Tarheel Consultancy

Services
Corporate Training and
Consulting

1
Part-14

Brokerage Operations
Meso Issues

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Standard Securities
Terminology
 Trade Date
 The date on which the two parties agree to
trade or the date of trade execution
 Operation
 The type and direction of the trade
 That is Buy or Sell
 Lend or Borrow
 Quantity
 The number of units of the security being
exchanged
3
Terminology (Cont…)
 Security
 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
4
 The cash value of the trade; the amount to
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.
8
 He can always take delivery in New
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
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 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 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
14
asset.
Control
 It is important for a company to
remain in control of its goods and
cash.
 For a securities trader this means
monitoring within its books and
records complete and up-to-date
records of the following.
 Trades: A complete record must be
maintained of all executed trades
 Trading Positions: The net quantity15
Control (Cont…)
 Open Trades: Trades which are yet to
settle and are outstanding with
counterparties.
 Settled Trades: Trades which have
settled at a custodian and are no longer
outstanding with a counterparty.
 Settled Positions: The net sum of all
settled trades in each security and in
each currency.
 In order to prove that the records are
accurate each of the items should be 16
Control (Cont…)
 Furthermore, a trader’s complete
picture for an individual security
can be reconciled internally by
comparing
 The trading position or `ownership’
position with the sum of `open’ trades
and the settled position also know as
the `location’ position.

17
Control (Cont…)
 The advantage of performing an ownership
versus location comparison is that it is
intended to confirm that whatever quantity of
goods that the trader owns as a result of
trading – which is represented by the trading
position is
 Held within the trader’s control at the

custodian and/or
 Is due to be delivered to it by counterparties

from whom it has purchased securities

and/or
 Is due to be delivered by it to counterparties
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 Example
 ALPHA a dealing firm undertakes the
following three trades in IBM.
Assume that there was no trading
position prior to the first trade
C’Pty T.Dt. V.Dt. Op. Qty. T.Pos.

BETA 15Sep 25SEp Buy 5,000 +5000

Gamma 1 Oct 10 Oct Buy 8,000 +13,00

0
PHI 15 Oct 25 Oct Sell 4,000 +9,000
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Example (Cont…)
 The ownership versus location position
of the shares at various points in time is
as depicted below. The convention in
these tables is:
 Within ownership
 A positive trading position is represented by
a + sign
 Consequently within location
 An open purchase due from a party will be
shown with a – sign
 A settled purchase held at a custodian will
be shown with a – sign
 An open sale due to a counterparty will be 20
Table-1
IBM Shares on 1 Sep
 Ownership Location
ALPHA +5000 -5000 BETA
________________ ___________
+5000 -5000
This shows the position immediately after
the first trade. It shows that 5000
shares are owned by ALPHA and that
these shares have not yet been
delivered to the custodian by the
counterparty as the value date is in the21
Table-1 (Cont…)
 Up to and including the day prior
to the value date the ownership
versus location position will remain
the same due to the fact that there
were no more trades and nor has
settlement occurred for the prior
trades.
 When the first trade settles on 25
Sep the internal records will need 22
Table-2
IBM Shares on 25 Sep
 Ownership Location
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
 Ownership Location
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
 Ownership Location
ALPHA +13,000 -13000
Custodian
in London
________________ ___________
+13000 -13000

25
Table-5
Position 0n 15 Oct
 Ownership Location
ALPHA +9000 -13000
Custodian
in London
+4000
PHI
________________ ___________
+9,000 -9,000
26
Table-6
Position on 25 Oct
 Ownership Location
ALPHA +9000 -9000
Custodian
in
London
________________ ___________
+9000 -9000
Due to the double-entry system of book-
keeping the ownership position will
27
always be equal to the location position.
Trade Flow for Individual
Trades
 Investor send order to an Agent
 Agent records the order and sends it to
an STO (Securities Trading
Organization) or an Exchange.
 The STO or Exchange executes the
order and sends the advice of execution
to the Agent.
 The Agent will record the execution and
send an advice of execution to the
investor. 28
Individual Investors
 An individual may decide to
operate one or more securities
accounts. They may be used:
 To distinguish between holdings in
equities versus debt
 Or to hold international and domestic
securities separately
 This enables separate assessment
of profitability in a way that suits
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Individual Investors
(Cont…)
 Similarly for cash accounts an
individual may require an Income
Account to be maintained to reflect
receipts of dividends on equities
and coupons on bonds, while
having a separate Capital or
Investment account over which the
cost of purchases is debited and
sale proceeds are credited.
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Institutional Investors
 Institutions may trade using an
Agent or without utilizing the
services of an agent.

