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Handout info - ALL
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  1. Trade Capture
  2. Links:
  4. 1.
  6. The successful capture of a trade within a trading system should result in the trade details being sent to the back office immediately, via an interface, for operational processing. Where an STO (Securities Trading Organisation) has no trading system (nowadays a rare circumstance), the trade detail is usually recorded manually, by the trader or market maker, onto a ‘dealing slip’ this will require collection by, or delivery to, the middle office or settlement department for operational processing. Under these circumstances, the trader or market maker will need to maintain their trading position manually, keeping it updated with any new trades.
  8. 2.
  10. •     As the order (and trade) flows though the firm, its front-office, middle-office, and back-office come into play one by one.
  11. •     So it is expected that at every step, all information from the previous step is carried forward along with some value addition by the step in question.
  12. •     This handover can be done manually but increasingly this is automated. The utopian stage for a firm is what is called “Straight-through processing” (STP) where each step and the handover between the steps is completely automated.
  13. •     The first step in the coding process transitions the transaction from order to trade by creating bare minimum trade information
  14. •     Once the order is executed by the front-office (through one of the market destinations), it has to be passed to the middleoffice/Back-office (either electronically or manually) through a “deal ticket” (also goes by “execution” “ trade” etc.)
  15. •     As the adjoining table shows, the deal ticket has all the trade information that will be used for all further processing
  17. Traders / Sales enter trade execution details into trade capture systems immediately after confirmed execution on trade date. Or the transaction may be electronically captured via systemic integration with an Electronic trade execution system.
  18. • Details required for successful trade entry for a Cash Security Transaction. (More complex transaction will have additional critical attributes)
  20. – Product Identifier, e.g. Symbol, Cusip or ISIN
  21. •     Every security that is traded needs to be identified uniquely so that there is no ambiguity about what is being traded
  22. •     CUSIP (Committee on Uniform Securities Identification Procedures) is a commonly used identifier: It is a 9 digit figure whose first 6 digits identify the issuer. The next two digits identify the issue. The final digit is a check digit which verifies (during the electronic transfer of data) the proper application of the preceding 8 digits
  23. •     To accommodate international securities, CUSIP has been modified into 12-digit International Security Identification Number (ISIN). The 3 additional digits identify the country of origin
  24. •     Firms often use a more compact internal number that can be mapped to CUSIP/ISIN for external communication
  25. – Morgan Stanley trading account number
  26. – Counter-party (C/P) account number (Global processing often entails other MS entities intermediating to enable the entity managing the risk to access the client in another region. In this regard a transaction may have several legs)
  27. •     In the world of finance, there are a large number of types of accounts a client can have. Each type of accounts has its own requirements and limitations.
  28. •     The type of account chosen by the client will also decide additional forms of documentation required by the firm.
  29. •     Some of the commonly used account types are below: 1. Individual Account – Can be operated by the accounts principal only. If the principal dies, then the account is frozen until the will has been gone through and the successor has been identified 2. A joint account – Can be opened for not more than three principals (usually only two). The account is assumed to be equally owned. In case of a party’s death, the portion of the account becomes part of the deceased’s estate.
  30. •     Investment club account – Must have a formal written agreement between club members stating clearly the investment objectives of the club and also who is authorized to operate the account.
  31. •     Trust account – It requires the completion of the trust agreement in addition to the regular account opening forms.
  32. •     Estate account – Requires copies of the will or documents naming the administrator appointed by the court, copies of death certificate, an affidavit of domicile, and tax waivers
  33. •     IRA accounts – These are usually tax deductible accounts. Contributions can be made to these until the client reaches 70.5 years. There are limits to the contribution also what the account can invest into. There are a large number of variations of IRA accounts.
  34. – Trade date (TD) and Settlement date (SD)
  35. – Trade price
  36. – Quantity of security
  37. •     In securities trading, the concept of “trading lot” is crucial. Not all securities in all markets can be traded in the same lot (say 100 shares or 200 bonds)
  38. •     This is important information to enable order management system to • Route orders to respective locations. And also in computing money involved in the trade
  39. •     The conventions across the world are not always similar: • In the US markets, most shares and preferred shares are traded in a lot of 100 but often the high priced shares are traded in 10-share lots. • In the UK, a common lot is 1000 shares • in Switzerland it is 20 and so on.
