuritiesTradingHouse

Exchanges

INVESTORS

INV

ES

TOR

S

INVESTORS

AGENTS

AGENTS

AG

EN

TS

ISSUERS

ISSUERS

Securities

Securities

A Market is an environment in which securities are bought and sold. Central to some market places is the Stock Exchange.◦ Trades executed over an Exchange are executed

“On-Exchange” or “Exchange Traded”.◦ Other trades are “OTC” (Over the Counter) or Non-

Exchange Traded.◦ Each securities market has an associated and

recognisable place to effect settlement. E.g. Bonds traded on the Shanghai Stock exchange are

settled in Chinaclear.

Region Country Financial Centre

Stock Exchange

Europe UK London London Stock Exchange (LSE)London Metal ExchangeLondon International Financial Futures & Options Exchange (LIFFE)

Germany Frankfurt Deutsche BourseSpain Madrid Bolsa de Madrid

Asia Pacific

China Hong Kong Stock Exchange of Hong KongHong Kong Futures Exchange

China ShenzhenShanghai

Shenzhen Stock ExchangeShanghai Stock Exchange

Japan Tokyo Tokyo Stock ExchangeTokyo International Financial Futures Exchange (TIFFE)

Singapore Singapore Stock Exchange of SingaporeSingapore International Monetary Exchange (SIMEX)

Australia Sydney Australian Stock Exchange (ASX)America USA New York

ChicagoNew York Stock Exchange (NYSE)Chicago Stock Exchange

◦ Salespeople.◦ Data Providers.◦ Registrars.◦ Coupon Paying Agents.◦ Trade Matching Services.◦ Settlement Instruction Communication Mechanisms.

Organisations occasionally need to raise cash/capital to expand their businesses by:◦ Selling part ownership issuing shares or equity.◦ Borrowing cash from investors issuing debt in the form of

bonds.

Type of Issuer ExampleCorporations Bank of Ningbo

Sovereign Entities China

Local Governments City of London

Government Agencies Ministry of Finance, China

Supranational Organisations International Bank for Reconstruction & Development (World Bank – IBRD)

Static Data

Static Data is the common term to describe the store of information used to determine the appropriate actions required for successful processing of each trade.

Critical to Straight Through Processing(STP) For Example:◦ Trading Entities◦ Trading Books within each entity◦ Counterparties◦ Instruments ◦ Currencies◦ Prices

◦ Where possible, financial institutions try and create a core of “Golden Source” static data to avoid data conflicts in inter-dependent systems.◦ Companies specialise in gathering and distributing

financial data to institutions Example:

Reuters, Bloomberg

Incorrect static data causes many processing errors:◦ Delayed Confirmations.◦ Unmatched Transactions.◦ Settlement Failure.◦ Incorrect Fee calculations.◦ Incorrect Profit & Loss Calculation.◦ Poor Reporting (Regulatory & risk impact).◦ Increased cost per transaction due to reduced STP.

Incorrect static data leads to reduced service and dissatisfied customers.

◦ Bad Static Data results in reduced service levels to clients due to processing hold-ups and possible trade failure.

◦ Bad Static Data impacts operational risk and increases the cost per trade processed.

◦ Bad Static Data contributes to poor internal & external reporting impacting risk & reputation.

◦ Static Data will continue to be an important dependency on the efficient processing of trades especially as the trade lifecycle window becomes smaller.

◦ STATIC DATA Must be populated correctly within all of the relevant

systems. Must be obtained from a credible source as timely as

possible.

Trade Execution & Trades Processing

Str

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(STP

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Trade Execution

Trade Instruction

Trade Confirmation/Affirmation/Matching

Trade Processing

Trade Validation

Trade Capture

Trade Settlement

Instruction/Agent Matching

Fails & Fail Management

Trade Enrichment

Pos

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Cor

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◦ A legal contract between two ‘counterparties’. A seller and a buyer.◦ The SELLER must deliver the commodity he has sold

to the buyer.◦ The BUYER must pay the agreed purchase price on

the agreed value date.

