Financial Markets Operations Management

KEITH DICKINSON is Director of The Settlement & Management Research Consultancy Limited, Principal of Financial Markets Training Limited and a Senior Teaching Fellow at the International Business School Suzhou at Xi'an Jiaotong-Liverpool University, Suzhou. His career has spanned twenty years as an industry practitioner in operations and over twenty years in executive education and academia.

• Preface xixAcknowledgements xxiiiPart OneChapter 1Introduction to Operations 31.1 Introduction 31.2 Organisational Structure of an Investment Company 51.2.1 Front Office 51.2.2 Middle Office 61.2.3 Back Office/Operations 91.3 Operations’ Relationships 101.3.1 Clients – External 101.3.2 Clients – Internal 111.3.3 Counterparties 111.3.4 Suppliers 121.3.5 The Authorities 121.4 Other Business Functions 131.5 Summary 15Chapter 2Financial Instruments 172.1 Introduction 172.2 Why Do We Issue Financial Instruments? 182.3 Money Market Instruments 192.3.1 Euro-Currency Deposits 192.3.2 Certificates of Deposit 232.3.3 Commercial Paper 232.3.4 Treasury Bills 252.4 Debt Instruments 262.4.1 A Bond Defined 262.4.2 Bond Issuance 272.4.3 Types and Features of Bonds 272.4.4 Other Key Characteristics of Bonds 282.4.5 Types of Bond 292.4.6 Form of Bonds and Interest Payment 302.4.7 Maturity and Redemption Provisions 312.4.8 Calculations 322.4.9 Accrued Interest 332.4.10 First Short Coupon 372.4.11 First Long Coupon 382.5 Equity Instruments 382.5.1 Equity Defined 382.5.2 Classes of Equity 412.5.3 Equity Issuance 432.5.4 Pricing and Calculations 442.5.5 Examples of Local Taxes 452.5.6 Disclosure 452.5.7 Summary of Cash Market Instruments 462.6 Derivative Instruments 472.6.1 Introduction 472.6.2 Definitions 482.6.3 Derivative Usage 492.7 Exchange-Traded Derivatives 522.7.1 Introduction 522.7.2 The Role of the Derivatives Exchanges 532.7.3 Major Derivatives Exchanges 532.7.4 Open Interest and Trading Volumes 562.7.5 Futures 582.7.6 Options 642.7.7 Summary of Exchange-Traded Derivatives 712.8 OTC Derivatives 712.8.1 Introduction 712.8.2 Forwards 722.8.3 Swaps 762.8.4 Summary of OTC Derivatives 802.9 Summary 812.9.1 Financial Products in General 812.9.2 Cash Markets 812.9.3 Derivatives Markets 81Chapter 3Data Management 833.1 Introduction 833.2 Importance of Reference Data and Standardisation 843.2.1 Introduction 843.2.2 Basic Securities Transactions 843.3 Types of Reference Data 863.3.1 Required Reference Data 863.3.2 Data Requirements – Securities 873.3.3 Data Requirements – Counterparties and Customers 913.3.4 Data Requirements – Settlement Information 923.3.5 Sources of Reference Data 933.4 Data Management 943.4.1 What is Data Management? 943.4.2 Approaches to Data Management 943.4.3 Data Processing 953.5 Legal Entity Identification 953.5.1 Background to Legal Entity Identification 953.5.2 The “Legal Entity” 963.5.3 The Global Legal Entity Identifier System (GLEIS) 963.5.4 LEI Structure 973.6 Summary 99Chapter 4Market Participation 1014.1 Introduction 1014.2 Market Players 1024.2.1 Retail Clients 1024.2.2 Institutional Clients 1034.2.3 Banks 1154.2.4 Sell-Side Intermediaries 1264.2.5 Market Regulators and Market Associations 1294.3 Market Structure 1314.3.1 Introduction 1314.3.2 Regulated Markets 1314.3.3 Alternative Trading Venues 1354.3.4 Over-the-Counter Market 1364.4 Summary 137Part TwoChapter 5Clearing Houses and CCPs 1415.1 