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Trade Flow if an Agent is
Used
 Investor send order to an Agent
 Agent records the order and sends it to
an STO (Securities Trading
Organization) or an Exchange.
 The STO or Exchange executes the
order and sends the advice of execution
to the Agent.
 The Agent will record the execution and
send an advice of execution to the
investor. 32
Trade Flow if an Agent is not
Used
 The investor sends the order to an
STO.
 The STO
 Records the order
 Executes the order
 Records execution
 It then sends an advice of execution
to the Investor.
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Institutional Investors
(Cont…)
 Following execution of a trade to
buy or sell securities, institutional
investors effect settlement of
trades either by utilizing the
services of a global custodian that
has a network of sub-custodians in
numerous financial centers around
the globe, or by having direct
relationships with custodians in the
34
relevant financial centers.
Institutional Investors
(Cont…)
 In those cases where a global
custodian is used, following the
execution of trade the institutional
client will issue a settlement
instruction to only one destination
– Its Global Custodian
 The global custodian will in turn
instruct the appropriate local
custodian to carry out settlement. 35
Securities Trading
Organization (STO)
 The terms STO is a collective
expression that describes those
who reside within the market
- Namely traders and market makers
who on their own behalf sell securities
to or buy securities from
- Agents acting on behalf of individual or
institutional investors
- Individuals (HNI) or institutional investors
who have opted not to use an agent
- Other STOs such as traders and market
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makers.
Methods of Trading
 Trades take place in two ways.
 Method-A:
 The STO receives the order from an agent

Executes the order

Records the detail of the execution

Communicates the details of the execution to the
agent
 The agent will apply commission to the
trade and communicate the detail to the
investor.
 The STO will normally not be aware of the
identity of the investor

The STOs client in this case is the agent. 37
Methods…(Cont…)
 Method-B:
 The STO receives an order directly
from an investor
 Executes it
 Records the details
 Communicates the execution details
directly to the investor
 The STOs client in this case is the
investor.
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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.
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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 40
Departments Within an
STO
 The Front Office
 Sales
 Traders
 Repo Traders
 The Middle Office
 Trade Support
 The Back Office
 Settlement
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Departments Independent of
Divisions
 These include
 Static Data
 Reconciliation
 Compliance
 Accounting
 Risk Management
 Internal Audit
 Information Technology
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The Front Office
 It is a collective term used to
describe those who are involved
with trading and market making
either directly or indirectly.

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Sales
 Institutional traders are powerful
organizations.
 They are the originators of a large
number of trades with large cash
values.
 When an institutional client has a
direct relationship with an STO the
STO can generate a large of
revenue provided it offers service 44
Sales (Cont…)
 In order to ensure that institutional
clients are given high quality
service sales people are typically
deputed to act as a primary
contact point between the client
and the STO.
 These point men are also known
as:
 Account managers or 45
Sales (Cont…)
 The institutional client will place
orders with the salesperson either
over the phone or via an order
management system to which it
has been given access.
 The salesperson is responsible for
the internal management of the
order which involves forwarding
the order to the trader or the 46
Sales (Cont…)
 The trader or the market maker
will decide whether or not to trade.
 The salesperson has no authority
to execute a trade on behalf of an
STO.
 If the trader or market maker
agrees to the terms of the order, a
trade will be executed between the
STO and the client. 47
Sales (Cont…)
 The trader will record the details of
the trade and advise the
salesperson.
 The salesperson will inform the
client that the order has been
executed.
 This will be followed by the
issuance of a formal trade
confirmation by the STO to the
client via a medium of the client’s 48
Sales (Cont…)
 The management of an STO requires a
mechanism to judge the performance of
a salesperson.
 Normally a method of Sales Credits is
employed for this purpose.
 This is a percentage of the value of
each trade
 The greater the number of trades and the
cash value of each trade the greater is the
accumulated sales credit.
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Sales (Cont…)
 The accumulated sales credits are
used to calculate the
compensation payable to the
salesperson.
 So it is in the salesperson’s
interest to:
 Generate as many orders as possible
 To maintain relationships with
existing institutional clients
 And to bring more clients to trade 50
Traders
 They execute trades with the following
types of counterparty.
 Institutional clients via their own internal
salespersons
 Agents acting on behalf of individual and
institutional clients
 Other STOs
 Other companies within the STOs group

51
Traders (Cont…)
 Traders involved with proprietary
trading within an STO are
responsible for the profitability of
their particular trading portfolio
 This is referred to as a Trading Book
 A trading book may be operated
 Either by an individual or
 By a small group of traders
52
Traders (Cont…)
 Each book contains a number of
individual securities in which the
trader or market maker trades
 The trading book is the primary
record of the traders current and
historical trades and trading
positions.

53
Trading Books
 Trading books may be defined
according to:
 Individuals or groups of traders to
whom securities have been assigned
 A group of securities to whom traders
have been assigned
 Currency of securities to which
traders have been assigned
 Trading strategies to which traders
have been assigned
54
Trading Books (Cont…)
 To enable the management to assess
the profitability of its trading activity,
the trading department typically
contains a number of trading books
 Each trade that is executed is `owned’
by a specific trading book.
 Trades are recorded against the
relevant trading book
 And the Profit and Loss (P&L) is
calculated at the trading book level
 From this the performance of an individual
or group of traders can be ascertained.
55
Traders (Cont…)
 Traders within an STO are normally
required to take positions within
predefined trading limits set by the
management.
 The objective is to prevent an over
enthusiastic trader from taking an
excessively risky position.

56
Traders (Cont…)
 When a trader receives an order to
trade for example from a salesman
on behalf of an institutional client,
he will first assess the terms of the
trade.
If feels that the terms are
reasonable he will execute the
trade.