◦ Trading◦ Sales◦ Broking◦ Corporate Finance◦ Repo Desk

◦ Speculate Profit from price move or increase in value of the

asset.◦ Accumulate Benefit from dividend on shares and interest on bonds.◦ Hedging: To speculate and accumulate. To reduce risk.

◦ Trading Long◦ Trading Short◦ Arbitrage Trading◦ Hedging

Trade execution tends to operate in one of three ways where sellers and buyers execute trades:◦ Trading Floor. Traditional method of trading – face to face on the

trading floor of a Stock Exchange.◦ Computerised Exchanges. Prevailing!◦ Telephone

Furthermore Trades can be:◦ Quote Driven. Market Makers quote prices via computerised screens

showing the level at which they are prepared to buy and sell with the intention of attracting business.

◦ Order Driven. Orders from sellers are matched with buyers’ orders

electronically.

Regardless of the trade execution/origin, all trades must be recorded formally by the market participant.◦ To update a trading position for a specific security within a

trading book.◦ To update average price of the current trading position to

enable the trader to calculate trading profit or loss.◦ To allow trade detail to be sent through to the Back Office

for trade processing and settlement.◦ As part of Market & Regulatory Reporting requirements.◦ To facilitate risk management.

Traders use complex trading systems to facilitate trading & position management, trade processing is usually done via Back Office processing systems.

◦ Trading Book◦ Trade Date◦ Deal Time◦ Value Date◦ Operation (e.g. Buy/Sell)◦ Quantity◦ Instrument/Security◦ Price◦ Counterparty

◦ Trade validation occurs to check if the trade information received in the Back office systems corresponds with the Front Office record.

◦ Trade validation includes the checking of constituent static data information:

◦ Examples include: Is the security recognised on the system? Is the Counterparty account recognised? Is the Trader allowed to trade on the trading book? Is the trading book valid to trade security x? Is the value date a valid settlement date in the location of

settlement? Are the securities restricted?

All detected errors must be investigated and corrected.

◦ Trade enrichment exists to add specific trade data to the basic trade detail to allow downstream processing.

◦ This data is not usually held in Front Office Trading systems.

◦ This data can be added manually however in the STP environment the aim is to derive this automatically.

◦ Examples include: Calculation of cash values. Regulatory Reporting required. Trade Confirmation requirements. Selection of custodian details. Selection of Settlement Instructions and communication

method.

Trade Confirmation

◦ Trade Confirmation/Affirmation is an important process required to reduce the risk of the traders P&L(Profit &Loss).◦ Until the counterparty acknowledges the trade

detail the effect on the price or quantity of the trade is subject to change, impacting the traders book.◦ Trade agreement can be achieved through: Sending trade confirmations to the counterparty. Receiving trade confirmations from the counterparty. Trade or Contract Matching. Trade Affirmation.

◦ Trade confirmations are generated using trade data and static information held on the counterparty account:

◦ Confirms can be sent or received via: Fax Telex SWIFT Email (in some markets)

◦ Generally trade confirmations are checked and any discrepancies are reported back to the counterparty if: Trade data differs (security, price, quantity, value date). Trade is not recognised.

Trade Matching generally applies to mandatory electronic matching of trade details.◦ Both parties are required to input details to a

central matching facility.◦ Matching results (i.e. matched, unmatched) are

provided by the trade matching facility to both parties.◦ Examples include: Omgeo Central Trade Manager (CTM). TRAX (Internationally traded debt & securities). National Securities Clearing Corporation’s Trade

Matching Service. (NSCC)

Trade Affirmation relates to the electronic matching of trade details typically between securities institutions and Institutional clients.◦ Trade details are input by the securities house and sent to a

trade affirmation facility.◦ The Trade affirmation central hub sends on the message.◦ The institutional client agrees (affirms) or disagrees and the

response is sent back to the securities house.◦ Both parties must subscribe to the service.◦ Examples include: Omgeo’s Oasys Global system. DTC ID (Institutional Delivery) – (US)

Basic Principles◦ The longer a trade’s detail remains unchecked after

trade date, the greater the risk of price movement and P&L impact.◦ Trade confirmation/matching messages should be

issued as soon as possible after trade validation.◦ Timely and accurate confirmation generation is a

major client service consideration.◦ Prompt actioning of all confirmation discrepancies

reduces trade risk.

