Part 14

Tarheel Consultancy
Services
Corporate Training and
Consulting
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
 The specific asset being exchanged
 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 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 be paid to
the seller on delivery of the securities
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 York.
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 securities and cash
in safekeeping on behalf of the trader.
11
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 receiving
cash at the same time.
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 and seller
through their respective custodians.
13
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 asset.
14
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 quantity of all
trades in each security.
15
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 reconciled independently with
external sources.
16
Control (Cont…)
 Furthermore, a trader’s complete
picture for an individual security
can be reconciled internally by
comparing
 The trading position or òwnership’
position with the sum of òpen’ 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 to whom it
has sold securities
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 +13,000
PHI 15 Oct 25 Oct Sell 4,000 +9,000

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 shown with
a + sign
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 the future.
21
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 to be updated.
22
Table-2
IBM Shares on 25 Sep
ALPHA +5000 -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 custodian in London.
23
Table-3
Position on 1 Oct
ALPHA +13,000 -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
Table-4
Position on 10 Oct
ALPHA +13,000 -13000
Custodian
in London
________________ ___________
+13000 -13000
25
Table-5
Position 0n 15 Oct
ALPHA +9000 -13000
Custodian in London
+4000 PHI
________________ ___________
+9,000 -9,000
26
Table-6
Position on 25 Oct
ALPHA +9000 -9000
Custodian in
London
________________ ___________
+9000 -9000
Due to the double-entry system of book-keeping
the ownership position will always be equal to the
location position.
27
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 the investor.
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
(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 relevant financial centers.
34
(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 makers.
36
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 maintain an accurate
picture of outstanding trades with counterparties.
40
Departments Within an
STO
 The Front Office
 Sales
 Traders
 Repo Traders
 The Middle Office
 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 of high quality.
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
 Client managers
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 market maker.
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 choice such as
 Telex or fax
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 with the STO.
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 òwned’ 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 custodian.
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
profit.
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 collateral.
 Consequently the rate of interest is also lower.
61
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 at an agreed later date.
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 STO and its counterparties
65
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
 Applying custodian details to the trade
 Validating the details of the trade
68
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
 Ensuring that income due is properly received
69
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 accounting.
70
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 and accounting entries for both
securities and cash are derived from the details of the individual
trades.
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 Location
Trading +2,000,000 -1,000,000
Book A Custodian L, NYC
-1,000,000
XYZ, Zurich
_________ __________
+ 2,000,000 -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 purchase of shares.
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 Skeleton’.
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 contained in the skeleton.
81
 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
 Accrued Interest
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
 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.
 Thus it is necessary to decide which location and custodian are relevant
for an individual trade.
 This information is essential for a trade to settle.
86
 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
 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 the
counterparty’s custodian is very
important.
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 increases the risk of losing the
client’s business.
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 the

outside world.
94
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 soon as possible after trade execution.
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 instruction.
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 specific settlement
instruction.
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 account holder and the custodian.
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
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 been received.
105
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 counterparty’s
106
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-asset will be delayed or
may never arrive at all.
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
 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
 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 order to settle
the trade.
110
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 external
movement of securities and cash.
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 for a sale.
112
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 external settlement to occur.
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 STO
buys securities.
114
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
 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 behalf of its clients.
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
 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 values will result.
120
 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 this can result in a reduced
service to institutional clients.
121
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 discrepancies requiring
investigation.
122
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 within the stated deadlines
123
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 considered to be a part of
the overall service that an STO is required to provide to
the institutional client.
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 cancelled. This is
known as Counterparty Risk.
128
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 received at all.
129
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 for the
regulatory bodies.
132
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
 Issue a settlement instruction - 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
 Trading position affected – No
 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
 Operation – Lend
 Face value of securities – GBP12,000,000
lent/borrowed
Security lent/borrowed – IADB 6.2% 1st Dec
2015
Price of security lent borrowed – 98.625%
139
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
 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
which the trade is executed.
145
Example
 Selling Trading Book – Book A
 Buying Trading Book – Book B
 Quantity – 2,000,000
 Security – ICI shares
 Price – GBP 3.80
146
Characteristics
 Trading position affected – Yes (both
books)
 External securities movement – No
 External cash movement – No
 No. of external counterparties – None
 Issue a confirmation – No
 Issue a settlement instruction – 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 securities
from one custodian to another.
148
Example
 From Depot – Custodian Q , Milan
 To Depot – Custodian S, Brussels
 Quantity – EUR 2,000,000
 Security – Italy 6%, 1 Sep 2012
149
Characteristics
 Movement of – Securities Only
 Origin – Back Office
 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
another source.
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 by
the Treasury department.
156
Example
 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
 Issue a Trade Confirmation – Yes
 Issue a settlement instruction – Yes (one for
opening value date and one for closing
value date)
158
 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 the STO requires payment.
159
 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 interest.
160
 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 account at the
custodian.
161
 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
164
Characteristics
 Movement – Cash Only
 Origin – Treasury Department or Back Office
 Number of external counterparties – None
 Issue a trade confirmation – No
 Issue a settlement instruction – Yes (to both paying
as well as receiving nostros)
165
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 number of USD.
166
Example
 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
 Number of external counterparties – One
 Issue a settlement instruction – Yes (both
nostros)
168
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 risk.
170
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 have to sell the SGD
7,600,000 for Euros immediately.
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
subsequent sales by clients and the collection of
income on their behalf.
177
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 electronic book
entry holdings and settlement.
178
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 recorded on the register of
holders maintained by the issuer or registrar, but no
certificates will be issued.
179
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 vaults by a
custodian or a Central Securities Depository.
182
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 Re-
registration
 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 payment.
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 Re-
registration
 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
 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 as
follows.
193
 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 payment of cash on
the value date.
194
 On value date the following will occur.
 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.
 As a result of settlement the CSD will need to update
its records of securities holdings for its participants.
 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 Re-
registration
 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
 Miscommunication of trade costs or sales proceeds to clients.
199
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
100
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 value.
203
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
 Accrued interest
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 payable on
equity purchases.
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 equities.
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 certificates.
209
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 be applied
and the cash amount derived
212
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, systems
costs, payroll etc. are divided by the number of trades.
213
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 straight-
through 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 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
 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
 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
 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
 For a principal trade such trading
information includes:
 Trading book
 Trade data
 Trade time
 Value date
 Operation
 Quantity
 Security
 Price
 Counterparty
224
 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 appropriate data.
225
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 up
within the static data.
226
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 European Bonds
All Italian Equities 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
 Issuing settlement instructions to custodians and banks
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 currencies.
232
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
 It is a 12 character code
236
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 are given and used
locally in most countries.
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 such as the required medium
of trade confirmation.
239
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
 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
 Historically the process of gathering such
information was a manual exercise.
 These days such information is available
electronically for subscribers to a service
called Àlert’ 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 systems.
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 providers or
data vendors.
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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Tarheel Consultancy

 Is due to be delivered to it by counterparties from whom

it has purchased securities and/or

has sold securities

BETA 15Sep 25SEp Buy 5,000 +5000

Gamma 1 Oct 10 Oct Buy 8,000 +13,000

PHI 15 Oct 25 Oct Sell 4,000 +9,000

 Or amendment of the trade details

Followed by transmission of trade details to the

the STO’s behalf

to the regulatory authorities is complete and

 Trade Time – 11:05

 Face value of securities – GBP12,000,000

 However if the counterparty were the Singapore

All European Trading

All European Equities All European Bonds

All Italian Equities All Spanish Equities All French Bonds

Textiles Chemicals Bonds 3-5 Years

Chemicals Forestry Bonds 6-9 Years

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