57
Traders (Cont…)
 Following execution the details of
the trade will be recorded
 The trader will the update the
trading book so that subsequent
tasks such as
 Settlement
 P&L calculations
can begin.
58
Repo Traders
 When an STO buys a security and
thereby takes a positive trading
position in that security, then once
settlement has occurred the
relevant custodian will be holding
the securities in safe custody on
behalf of the STO.
 Conversely the purchase cost will
be represented by a debit on the
STOs Nostro account at the 59
Repos (Cont…)
 The rate of interest charged by a
custodian to remain overdrawn on
the Nostro account may not be as
low as borrowing rates in the
money market.
 Unless action is taken to minimize
the overdraft cost the rate of
interest payable will have a
detrimental effect on the trader’s 60
Repos (Cont…)
 The cheapest method of borrowing cash
is for the borrower to place some form
of security as collateral with the lender.
 Lenders will charge a high rate of
interest if the risk of not being repaid is
high which is the case with unsecured
loans.
 However if cash is lent on a secured or
collateralized basis the risk to the
lender is much reduced since he can
recover the cash by selling the
collateral. 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 63
Middle Office
 The middle office also known as
Trade or Trader Support is typically
responsible for a number of tasks
relating to the servicing and
support of its traders, market
makers, and salesmen.

64
Middle Office (Cont…)
 The tasks of a middle office
include:
 The keying of trade details to trading
systems (on behalf of the traders)
thereby allowing the traders to focus
on trading
 The agreement of trade details with
counterparties
 The investigation of trade details
discrepancies if any between the STO65
Middle Office (Cont…)
 New counterparty and security setup
within the internal systems
 Production of the daily P&L from the
STO’s formal books and records
 Ensuring agreement with the traders’
view of the P&L
 Reconciliation of trading positions
(that is the quantity of specific
securities within each trading book)
between the STO’s books and the
records and the trading system. 66
Operations or the Back
Office
 The Settlement Department
 Following the execution of a trade
within the front office and the
subsequent recording of the trade
within the trading system, trade
details are typically fed through an
interface between the trading system
and the settlement system.

67
Back Office (Cont…)
 Having received details of the
trade, the back office is typically
responsible for the following
actions
 Capturing the details of the trade
within the settlement system
 Capturing the trading positions within
internal books and records
 Applying additional details to the
trade
68
 Applying custodian details to the
Back Office (Cont…)
 Gaining agreement of the trade details with
the counterparty
 Providing details of the trade to regulatory
authorities
 Issuing a settlement instruction to the
relevant custodian
 Ensuring that the trade settles on the value
date
 Updating internal books and records as a
result of settlement
 Operating a custodian service for clients
69
 Ensuring that income due is properly
Capturing the Details of the
Trade within the Settlement
System
 The back office normally maintains
the formal books and records
pertaining to securities trades and
positions within an STO
 Trades are first recorded in the
front office trading system
 But the responsibility for updating the
formal books and records lies with
areas such as settlement and
70
accounting.
Capturing…(Cont…)
 The starting point for the settlement of
trades and all subsequent activities is
the capture of trade details within the
settlement system.
 These days the formal books and
records are very highly interlinked with
software systems
 Having been fed from the trading system
trades are recorded in the settlement
system (which forms a part of the STO’s
formal books and records) automatically 71
Information Example
 Trade information that is normally fed
by a trading system to a settlement
system includes:
Trading Book: Book A
Trade Date: 20 April
Trade Time: 11:25
Value Date: 23 April
Operation: Buy
Quantity: 500,000
Security: IBM Shares
Price: USD 97.92
72
Counterparty XYZ, Zurich
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
79
exact amount owed to XYZ for the STO’s
Applying Additional Details to
the Trade
 Trading systems cater primarily for
the needs of traders and do not
typically provide all the
information about a trade that is
needed for complete operational
processing by the back office.
 The typical trade information fed
by a trading system and which is
captured by the settlement system
could be described as the `Trade 80
Applying…(Cont…)
 The skeleton represents the
minimum detail that a trader must
provide for these items are
variable and cannot be guessed by
the settlement department.
 The exceptions are:
 Trading Book, Trade Date and Value
Date
 In most cases it is possible to derive
81
these details from the information
Applying…(Cont…)
 However for trades to settle
successfully and for the
operational activities to be
completed, all trades require
additional information to be
attached, over and above what is
contained in the skeleton.
 Examples Include:
 Mandatory charges
 STO imposed charges 82
Applying (Cont…)
 Mandatory Charges: These include
cash amounts that are imposed by
law.
 For example stamp duty at a fixed
percentage rate is payable on the
purchase of UK securities.
 The STO will charge the buyer the
purchase cost inclusive of stamp
duty, and must in turn pay the duty to
the authorities. 83
Applying (Cont…)
 STO Imposed Charges:
 An STO will typically levy an
administrative fee.
 This will be added to the purchase
cost
 And will be deducted from the sales
proceeds.

84
Applying…(Cont…)
 Accrued Interest:
 When trading in an interest bearing
bond the value of the interest payable
by the issuer up to the value date is
payable by the buyer to the seller in
addition to the trade price.