Trade Instruction

Settlement Instructions are used to communicate the movement of securities and cash to the custodian.◦ Trade Agreement confirms the commercial details

of the trade.◦ Settlement Instructions indicate the commercial

details of the trade AND the location and account details for the cash and security movements. (Settlement Details).

Settlement Instructions tell the custodian/Agent to carry out precise commands such as:◦ The quantity of securities to be received or

delivered.◦ The net settlement value to be paid or received.◦ From whom securities will be received.◦ To whom payment must be made.◦ From whom payment will be received.◦ To whom securities must be delivered.◦ On which date to carry out these instructions.

◦ Delivery versus Payment (DVP) The simultaneous exchange of cash and securities. A single settlement instruction is generated to tell the

custodian to deliver securities out against a cash receipt in.

◦ Receipt versus Payment (RVP) The simultaneous exchange of cash and securities. A single settlement instruction is generated to tell the

custodian to receive securities in against a payment of cash out.

◦ Free of Payment (FOP) A non-simultaneous exchange of cash and securities. A settlement instruction is generated to instruct the

receipt or delivery of securities against nil cash. A second instruction is generated to instruct either a

cash payment or a pre-advice to expect a cash receipt against nil securities.

Higher level of risk therefore usually requires high level of authorisation.

Modern methods of electronic instruction generation and transmission include the following characteristics:◦ Automatic generation of settlement instructions by

settlement systems.◦ Automatic transmission of settlement instructions

(individually or in batches).◦ Settlement instructions in standardised formats.◦ Secure transmission environment due to high levels of

message encryption.◦ High speed of transmission.◦ Predictable cost of transmission.◦ Enabler of Straight Through Processing (STP).

S.W.I.F.T.◦ CREST◦ DTC◦ Euroclear◦ Clearstream◦ Agent Banks◦ Custodians

Proprietary Messaging◦ CREST◦ DTC◦ Euclid (for Euroclear)◦ Cedcom (for

Clearstream)

Instruction/Agent Matching

To reduce settlement risk by:◦ Increasing the chances of trade settlement on value

date.◦ Resolving differences between trades and

counterparties.◦ Enabling accurate funding of cash in nostro

accounts.◦ Managing stock inventory in depositories.

Once Instructions have been received at the Custodian, the next lifecycle steps include:◦ Instruction Matching Custodian attempt to match the instruction to the

counterparty instruction.◦ Status Update Attachment of the current status of the instruction.

(matched/unmatched/unknown).◦ Unmatched Resolution Investigation and resolution of non-matching

instructions.◦ Trade Settlement Updating the current status within the securities

trading organisation’s books and records.

SecuritiesTradingHouse

CounterpartySecurities

House Counterparty

CSD or ICSDInstruction

Comparison

2

1 1

4 4

3Status Status

SettlementInstruction

SettlementInstruction

StatusMatched orUnmatched

StatusMatched orUnmatched

1 Instructions sent in by Securities House and Counterparty.2 Instruction matching occurs.3 Status is recorded.4 Instruction Status (Matched/Unmatched) is sent back to both

parties.

Trade Settlement

Trade settlement is the act of exchanging securities and cash between buyer and seller.◦ Value Date is the intended date of delivery and

payment also known as Contractual Settlement Date.◦ Actual Settlement Date applies to the actual date

the exchange took place.◦ Value Date and Settlement Date will be the same in

the majority of trade settlement cases.◦ A percentage of trades fail to settle on value date

and will settle on another date referred to as the actual settlement date.

How to ensure trade settlement.◦ Ensure the seller holds the required level of securities at

the correct custodian. Some securities can settle at more than one location.