  40. – Buy/sell indicator
  42. • Trading Execution Capacity
  44. – Agency – MS acts as intermediary broker for orders between client and exchange or second client
  45. – Principal – MS trades from inventory held on its books
  46. – On exchange – Execution traded against an exchange (i.e. LIFFE)
  47. – OTC – ‘Over the counter’ as opposed to ‘listed on an exchange’
  49. Pre-Settlement
  51. Clearing
  53. 1.
  55. •     It is the process of defining settlement obligation and then assigning responsibility for settlement.
  56. •     It is done by a clearing houses and typically it involves netting all incoming cash versus all outgoing cash across all the participants (“Multilateral netting”).
  57. •     We can think of Clearing as all activities from the time a commitment is made for a transaction until it is settled.
  58. •     In its widest sense clearing involves the management of post-trading, pre-settlement credit exposures, to ensure that trades are settled in accordance with market rules, even if a buyer or seller should become insolvent prior to settlement
  59. •     Clearing is necessary because the speed of trades is much faster than the cycle time for completing the underlying transaction
  61. Novation - The role of a clearinghouse as a common counterparty to all trades is a key ingredient in successful clearing process.
  62. This process is called “Novation” – Let’s take an example: • Party A has bough 100 shares of CTU from Z @ $2.6 each and the trade has cleared all the steps we have seen so far and is now waiting to be cleared • The clearing house (could be exchange itself or an entity usually owned by the exchange), splits this trade into two trades: • A trade where A bought 100 shares of CTU from CH @ $2.6 each • A trade where Z sold 100 shares of CTU to CH @ $2.6 each • Each of these trades are now ready to be settled individually (thus reducing the settlement risk)
  63. Netting
  64. •     A trading organization every day does a large number of transactions involving multiple clients, multiple markets, and multiple products.
  65. •     Each of these transactions will involve the amounts (sometimes in different currencies) which need to change hands. This can put a considerable workload on those who are involved in the transaction settlement processes
  66. •     Netting is a process to avoid gross settlement of each individual trade by creating summary level payments and thereby reducing the volume of trades to be settled
  67. •     This effect of this is it allows a single transaction or payment be made by each counterparty to settle a large number of transactions
  68. •     Netting has obvious benefits to the parties involved in it 1. The number of payments in progress and volume in transit is dramatically reduced. 2. The opportunity for errors is reduced as ‘human’ error is largely excluded. 3. Reconciliation is easier. 4. Charges, when incurred, are likely to be smaller.
  69. •     The process of netting is also crucial from the risk management point of view
  70. •     A clearing house or a broker-dealer has a considerable choice in terms of netting methods. At the highest level, there are two families of netting - Bilateral and Multilateral
  71. •     Bilateral – which assumes two counterparties. Bilateral category itself can give rise to more possibilities such as • Two broker-dealers and one currency • Two broker-dealers and more than one currency
  72. •     Multilateral – which assumes more than two counterparties offsetting their mutual payments/receipts via a central clearing system/clearing house where all members can net both gross or already bilaterally netted positions • Such a system would result in just one payment, per currency, per day from each member. • Let’s take an example…
  73. 2.
  74. Stage nine: clearing begins
  75. The clearing house will make all of the necessary calculations for the buy side and the sell side of the trade in order to determine what’s needed from each of them and by when. It’s their job to make sure all of the obligations are fulfilled. They inform each party of what’s needed.
  77. Trades are referred to generally as T+1, T+2 and T+3. ‘T’ refers to the transaction date (the date on which the trade was made). +1, +2 or +3 refers to the settlement date. If a trade is marked T+2 for example, securities and cash will be exchanged two days after the trade is made. On the settlement date the sell side must have transferred their security and the buy side must have transferred the money for their purchase.
  79. The majority of settlements are now T+2. The UK and Irish capital markets will move to a T+2 settlement period from October 2014.
  80. 3.
  81. Middle Office - Clearing / Pre-Settlement
  82. This denotes all activities from the time confirmation is made for a transaction until settlement begins. In theory, this includes the management of posttrading, pre-settlement credit exposure, ensuring trades are settled in accordance with market rules. It is important to note that clearing may occur either bi-laterally or through a central party.
  84.  Matching - The process of “pre-matching” in order to alleviate issues (fails) in the settlement process, prior to instruction of settlement.
  85. Netting - The process of netting trading obligations (cash, securities or other), with a goal to reduce the number of settlement transactions.