85
Applying Custodian Details to
The Trade
 In the past business was typically
transacted by STOs only in their
domestic securities markets.
 With the result that all trades settled
with the same custodian in the home
country.
 Thus there was little or no choice as to
where to settle the trade.
 These days business is transacted
worldwide.
86
 Thus it is necessary to decide which location
Applying…(Cont…)
 Thus when a trade is input into a
settlement system such as the
purchase of 1,000,000 IBM shares,
the system will derive the STO’s
relevant custodian by a series of
links.
 For example the individual security
(IBM) is linked to the nationality of the
security (USA) which is linked to the
relevant financial centre (NYC) which
is linked to the relevant custodian. 87
Applying…(Cont…)
 However it is important that the
STO also derive the counterparty’s
relevant custodian.
 With regard to an individual trade
the STO’s custodian is required to
act on the STO’s behalf only after
the custodian has received a direct
and specific communication from
the STO. 88
Applying (Cont…)
 The STO communicates with the
custodian by issuing a settlement
instruction directly to the custodian.
 The instruction tells the custodian to
either receive or deliver:
 A specific quantity
 For a specific security
 From/to a specific counterparty or its
custodian
 On a specific value date
89
 Against a specific amount of cash
Applying (Cont…)
 In order for the trade to settle
settlement instructions must
match between the two
custodians.
 If a match is not made it could lead
to a settlement failure and may
lead to a monetary loss for the
STO.
 For this reason timely and accurate
calculation of both the STO’s and 90
Validating the Details of the
Trade
 Inaccurate recording of the details of a trade
can lead to unnecessary costs and risks being
taken by the STO.
 For instance settlement instruction matching
between the two custodians must happen
before settlement can occur.
 Therefore inaccurate trade recording either by
the trader who enters trade details into the
trading system or when writing the details of a
trade or by middle or back office personnel
inputting trades manually into the settlement
system is likely to lead to a mismatch of
settlement instructions.
 This can cause delays in settlement – that is,
the trade fails to settle on the value date. 91
Validating… (Cont…)
 Another example is where the
STO’s counterparty to a trade is an
institutional client who expects
service of a high quality from the
STO.
 Part of the service provided by the
STO is the issuance of a formal trade
confirmation that lists all the details
of the trade.
 If the information contained in a
confirmation is inaccurate the STO 92
Validating…(Cont…)
 In an attempt to prevent
inaccurate information being sent
to the outside world, the process of
validating trade information is
adopted by many STOs.
 Historically valuation used to be a
manual task undertaken by those
within the settlement department.
93
Validating…(Cont…)
 In modern settlement systems rules can be
written and then compared with individual
trade details as each trade is received,
resulting in the trade either passing or failing
the internal check.
 Validation failures can then be investigated
resulting in:
 Continued processing of the trade in its

original state
 Or amendment of the trade details

Followed by transmission of trade details to

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 95
Gaining…(Cont…)
 These days electronic trade
matching mechanisms exist in
some markets
 In other markets trade agreement
is reached by the STO issuing an
advice of trade confirmation known
as a Trade Confirmation by a more
conventional method such as
paper or fax. 96
Gaining…(Cont…)
 From the perspective of an STO
there are two main reasons for
wishing to achieve trade
agreement and issuing a trade
confirmation to the counterparty
 Client service: Institutional clients are
likely to require a formal written or
electronic notification of trade details
from the STO within a specified
deadline following trade execution. 97
Gaining…(Cont…)
 Risk Reduction: The issuance of a trade
matching message by the STO provides the
counterparty with the opportunity to agree
or disagree with the details of the trade.
 It is in the STO’s interest to remove any
doubt that the counterparty may have as
soon as possible after trade execution.
 For there is always the possibility that the
counterparty disagrees with details such as price
or quantity or it may even claim that it never
sought to have the trade executed.
 The risk is that the trade may potentially have to
amend or cancel a trade that was executed
earlier.
98
Providing Details of the Trade
to Regulatory Authorities
 In many securities markets in
order to enable the local regulator
to monitor all trades executed by
STOs, individual trade details must
be sent to the regulator by a
specified deadline typically during
or at the end of the trade date.
 This is known as Transaction
Reporting. 99
Providing…(Cont…)
 Methods of achieving transaction
reporting vary
 In some markets the trade detail is
conveyed to the regulator as an
individual message serving no other
purpose
 Or else it may be sent as a part of a
trade matching message
 Or else it may be derived from the
receipt by a Central Securities
Depository of the STO’s settlement 100
Issuing a Settlement
Instruction to the Relevant
Custodian
 Once the STO has determined
which of its custodians to use for
the settlement of an individual
trade a settlement instruction
must be issued by the STO to its
custodian in order for settlement
to occur.
 Custodians are required to remove
securities or cash from the client’s
account only after receipt of a 101
Issuing…(Cont…)
 From an STO’s perspective there is
a risk that its custodian may
inadvertently act upon an
instruction to remove securities or
cash from its account when
someone other than the STO has
sent the instruction.
 However the responsibility of
minimizing the possibility of fraud
and error lies with both the 102
Issuing…(Cont…)
 The STO and the custodian must
agree on the method of
communication of settlement
instructions
 The choices include electronic
methods like SWIFT
 As well as less automated methods
such as telex and fax.