Introduction 1415.2 Overview of Clearing and Settlement 1425.3 The Clearing House Model 1435.4 The Central Counterparty Model 1455.4.1 Risk Management 1475.5 Features of CCPs and Clearing Houses 1485.5.1 The Committee for Payment and Settlement Systems’ Statistics 1485.6 Summary 150Chapter 6Securities Depositories (CSDs and ICSDs) 1516.1 Introduction 1516.2 Historical Context 1516.3 Definitions 1546.3.1 Domestic (Local/National) CSDs 1546.3.2 International CSDs 1546.4 Central Securities Depositories 1546.4.1 Features of CSDs and ICSDs 1546.4.2 Functions of CSDs 1556.4.3 The Changing World of CSDs 1586.4.4 CSD Links and Interoperability 1616.5 International Central Securities Depositories 1636.5.1 Background 1636.5.2 Features of the ICSDs 1646.5.3 Clearstream Banking Luxembourg (CBL) 1646.5.4 Euroclear Bank (EB) 1656.6 Linkages – Exchanges, Clearing Systems and CSDs 1676.6.1 United States of America 1686.6.2 Europe 1696.6.3 Rest of the World 1706.7 CSD Associations 1716.7.1 Introduction 1716.7.2 Americas’ Central Securities Depositories Association (ACSDA) 1716.7.3 Asia-Pacific CSD Group (ACG) 1716.7.4 Association of Eurasian Central Securities Depositories (AECSD) 1726.7.5 European Central Securities Depositories Association (ECSDA) 1726.7.6 Africa and Middle East Depositories Association (AMEDA) 1726.8 Summary 173Chapter 7Securities Clearing 1757.1 Introduction 1757.2 Generic Clearing Cycle 1767.2.1 Trade Capture 1767.2.2 Trade Enrichment and Validation 1777.2.3 Trade Reporting 1777.2.4 Confirmation and Affirmation 1787.2.5 Clearing Instructions 1787.2.6 Forecasting – Cash 1797.2.7 Forecasting – Securities 1807.3 Trade Capture 1827.3.1 Dealer’s Blotter 1827.3.2 Trade Input 1827.3.3 Trade Output 1837.4 Trade Enrichment and Validation 1847.5 Regulatory Reporting 1867.5.1 Background 1867.5.2 Transaction Reporting 1867.5.3 Transaction-Reporting Mechanism 1877.5.4 Trade Repositories 1887.6 Confirmation and Affirmation 1887.6.1 Confirmations 1897.6.2 Affirmation 1907.7 Clearing Instructions 1947.7.1 Types of Instruction 1947.7.2 Instruction Validation 1967.7.3 Instruction Matching 1967.8 Forecasting – Cash 1997.8.1 Introduction 1997.8.2 Timing Issues 1997.8.3 Cash Forecasting Methodology 2007.8.4 Funding Uncertainties 2017.8.5 Benefits of Predictive Forecasting 2027.9 Forecasting – Securities 2037.9.1 Introduction 2037.9.2 Securities that are Available for Delivery 2047.9.3 Securities that are Not Available for Delivery 2047.10 Summary 205Chapter 8Settlement and Fails Management 2078.1 Introduction 2078.2 The Different Types of Settlement 2088.2.1 Gross Settlement 2098.2.2 Net Settlement 2108.3 Delivery versus Payment 2118.3.1 Definition of DVP 2128.3.2 DVP Models 2138.3.3 Settlement Instructions for DVP 2148.4 Free of Payment Settlement 2158.4.1 Settlement Instructions for Free of Payment 2158.4.2 Where Settlement Takes Place 2168.4.3 Settlement Conventions 2168.5 Settlement Fails 2178.5.1 Overview of Settlement Failure 2178.5.2 Why Transactions Fail to Settle 2188.6 The Move to Shorter Settlement Cycles 2288.6.1 Background 2288.6.2 Project Status 2288.7 Summary 229Chapter 9Derivatives Clearing and Settlement 2319.1 Introduction 2319.2 Regulatory Changes 2329.2.1 Background 2329.2.2 Financial Stability Board (FSB) 2329.2.3 Reform Requirements 2339.3 Exchange-Traded Derivatives Contracts 2349.3.1 Introduction 2349.3.2 Derivatives Exchange and