  86. Funding - The process in which a party, individual corporate or central counterparty is responsible for ensuring that trades It is important to note that clearing may occur either bi laterally or through a central party. g p p y,p p y p g are properly funded, prior to settlement process initiating.
  87. Reference Data - Settlement location, clearing account numbers, CSD identifiers, etc.
  88. ---------------------------------------------------------------------------------------------------------
  90. Trade Capture
  92. 1.
  94. It is important to capture details of all the trades without delay. Trade Capture in Morgan Stanley is a process which ensures the details of all transactions are record on all the correct systems. Unless the trade is executed through an electronic source it is difficult to ensure that a trade has input the trade into the system correctly.
  96. In an investment bank the trades flow through the Front Office, Middle Office and Back Office. Initially trades are booked internally in a Front Office system where they then flow down to the operations systems. This is important to keep track of the trades and follow the instructions needed to proceed to the back office operation. From then they are booked in a Risk Management System (RMS).  This system lies within the Back Office and is termed as ‘book-keeping’.
  98. The components which should be in the book are:
  100. Trade Date
  101. Trade Time
  102. Value date
  103. Number of shares
  104. Security
  105. Price
  106. Operation
  107. The counter-party involved
  108. The risks that can arise within the Trade Capture process are segregation of duties issues. Fraud can arise within banks at anytime, it is thus important to ensure that duties are segregated appropriately and staff are not given an opportunity to commit fraud.
  110. 2.
  112. Process
  114. Trade details entered into trade capture systems immediately after confirmed execution
  116. Potential for electronic execution
  117. MS offers various capacities for trade executions:
  119. Agency – Intermediary broker for orders between clients and exchange/second clients
  120. Principal – trades from inventory held on books
  121. On exchange – execution traded against an exchange
  122. OTC – ‘over the counter’ – traded off exchange
  123. Above are subject to a range of different memberships, legal requirements, regulations and documentation
  124. Captured trades are generally made up of the following details:
  126. Product Identifier
  127. Trade price
  128. Quantity
  129. MS trading account no.
  130. Counterparty account no.
  131. Trade date and Settlement date (TD and SD)
  132. Buy/Sell indication
  133. If the client agrees then the trade is legally “born”.
  135. Who is involved
  137. Equity Booking (EUCCP)
  138. Front office (IED)
  139. Risks
  141. Operational – details can often be entered wrong into Morgan Stanley capture systems. These incorrect details result in mismatches and rejections from clients.
  143. Reputational – if trades do not flow through because of an error on our side then clients may become frustrated and annoyed. Also if an issue is picked up by our team, regardless of fault, and multiple people/teams reach out to the client then they can feel like we do not communicate.
  145. 3.
  147. Trade Capture – is the process of booking (or capturing) the trade into the systems used within a financial organisation. The aim of the process is to ensure that the complete details of all transactions are recorded on all the applicable internal firm systems.
  149. Capture makes sure that bond trades are formally recorded within the books and records of the trading institution. Trades that have been executed and entered into the front office system (for example FTS) should flow through to the back office systems immediately in an automated environment. To ensure that all trades have successfully arrived in the back office settlements system, a trade by trade reconciliation should take place (as we go through the lifecycle of a trade it becomes obvious that checks and adjustments are continuously being done to the trade to make sure successful settlement).
  151. Trade capture systems only record the basics of the trades (book, TD, quantity, security, price and counterparty), information required for booking, further steps of confirmation and enrichment are needed to make sure trades actually settle and to calculate the exact impact of those trades to firms profits.
  153. Pre-settlements and settlements:
  155. 1.
  157. There’s just one more obstacle in our way until we can reach our goal of completing the course and settling our trade i.e. successfully exchanging the equity for cash. This obstacle is known as The Settlement Sucker Punch.
  159. In order to overcome The Settlement Sucker Punch and complete the course, we must match the trade. However to pass this obstacle we must make the correct training preparations, otherwise this will result in the trade failing to settle and failure to complete the course.
  161. The exchange of cash and equity and overall completion of the course will not occur until the SSI’s (standard settlement instructions) have been issued to the custodian by both parties. This is known as pre settlement and these instructions are normally transmitted from Morgan Stanley’s settlement system to a custodian via the secure method of SWIFT.
  163. SSI’s include details such as name of issuing party, name of issuer’s/counterparty’s custodians, account numbers, quantity of stock and settlement date and these details must match on both parties’ sides, otherwise trades will fail to match therefore delaying settlement. Each time a trade fails to match we will be struck by one of the red boxing gloves, falling into the water thus delaying our finishing time.