103
Issuing…(Cont…)
 The chosen method is very important as
it will impact:
 The ability to achieve STP
 The speed and accuracy with which a
settlement instruction can be generated and
transmitted to the custodian
 The deadline imposed by the custodian for
the receipt of settlement instructions
 The type and extent of checking necessary
by the custodian to prove the authenticity of
the settlement instruction.
104
Issuing…(Cont…)
 Irrespective of the method of
transmitting the settlement
instruction, the STO should seek
from the custodian an
acknowledgement of receipt of
each individual instruction.
 If the STO does not know whether the
instruction has been received it takes
the risk that the instruction has not
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 settlement 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-
107
Ensuring…(Cont…)
 The desired method of settlement
is DvP meaning simultaneous
exchange of securities for cash.
 Where securities have been sold
and the trade is due to settle on a
DvP basis the seller has a further
risk; unless he is able to deliver the
securities he will not receive cash
at the earliest opportunity and
hence will have a loss of interest. 108
Ensuring…(Cont…)
 For example if 20MM USD is received a
day late the loss of interest will be
$2,500 assuming a rate of 5%.
 Settlement failures are normally caused
by the seller not having the securities
available for delivery on its value date.
 The first step in ensuring that the
settlement occurs on the value date is
to achieve a match of settlement
instructions between the two
custodians.
109
Ensuring…(Cont…)
 Both parties to the trade should
proactively seek the status of their
settlement instruction from their
respective custodian, and where
unmatched, take immediate action to
achieve a match.
 On the value date provided the
settlement instructions have matched,
settlement will occur if the seller has
the securities and the buyer has the
cash.
 Should the seller be deficient in securities it
may be possible to borrow securities in 110
order to settle the trade.
Updating Internal Books and
Records as a Result of
Settlement
 Once settlement has occurred the
STO’s custodian will advise the
STO.
 In order to bring the STO’s internal
books and records up to date to
reflect the true position in the
outside world, the appropriate
trade within the STO’s settlement
system must be identified and
updated so as to reflect the 111
Updating…(Cont…)
 The successfully updated
settlement system will reveal that
the trade is no longer awaiting
settlement with the counterparty,
and that in the case of a purchase
by the STO securities have been
credited to and cash has been
debited from the STO’s account
with the custodian and vice versa
112
for a sale.
Operating a Custodian
Service for Clients
 Following the execution of a trade
STO’s typically expect to settle
externally with counterparties that
are STOs.
 This means exchanging securities and
cash between two custodians.
 However where the counterparty
to the trade is an institutional
client the client may not have a
custodian relationship to enable 113
Operating…(Cont…)
 For client such as these the STO may
offer to hold the client’s securities and
possibly cash in safe custody.
 This means that when the STO sells
securities to an institutional client:
 He externally moves the securities to a
segregated account from his own account at
the custodian, while retaining control but
not ownership of the securities
 Internally maintains records of the client’s
securities holdings and possibly cash
balances
 The reverse flow must occur when the
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
Ensuring…(Cont…)
 Secondly the STO must calculate
whether it is in fact entitled to the
income and if so must assess by
whom the payment of income will
be made and monitor the
receivable amount till the payment
is received.
 Where an STO offers safe custody
service to clients, the STO is
expected to collect income on 116
Independent Departments
 Some departments are independent of
divisions.
 These include:
 Static Data
 Reconciliation
 Compliance
 Treasury
 Accounting
 Research
 Risk Management
 Internal Audit
 Information Technology
117
Static Data
 Static Data or Standing Data is a
term used within the securities
industry to describe data that
changes occasionally or not at all.
The two principal components are:
 Securities static data
 Counterparty static data

118
Static Data (Cont…)
 The responsibilities of the static data
department are the input of new and
the update of changed securities and
counterparty details to one or more
systems such as the settlement systems
and corporate action systems.
 If an STO wishes to achieve the highest
possible automation of trade throughput
known as STP, it must have complete
confidence in the static data that is
being input to the settlement system. 119
Static Data (Cont…)
 STP is achievable if the two main types
of data that are fed to the settlement
system
 Trade Data
 And Static Data
are both of high quality.
 Many components form security static
data
 For instance if the coupon rate on a bond is
not correctly set up incorrect trade cash
120
values will result.
Static Data (Cont…)
 Likewise static data relating to
counterparties involves a number of
attributes
 For example the setting up of an incorrect
counterparty postal address could result in
an institutional client failing to receive a
trade confirmation.
 Where static data is not accurate
monetary losses may be incurred by an
STO through settling trades against
incorrect cash values.
 If static data is incomplete delays in the
throughput of trades are likely and this121
can result in a reduced service to
Reconciliation Department
 An important process for any company is
proving that its books and records are
accurate meaning that
 They are up-to-date
 Are complete
 And reflect reality
 Reconciliation is achieved through the
comparison of specific pieces of information
within the STO’s books and records and
between the STO’s records and the outside
world.
 Frequent reconciliation is extremely important
in order to minimize the number of
122
discrepancies requiring investigation.
Compliance Department
 The compliance officers within an STO
are responsible for ensuring that the
various rules and regulations as laid
down by the local regulatory authority
are adhered to by the STO. This
includes ensuring that:
 Only qualified personnel execute

trades on the STO’s behalf

 Reporting of trade and positional

information to the regulatory

authorities is complete and effected
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
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 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 for132
Transaction Types
 The following transaction types are
typically used by STOs:
 Principal
 Repo
 Securities lending and borrowing
 Trading book transfer
 Depot (custodian) transfer

133
Principal Transactions
 A principal transaction represents
either a purchase or a sale by an
STO on a proprietary trading basis.