◦ Ensure the purchaser has sufficient cash to make the payment. The purchaser may aggregate balances over a number of

accounts, the total amount must cover the amount required. (Funding).

The purchaser may have a credit agreement with the custodian who will cover the cash shortfall. (Secured credit line/Overdraft).

The purchaser may have a collateral agreement whereby collateral is held in the account to offset any non return of funds. (Margin)

◦ Full Settlement◦ Partial Settlement◦ Securities Only◦ Cash Only◦ Cross Currency Settlement◦ Net Settlement

Timely settlement of trades is an important part of the Trade Lifecycle with implications across the following areas:◦ Inventory Management◦ Cash Management◦ Settlement Risk◦ Cost Management◦ Firm Reputation

Position/Inventory Management

Management of the stock holding is an integral part of trade settlement:◦ Inventory Management ensures: The correct amount of securities (nominal) are

available At the correct location (depot). At the correct time (on value date).

If securities are unavailable we can consider the following:◦ Internal Book Transfer. Borrow securities from another firm account same depot.

◦ Realignment. Borrow securities from another firm account different depot.

◦ Stock Borrow Loan Trade. Borrow the securities from the market.

◦ Autoborrow. Borrow the securities from the custodian/central depository.

◦ Execute a Repurchase Agreement (Repo)◦ Do nothing and let the trade fail.

Transmit Settlement Instruction

Match Settlement Instruction at Custodian

Settle at Custodian

Securities

Choices

Cash

Choices

Do NothingLend Repo Do NothingBorrow viaRepo

BorrowUnsecuredAutoBorrow

◦ Allows investors to earn money by lending out their securities portfolio.◦ Allows investors who need to fulfil a trade but are

insufficient of securities to borrow and complete the delivery.◦ Reduces risk and impact from a Buy-In as a result

of failed delivery.◦ Facilitates receipt of cash funds which may reduce

overall borrowing requirement.◦ Reduces risk of interest claims.

◦ Legal title to the lent securities passes from lender to borrower for the period of the loan.◦ Lender’s rights are protected with regard to most

Corporate Actions: Dividends on Equity. Coupon Payments on Bonds.◦ The Borrow typically provides collateral to the

lender (securities or cash) against non return of the loan.◦ The Lender receives income from the borrow

periodically.

Service provided by large Custodians and Central Security Depositories:◦ Borrowers Borrow required securities automatically. Borrow certain types of security automatically i.e.

Spanish Bonds. Borrow upon request. Sometimes used as a last resort due to the cost.◦ Lenders. Lend all securities automatically. Lend certain types of security automatically. Lend upon request.

◦ Once a trade has settled it is essential to update the firm internal books and records to ensure: The transaction is no longer shown as outstanding. The securities are shown as having been received in so

they can be sold on. The securities are shown as having been delivered out

so more can be purchased if required. The cash is showing as having being paid out and

additional cash can be borrowed if required. The cash is shown as having been received in so it can

be lent out to make interest. To retain full control of all assets and liabilities at all

times. And facilitate further trading.

◦ Automated Updates Instruction statuses are sent in by the custodian (fully

settled, partially settled, failed etc). The Securities Trading House automatically loads this

information into the settlements systems. The system attempts to locate the relevant trade in its

internal books and records. Once found it records the status update against the

transaction. It will also automatically update the relevant security

positions and balances reflecting the delivery or receipts.◦ Manual Updates In some cases it may be necessary to settle trade manually

and a settlements specialist may manually record the update against the trade record.

Timely and accurate reflection of trading activities enables the following:◦ Repo Trading. Accurate picture of open and settled trades and settled

securities and cash positions at each custodian.◦ Securities Lending & Borrowing. As with repo trading accurate information is required

to maximise revenues and minimise costs.◦ Credit Risk Assessment. Facilitates risk assessment with counterparties and

markets.◦ Corporate Action entitlement. Enables accurate calculation of entitlements and timely

receipt of proceeds.