  165. If this does occur and details do not entirely match, internal systems such as SAFE will assign the trade with an ‘unmatched’ status.
  167. The custodian will inform the counterparties of this, who whill then proceed to investigate the reasons for the failure to match the details and inability to pass the obstacle. If the counterparty recognises the trade then they will attempt to amend the error – and if all issues are rectified in a satisfactory manner, the matching succeeds and we can now safely pass this obstacle without getting struck and the trade proceeds to settlement. If the counterparty does not recognise the trade then they will need to reach out to the other counterparty to advise on this, seeking information such as the name of the counterparty trader who executed the trade.
  169. Once we have investigated on how to match the trade details and pass the Settlement Sucker Punch, systems such as SAFE will assign the ‘matched’ status to the trade. The trades will now be ready for settlement and the cash and equity will be successfully exchanged.
  171. The custodian will then issue a report whereby their updated balances have to match that of the counterparty’s internal balances – there can be no inaccuracies in our finishing time.
  173. Risks
  175. During our attempts to pass The Settlement Sucker Punch we will face many risks that will hinder our chances of success. We must mitigate these risks in order to achieve the best finishing time possible.
  177. We face the risk of trades failing to match resulting in getting struck and falling into the water:
  179. Information may not match for numerous reasons:
  181.  SSI mismatch
  182.  Trade Date/Value date mismatch
  183.  Mapping issues on internal systems
  184.  Delays in trader booking resulting in counterparties DK’ing trades.
  185. If trades are unable to get matched before cut off, we face the risk of failing to settle the trades and failing to complete the course.
  187. Settlement failure can be a result of errors made by either party.
  189. The paying counterparty may fail to transfer the agreed amount, even if they have obtained legal ownership of the equity. The seller of equity would suffer in this case due to losses from not receiving the principal amount and the regulators could impose penalties on the buyer as a result of this, making them liable to provide compensation. This would be a form of credit risk, which in turn could develop into reputational risk.
  191. The seller on the other hand may not possess enough of the securities to give to the buyer, perhaps due to loaning it out to an additional counterparty or due to insufficient liquidity in the market. This would result in the buyer suffering as they may need the equity to cover short positions. The counterparty may not receive instructions before the cut-off date.
  193. How can this risk be mitigated in order to improve our finishing time?
  195. In order to mitigate this risk we could perform ‘prematching’ which involves investigating all unmatched trades on VD -1 in order to spot potential mismatches in advance so enough time is available to match the trade, limiting settlements failures. This will give us an advantage to help avoid getting struck by the boxing gloves and smoothly completing the course in our desired time.
  197. When a trade fails it is possible for one side to act to ‘force’ settlement;
  199. A buy in occurs when the purchaser issues a note to the seller stating that unless settlement occurs after a specific time the buyer will purchase the assets in the market at the prevailing price while any additional costs will be passed onto the seller.
  201. A sell out occurs whereby if a seller does receive cash then after a period of time they can notify the buyer that the assets will be sold in the market. Any shortfall in the received proceeds will become the original buyer’s liability.
  203. Actioning these will result in the trade settling after settlement date meaning the course will be finished but at a very high/not ideal finishing time.
  205. 2. Settlement
  206. PROCESS
  207. Pre-Settlement
  208. The pre-settlement process is the stage in which issues with the trade are mitigated. This is completed in regards to the following aspects:
  209. •     Liquidity
  210. •     Settlement date
  211. •     Quantity
  212. •     Price
  213. Liquidity
  214. Liquidity is required from both parties of the trade. The buyer of the shares must have the assets in a liquid state at the settlement date to ensure the transfer of equity for cash.
  215. Similarly, the buyer of the shares must ensure that they have a liquid cash position in order to pay for the shares which they have agreed to.
  216. Settlement Date
  217. The settlement date for both sides of the trades must match. Where differentials occur between the two parties separate issues can arise depending on the settlement process.
  218. When Delivery-Versus-Payment (DVP) is used the trade will fail to process as the cash and the shares need to be present.
  219. When Free-of-Payment (FOP) is used exposure is large as the trade of either product without the matching of the counterparty leaves one exposed.
  220. Quantity
  221. If the quantities do not match then the trade is likely to fail as the transference of goods will not match to the pre-agreed value. Where this occurs, the transfer of goods will likely be caught in the checking systems implemented. However, the trade will be delayed or cancelled which is inefficient.