134
Example
Principal Transaction
 Trading Book – Book A
 Trade Date – 20 April
 Trade Time – 11:05
 Value Date – 23 April
 Operation – Buy
 Quantity – 3,000,000
 Security – Telstra
 Price – AUD 46.30
 Counterparty – RST, Hong Kong
135
Example
Characteristics
 Movement of – Securities and cash
 Origin – Front Office
 Trading position affected – Yes
 External securities movement –
Yes
 External cash movement – Yes
 No. of external counterparties –
One
 Issue a trade confirmation – Yes 136
Repurchase Transactions
Example
 Trading Book – Repo Book D
 Trading Date – 20 April
 Trading Time – 11:05
 Operation – Repo (deliver securities and
receive cash)
 Cash Amount – USD 20,650,000 (to
receive)
 Face value of securities – USD
20,000,000 (to deliver)
 Security – World Bank 6.75%, 15 Feb 2025
 Price – 102.25
 Counterparty – DEF, NYC
 Opening value date – 22 April (value date of cash
receipt)
 Closing value date – 30 April (value date of cash
repayment) 137
 Interest rate – 4.50%
Repurchase Agreement
Characteristics
 Movement of – Securities and cash
 Origin – Front Office
 Trading position affected – No
 External securities movement – Yes
 External cash movement – Yes
 No. of external counterparties – One
 Issue a trade confirmation – Yes
 Issue a settlement instruction – Yes (one
for the opening value date and one for
the closing value date)
138
Securities Lending and
Borrowing
Example
 Trading Book – Securities lending and
borrowing book
 Trade Date – 20 April

 Trade Time – 11:05

 Operation – Lend

 Face value of securities –

GBP12,000,000
lent/borrowed
Security lent/borrowed – IADB 6.2% 1st
Dec 2015
139
Price of security lent borrowed – 98.625%
Example (Cont…)
 Face value of collateral – GBP
12,500,000
 Collateral – Denmark 6.5% 15 may 2020
 Collateral Price – 99.10%
 Counterparty – JKL London
 Opening value date – 22 April
(securities delivery)
 Closing value date – 28 April
(securities return)
 Fee – 4.2% of market value 140
Characteristics
 Movement of – Securities only or
securities plus cash
 Origin – Front Office
 Trading position affected – No
 External securities movement – Yes
 External cash movement – Yes
 No. of external counterparties – One
 Trade confirmation – Yes
 Issue a settlement instruction – Yes (two
for opening value date and two for the
closing value date)
141
Securities
Lending/Borrowing
 This illustrates a securities lending
transaction from the STO’s perspective
where the STO’s securities have been
lent and delivered to the counterparty
against receipt of collateral on the
opening value date.
 The lent securities are subsequently
returned to the STO by the counterparty
against delivery of the collateral on the
closing value date.
142
Securities…(Cont…)
 The lending of securities does not result in a change to
the trader’s trading position, as from the trader’s
perspective ownership is retained.
 As a safeguard to the lender of securities the borrower
is required to provide collateral that has a market value
greater than the market value of the lent securities; the
collateral may be in the form of cash or securities.
 Settlement instructions need to be issued to the STO’s
custodian with settlement occurring on a DvP basis.
 Securities lending transactions normally involve a
minimum of one movement of securities and one
movement of collateral at the same time on two
separate occasions – the opening value date and the
closing value date.

143
Trading Book Transfer
 An STO’s traders trade on a
principal basis with other STOs and
institutional clients.
 Within some STOs two or more
trading books within the same
legal entity may be allowed to
trade and hold positions in the
same security.
144
Trading Book Transfer
(Cont…)
 Under these circumstances one
trading book may agree to trade
with another trading book - a
counterparty that is internal to an
STO.
 This trade will b executed at a
price that is agreeable to both
parties and the P&L of both books
will be affected by the price at 145
Example
 Selling Trading Book – Book A
 Buying Trading Book – Book B
 Trade Date – 20 April
 Trade Time – 11:05
 Value Date – 20 April
 Quantity – 2,000,000
 Security – ICI shares
 Price – GBP 3.80
146
Characteristics
 Origin – Front Office
 Trading position affected – Yes
(both
books)
 External securities movement – No
 External cash movement – No
 No. of external counterparties –
None
 Issue a confirmation – No 147
Depot (Custodian) Transfer
Transactions
 An individual STO typically appoints a
custodian in each financial centre to settle
transactions and hold securities.
 Normally an STO will hold securities with one
custodian per financial centre.
 However certain securities may be held at
more than one custodian.
 For example Italian government bonds can be
settled in Milan, but are also able to be settled
in the international clearing systems –
Euroclear in Brussels and Clearstream in
Luxembourg.
 On occasions an STo may need to switch 148
Example
 From Depot – Custodian Q , Milan
 To Depot – Custodian S, Brussels
 Quantity – EUR 2,000,000
 Security – Italy 6%, 1 Sep 2012
 Value Date – 20 April

149
Characteristics
 Movement of – Securities Only
 Origin – Back Office
 Trading position affected – No
 External securities movement – Yes at
both custodians
 External cash movement – No
 No. of external counterparties – None
 Issue a trade confirmation – No
 Issue a settlement instruction – Yes (to
both custodians)
150
Depot Transfers
 In situations where the seller holds
securities with one custodian and
the buyer wishes to take delivery
at a different custodian, there is
normally a choice of effecting a
cross-border settlement, or of
effecting settlement within the
same custodian as the buyer,
following a depot transfer.
151
Cash Transaction Types
 The following transaction types are
typically used by STOs.
 Each of these involves cash.
 Repo
 Unsecured lending and borrowing
 Nostro transfer
 Foreign exchange

152
Cash…(Cont…)
 In general terms cash transaction
types are used for the purpose of
covering actual or projected
overdrafts of cash at the STO’s
custodian resulting from the
settlement of purchases.