◦ Trade Date Positions◦ Value Date Position◦ Settlement Date Positions◦ Short Positions◦ Long Positions◦ Client Positions◦ Firm Positions

Reconciliations

◦ Reconciliations exist to check the accuracy of the firms books and records: Internally between systems and departments Externally where securities and cash are held.◦ A Reconciliation Break is a discrepancy between one

record and another.◦ All breaks should be investigated, accounted for

and corrected to ensure continued integrity.◦ Automation of reconciliation reporting facilitates

timely investigation and resolution of breaks on a daily basis.

◦ Regulatory Requirement to show we are acting responsibly in the

market place. Trading within recommended guidelines. Maximum security holdings in certain Firm entities.◦ Managing Risk Understanding true trading position. Understanding true cash balances. Understanding failed trades.◦ Corporate Actions Calculating correct Corporate Action entitlement from

true security holding. Correctly reflect changes caused by Corporate Actions

to the relevant internal accounts held on all systems. (FO & BO)

◦ Position Reconciliations. Report Position differences between trading systems

and trade processing systems. (FOBO Recs). Track cash balances held internally against external

Agents (Nostro Reconciliations). Track stock/security positions held internally against

external Custodians (Stock/Depot Reconciliations).◦ Trade Reconciliations. Report transaction differences between systems. Report open trades/instructions.◦ System Reconciliations. Report data differences between systems.

Clearing and Custody

ISSA* Definition of a Global Custodian◦ ‘‘A Global Custodian provides clients with multi-

currency custody, settlement and reporting services which extend beyond the Global Custodian’s and its clients’ base region and currency, and encompasses all classes of instruments.’’

* International Society of Securities Administrators

Term Description ExampleCustodian An organisation that holds securities

and cash on its clients’ behalf and may effect trade settlement on its clients’ behalf.

Deutsche Bank Domestic Custody Services

Global Custodian As per custodian, but has a network of local (or sub-custodians) that hold securities and cash and effect trade settlement on behalf of the global custodian.

State StreetCitigroupBoNYParibas

Local Custodian A custodian that operates within a specific financial centre.

Credit Lyonnais ParisBanco Espirito Santo Lisboa

Sub-Custodian A custodian within a Global Custodian’s network of custodians.

Citibank MilanCitibank Madrid

Term Description Examples

Central Securities Depository (CSD). National Central Securities Depository (NCSD)

An organisation that hold securities, normally in book entry form; usually the place of settlement, effected through book transfer. A CSD that handles domestic securities of the country in which it is located.

DTC (USA)CREST (UK & Eire)JASDEC (JPY)CCASS (HK)

International Central Securities Depository (ICSD)

A CSD that handles domestic and international securities. Only two organisations are recognised as ICDS’s.

Euroclear (Brussels)Clearstream (Luxembourg)

Settlement Agent An organisation that effects the exchange of securities and cash on behalf of its clients; resultant securities and cash balances may or may not be held.

Citibank MilanCitibank Madrid

Corporate Actions

Any action by an Issuer which may affect the investor:◦ The distribution of benefits to existing shareholders

or bondholders. Coupon Payments Cash Dividends Stock Dividends◦ A change in the structure of an existing security. Stock Split Bonus Shares◦ A notification that may or may not require a

response from the securities owner. Annual Meeting Voting Rights

◦ Timely notification of each Corporate Action which may affect a position or outstanding trade.◦ Understanding the nature of each Corporate Action.◦ Timely execution of responses within deadlines.◦ Understanding the cost, benefit and impact of each

Corporate Action.◦ Ensuring the receipt of entitled assets.◦ Ensuring costs are charged at the appropriate time.

◦ Calculating Tax on benefits.◦ Impact of failing trades on Corporate Actions.◦ Reliable Announcement (Static Data) feeds.◦ High instance of manual processing of many

Corporate Actions impacted by volume increase during Corporate Action season.◦ Correct allocation of Corporate Actions across all

trading and client positions in Trading and Settlement systems.◦ Correct reconciliation of Corporate Actions at

custodian (depots and nostro accounts).

Securities Operations – A Guide to Trade & Position Management-by Michael Simmons