  222. Price
  223. If the prices do not match the pre-agreed rate, the trade will fail due to the failure to meet the pre-agreed contract. One instance of this occurring is human error of incorrect booking.
  224. Standard Settlement Instructions (SSI)
  225. SSI can be used to mitigate many of these issues and to streamline the process of the trade. The value of this is that many of the human errors are mitigated within the standardisation. It also reduces the amount of time in the processing of the trade as pre-agreements for all trades have basis within the instructions.
  226. Settlement
  227. The settlement is the stage of the trading life cycle in which both parties actually exchange the goods which they own. For the buyer this is the exchange of the cash for the set amount of shares in which they have agreed to buy. The seller will exchange the set amount of shares for the cash equivalent.
  228. The exchange can be in two forms.
  229. Delivery vs Payment (DVP)
  230. Within this method, the transference of either the equity or the cash cannot occur without the other being present. This is the safer of the two options with regards to credit risk as if one party exits the contract prematurely, the other will not lose the value of the trade.
  231. Free-of-Payment (FOP)
  232. With this method, the exchange of cash and the equity does not need to be at the same time. As such, if one party defaults in the trade where the other party has already exchanged the goods, the initial party will have lost the trade value. The benefit of this system is that the trading can be more efficient will less chance of the trades failing due to timing issues of transference of goods.
  234. Operational Risk        The risk that the settlement will not be processed correctly. This would lead to the trade being delayed/ cancelled.
  235. Credit Risk     The risk that one of the parties of the trade defaults on either buying/ selling the shares while the settlement is being processed.
  236. Market Risk     The risk that the value of the shares fluctuates during the settlement process. If the trade is rebooked at a different rate, losses can occur.
  238. 3.
  239. Settlement
  240. If the transaction is a DVP, cash and securities are exchanged simultaneously. The Cash Settlements team is responsible for this process with Operations overseeing. Counterparties have to ensure timely and accurate settlement.
  242. Pre-Settlement
  243. The exchange of stocks/cash cannot take place until a settlement instruction has been issued to the custodian.
  244. To ensure that the correct settlement instructions can be received and acknowledged we need:
  245. Affirmation.
  246. Documented SSIs: Reduces the risk of settlement failure, fraud and trade processing costs and facilitates STP.
  247. Disbursement of Funds (3 Touch): Initiation, Review/Approval(SAFE)and System-Driven automated review by Treasury (EPS) (Cross Operations Policy Settlement Instructions Authorisation Model)
  248. Once instructions have been received and acknowledged the custodian tries to match their instruction with the counterparty instruction.
  249. •     Matched Instructions: Custodian compares details of both instructions and find everything is accurate.  The custodian holds the instructions until the Value Date.
  250. •     Unmatched Instructions: Instructions with any discrepancies are unmatched. Investigation is required immediately. Priority is given to closer Value Dates and/or higher net cash settlement amounts.
  251. •     Advisory Instructions: Situations indicating that a settlement instruction has no matching instruction. It has to be established immediately whether the trade is recognised at all.
  252. A trade can fail to settle due to three factors:
  253. 1.      Unmatched Settlement Instructions: Can be caused by incorrect trade details inputted, instructions issued but not received or counterparties are in dispute over the trade/value date, the amount or even the security/transaction itself.
  254. 2.      Insufficient Securities: The seller of securities may not have the sufficient securities in its account to deliver to the buyer on the value date. This could occur if the seller is awaiting receipt of securities from a purchase, is unable to recall securities that have been loaned out or has engaged in short-selling.
  255. 3.      Insufficient Cash: The buyer of securities may not have sufficient cash (or collateral/credit line) in its account at the custodian. This could occur if the buyer is experiencing funding problems or is awaiting payment on a sale.
  256. Settlement failures can have serious repercussions:
  257. •     Legal ownership of shares moves from the seller to the buyer upon the trade’s intended settlement date regardless of when the trade actually settles.
  258. •     If a trade fails to settle for several days, the seller faces a prospective loss in interest. If the buyer has caused the failure then the seller is usually compensated for this loss of interest.
  259. It is extremely important for trades to settle in a timely and efficient manner. Bobsleigh teams will lose points for slow times in the heat. Once a trade has been fully settled, a status of settled is applied to the settlement instruction. The actual settlement date which may vary from the value date if there has been any delay in settling the trade.

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