153
Repos
 These may be viewed as a cash
transaction type as well as a
securities transaction type.
 Many repo transactions are
executed by STOs from the
perspective of the need to borrow
cash, against which securities are
given as collateral.
154
Unsecured Cash Borrowing
and Lending
 The settlement of a principal
purchase will result in a debit of
cash and usually a negative cash
position on the STO’s nostro
account with the custodian.
 As the rate of overdraft interest
charged by the custodian may be
out of line with market rates, an
STO will reduce its costs if it can
borrow cash more cheaply from 155
Unsecured…(Cont…)
 In order to cover a cash overdraft
at the custodian an STO may
choose to borrow cash on an
unsecured basis
 This is analogous to a repo except
that no collateral is provide.
 As a consequence the cost of
borrowing will be higher.
 Unsecured borrowing and lending
transactions are typically executed
156
Example
 Trade Date – 20 April
 Trade Time – 11:05
 Operation – Borrow
 Currency – HKD
 Amount – 22,500,000
 Counterparty – HSBC
 Start Date – 22 April
 Maturity Date – 29 April
 Interest Rate – 6.4%
157
Characteristics
 Movement of – cash only
 Origin – Treasury department
 Trading position affected – No
 External cash movement – Yes
 No. of external counterparties – One
 Issue a Trade Confirmation – Yes
 Issue a settlement instruction – Yes (one
for opening value date and one for
closing value date)
158
Unsecured…(Cont…)
 An unsecured cash borrowing
transaction is executed on a Trade
Date;
 The borrower is due to receive the cash
on the start date
 He is due to repay the cash plus interest
on the maturity date
 A trade confirmation is issued by the
STO to its counterparty containing the
details of its transaction including the
bank and account number to which the159
Unsecured…(Cont…)
 Typically a settlement instruction is
required to be issued by the STO to its
receiving bank, so that the bank is
alerted to the impending receipt of
funds
 This type of an instruction is known as a
`pre-advice’ of funds.
 At maturity the STO must issue a
settlement instruction to its bank
requesting repayment of cash plus
160
Unsecured…(Cont…)
 Most of the time the STO will have
a positive securities trading
position and consequently will
need to borrow cash in order to
fund the purchases of securities.
 On occasions however the cash
value of settled trades may be
greater than that of settled
purchases resulting in a credit
cash balance at the STO’s account161
Unsecured…(Cont…)
 The interest rates given by
custodians on credit cash balances
is typically lower than what can be
obtained in the money market, and
in some cases may even be zero.
 An STO desiring a better rate of
return has no option but to lend.

162
Nostro Transfer
Transactions
 When an STO has an overdraft or
anticipated overdraft at a
custodian as a result of settlement
of trades and it wishes to cover the
overdraft, one of the options open
is to transfer cash from
 Another account with the same
custodian
 an account held at another bank
163
Example
 From Nostro – Custodian S,
Brussels
 To Nostro – Custodian H, Hong
Kong
 Currency – HKD
 Amount – 37,800,000
 Value Date – 25 April

164
Characteristics
 Movement – Cash Only
 Origin – Treasury Department or Back
Office
 Trading position affected – No
 External cash movement – Yes
 Number of external counterparties –
None
 Issue a trade confirmation – No
 Issue a settlement instruction – Yes (to
165
both paying as well as receiving
Foreign Exchange
Transactions
 A further option for an STO to
cover an overdraft is to execute a
foreign exchange transaction.
 When an STO has a credit balance
in a nostro account in one currency
(say JPY) but has an overdraft in
another currency (say USD), it can
effect an FX transaction that sells
the appropriate number of JPY in
exchange for the required number166
Example
 Trade Date – 20 April
 Trade Time – 11:10
 Value Date – 22 April
 Selling Currency – JPY
 Selling amount – 2,000,000,000
 Buying Currency – USD
 Rate – 124.075
 Buying amount – 16,119,282.69
 Counterparty – Bank Y
 From Nostro – Custodian E, Tokyo
 To Nostro – Custodian L, NYC
167
Characteristics
 Movement of – cash only (2 currencies)
 Origin – Back Office or Treasury
Department
 Trading position affected – No
 External cash movement – Yes
 Number of external counterparties –
One
 Issue a trade confirmation – Yes
 Issue a settlement instruction – Yes
168
(both nostros)
Cross-Currency Securities
Settlement
 Cross-currency settlement typically
occurs when an STO has executed
a securities transaction with an
institutional client who wishes to
pay or receive cash in a currency
other than the normal traded
currency of the security.