Clearing System 2359.3.3 Give-Up Agreements 2359.3.4 Clearing Process 2369.3.5 Margin Calculations 2379.3.6 Initial Margin – Eligible Assets 2399.4 Cleared OTC Derivatives Contracts 2409.4.1 Types of OTC Derivative that are Cleared Centrally 2419.4.2 Trading Platforms 2429.4.3 Trade Repositories 2449.4.4 Central Counterparties 2449.5 Non-Cleared OTC Derivatives Contracts 2459.5.1 Documentation 2459.5.2 Non-Cleared OTCD Processing 2489.5.3 Trade Capture 2489.5.4 Confirmation 2499.5.5 Settlement 2509.5.6 Collateral 2519.5.7 Event Monitoring 2549.5.8 Reconciliation 2549.6 Summary 255Part ThreeChapter 10Custody and the Custodians 25910.1 Introduction 25910.2 Custody 26010.2.1 What is Custody? 26010.2.2 Forms of Securities 26010.2.3 Ownership Transfer – Bearer Securities 26110.2.4 Ownership Transfer – Registered Securities 26210.3 Holding Securities 26310.3.1 Register in the Custodian’s Name 26310.3.2 Nominee Account 26410.3.3 CSD Nominee 26610.3.4 Safekeeping Methods – Summary 26710.4 The Custodians 26710.4.1 Custody in a Local Market 26710.4.2 Custody in Global Markets 27110.4.3 Custody in the EuroMarkets 27710.5 Target2Securities (T2S) 27910.5.1 Introduction 27910.5.2 Eurosystem 28010.5.3 How T2S Will Work 28110.5.4 Migration Plan 28210.5.5 Further Information 28210.6 Summary 283Chapter 11Corporate Actions 28511.1 Introduction 28511.2 Types of Corporate Action Event 28611.2.1 Voluntary or Mandatory Events 28611.2.2 Predictable or Announced Events 28711.3 Participation in Corporate Actions 28711.3.1 Fund Manager 28711.3.2 Global Custodian 28711.3.3 Local/Sub-Custodian 28811.3.4 Local Central Securities Depository 28811.3.5 International Central Securities Depository 28811.3.6 Data Vendors 28811.3.7 Receiving/Paying Agent 28811.4 Entitlements, Key Dates and Claims 28911.4.1 Entitlement 28911.4.2 Record Date 29011.4.3 Ex-Dividend Date 29011.4.4 Payment Date 29211.4.5 Claims 29211.4.6 Key Dates for Bonds 29411.5 Corporate Action Event Processing 29411.5.1 Introduction 29411.5.2 Cash Dividend 29611.5.3 Optional Stock Dividend 29811.5.4 Fixed-Income Bond Coupon 30011.5.5 Floating-Rate Note (FRN) Coupon and Rate Reset 30211.5.6 Bond Redemption 30511.5.7 Bond Conversion 30711.5.8 Capitalisation (Bonus) Issue 30911.5.9 Rights Issue 31011.5.10 Other Examples of Event Types 31411.6 Information Flows 31511.6.1 Introduction 31511.6.2 The Communication Problem 31511.6.3 Global Communication Chain 31611.6.4 Local Communication Chain 31811.6.5 International Central Securities Depository Chain 31911.6.6 Summary 32011.7 Corporate Action Risks 32011.7.1 Introduction 32011.7.2 Data/Information Capture Risk 32111.7.3 Replacement Risk 32211.7.4 Decision-Making/Election Risk 32211.7.5 Reputational Risk 32211.7.6 Reconciliation Risk 32311.8 Industry Initiatives 32311.8.1 Introduction 32311.8.2 The International Securities Services Association (ISSA) 32311.8.3 Giovannini Group 32411.8.4 European Central Securities Depositories Association (ECSDA) 32511.9 Corporate Governance and Proxy Voting 32811.9.1 Introduction 32811.9.2 Relations with Shareholders 32811.9.3 Proxy Voting 32911.9.4 Relations with Preference Shareholders 33111.9.5 Relations with Bondholders 33111.9.6 Company in Bankruptcy or Administration 33111.9.7 Disclosure Reporting 33211.10 Withholding Tax 33311.10.1 Introduction 33311.10.2 The Problem of Double Taxation 33511.10.3 Double Taxation Treaties 33511.10.4 Tax Reclaims 33611.11 Impact on Other Departments 33711.11.1 Introduction 33711.11.2 Front Office 33711.11.3 Clients 33811.11.4 Settlements 33811.11.5 Securities Lending and Borrowing 33811.11.6 Reconciliations 33911.11.7 Pricing and Valuation 33911.11.8 Reference Data 34011.12 Summary 340Appendix 11.1: Corporate Action Event Type Categories 340Appendix 11.2: Voluntary and Mandatory Events for Equities and Bonds 341Chapter 12Securities Financing 34312.1 Introduction 34312.2 Types of Securities Financing 34412.2.1 Securities Lending and Borrowing 34412.2.2 Repurchase Agreements 34412.2.3 Sell/Buy-Backs 34512.2.4 Summary of Securities Financing Transactions 34512.3 The Players and Their Motivations 34612.3.1 Introduction 34612.3.2 The Buy Side 34612.3.3 The Sell Side 34712.3.4 Borrowing to Cover Short Positions 34812.3.5 Borrowing Cash to Finance Inventory 34912.3.6 Temporary Transfer of Ownership 35012.3.7 Summary 35212.4 Intermediaries 35212.4.1 The Relationship between Lender and Borrower 35212.4.2 Agent Intermediaries 35212.4.3 Principal Intermediaries 35312.4.4 Choices for the Lenders and Borrowers 35312.5 Agreements and Code of Guidance 35412.5.1 Introduction 35412.5.2 Securities Lending Agreements 35412.5.3 Repurchase Agreements 35512.5.4 Code of Guidance 35612.6 Securities Lending Lifecycle 35612.6.1 Phase 1: Loan Initiation 35712.6.2 Phase 2: Loan Maintenance 36112.6.3 Phase 3: Loan Closure 36712.6.4 Lending Fees 36812.7 Repurchase Agreement Lifecycle 37012.7.1 Motivations 37012.7.2 Repurchase Agreement Types 37112.7.3 Sell/Buy-Backs 37412.7.4 Settlement 37612.8 Collateral and Margin 37912.8.1 Terminology 37912.8.2 Types of Collateral 38012.8.3 Repurchase Agreements (and Sell/Buy-Backs) 38012.8.4 Securities Lending 38112.8.5 Delivery by Value (DBV) 38112.8.6 Repo Exposure, Haircuts and Margin 38212.9 Default and Close-Out Provisions 38412.9.1 Introduction 38412.9.2 Event of Default 38412.9.3 Consequences of an Event of Default 38512.10 Central Counterparty (CCP) Services 38612.10.1 Introduction 38612.10.2 The Options Clearing Corporation (OCC) 38612.10.3 Eurex Clearing 38712.10.4 LCH.Clearnet 38712.10.5 Clearstream Banking Luxembourg (CBL) 38812.10.6 Euroclear Bank 38812.11 Summary 389Appendix 12.1: Credit Ratings – Long Term 390Appendix 12.2: Delivery by Value (DBV) Class List 391Appendix 12.3: Technology Vendors 392Part FourChapter 13Accounting for Securities 39513.1 Introduction 39513.1.1 Accounting and Why We Need It 39513.2 The Accounting Equation 39713.2.1 Key Financial Statements 39713.3 The Accounting Lifecycle for Securities 40013.3.1 Introduction 40013.3.2 Trade Date 40113.3.3 Settlement Date 40213.3.4 Revaluation 40313.4 Gains and Losses 40513.4.1 Introduction 40513.4.2 Fair Value (Mark-to-Market) 40513.4.3 Amortised Cost 40713.4.4 Calculation Conventions 41013.5 The Accounting Lifecycle for Derivatives 41113.5.1 Introduction 41113.5.2 Exchange-Traded Derivatives 41213.5.3 OTC Derivatives 41513.6 Summary 416Appendix 13.1: Closing Prices for Singapore Equities (SGX) 416Chapter 14Reconciliation 41714.1 Introduction 41714.2 Importance of Reconciliation 41814.2.1 Internal vs. External Records 41814.2.2 Ownership vs. Location 41914.3 Types of Reconciliation 42114.3.1 Reconciliation Methods 42214.3.2 Reconciliations – Worked Examples 42314.4 Automation of Reconciliations 42714.5 Summary 428About the Author 429Index 431