169
Example
 Most bonds are traded in the currency
of issue; for example a bond issued in
Euros that pays interest in Euros and
which will repay the principal in Euros at
maturity will be traded in Euros in the
secondary market.
 If an STO trades that bond in a currency
other than Euros, an FX position and
consequent risk will be taken by the
STO unless it takes action to negate the
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.
173
 To remove the risk in this case the STO would
Security Forms
 Historically issuers printed paper
certificates to represent equity and
debt issues.
 The certificate was intended to
provide proof of ownership.
 For an individual issue, certificates
were normally designated as being
in either registered or bearer form.
174
Registered Securities
 The holders of a registered security will
have their name and address recorded
on a register of holders, which is
typically maintained by a registrar or
transfer agent on behalf of the issuer.
 The register contains
 The name of the holder
 The address of the holder
 The quantity of shares or bonds held
 The date of registration and of changes of
holdings
 The registrar is responsible for keeping
the register updated following a sale. 175
Certificated Form
 Some issues in registered form are
represented by certificates also known as a
Scrip, which are printed and sent to the
registered holders.
 A registered certificate typically contains the
following information
 The name of the issuer
 The description of the issue including the par value
 The certificate number
 The date of registration (the date on which the
register was updated with the information contained
in the certificate)
 The number of shares
 The registered holder’s name and address, which
clearly identified the owner.
176
Certificated Form (Cont…)
 Registered securities held by an
company such as an STO, agent, or
custodian on behalf of an investor are
likely to be registered in a nominee
name for all clients.
 The nominee’s name will appear on the
issuer’s register of holders and
represent the holdings of the underlying
clients.
 This enables more efficient administration of
177
subsequent sales by clients and the
Uncertificated Form
 The registered owner’s holdings in some
securities, although issued originally in
certificated form may subsequently be
held electronically via a method known
as book entry.
 In these cases holdings are maintained
centrally within a Central Securities
Depository (CSD) as this facilitates more
efficient holding and faster transfer of
ownership.
 The global trend is moving towards
electronic book entry holdings and 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 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
182
vaults by a custodian or a Central
Standard…(Cont…)
 Failure to have the securities held in a
safe place could result in financial loss
to the investor if the securities are lost
or stolen.
 The responsibility for making payment
of interest and maturity proceeds lies
with the issuer or its appointed agent.
 But payments are not made automatically.
 The bearer or its custodian is responsible for
initiating these payments by presenting
coupons (for interest payments) and the
bond itself for the maturity proceeds. 183
Information on a Bearer Bond
Certificate
 The name of the issuer
 The description of the issue
 The annual interest rate as a
percentage of face value
 The maturity date
 The total issue size
 The certificate number
 The face value
 A sheet of coupons
184
Coupons
 Each coupon represents one of a
number of interest payments
during the life of the bond
 Interest may be paid
 Annually
 Semi-annually
 Quarterly
 Or even monthly
185
Coupons (Cont…)
 Each coupon contains the following
information
 The certificate number of the bond to
which the coupon relates
 The face value of the bond
 The interest rate or amount per
coupon
 The specific interest payment date
 The coupon paying agent
186
Methods of Transfer of
Registered and Bearer
Securities
 When securities are sold or
transferred the method of transfer
from seller to buyer is closely
linked to the form of the security
being sold, because there may or
may not be a need to re-resister
the security.

187
Transfer and 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 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
Book Entry…(Cont…)
 Sales and purchases of bearer
bonds are executed as a minimum
of and multiples of the smallest
denomination.
 The seller is required to deliver the
bearer certificates representing
the quantity sold to the buying
STO’s custodian.
 The steps involved in a transfer are193
Book Entry…(Cont…)
 Having executed a sale the selling STO
will issue a settlement instruction
directly to the relevant CSD to deliver
the securities to the byer’s account,
within the CSD, versus receipt of cash,
on the value date.
 Having executed a purchase the buying
STO issues a settlement instruction
directly to the relevant CSD to receive
securities from the seller versus
payment of cash on the value date. 194
Book Entry…(Cont…)
 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 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 JPY202
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 205
Examples
 Hong Kong: Stamp duty of 0.125%
and transaction levy of 0.007% is
payable on equity purchases and
sales.
 India: Stamp duty is payable when
registering physical securities and
is not payable on dematerialized
securities.
In addition STT is payable.
 Ireland: Stamp duty of 1% is 206
Examples (Cont…)
 Japan: Registrars may charge a fee
for the registration of securities.
 UK: Stamp duty of 0.5% is payable
on equity securities and PTM Levy
(Panel on Takeovers and Mergers)
at a fixed GBP 0.25 is payable on
purchases and sales over GBP
10,000.
 USA: SEC fee of 1/300th of one
percent is payable by sellers of 207
Compulsory…(Cont…)
 Automation of these calculations
can occur where the calculation
details are held within an STO’s
settlement system.

208
Optional Trade Amounts
 Optional trade amounts are cash
values that STOs choose to charge
that will affect the NSV.
 Administration Fees:
 An STO may choose to charge an
additional amount to its counterparty
where for instance an unusual
method of settlement is desired such
as the processing of physical
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
212
be applied and the cash amount
Internal…(Cont…)
 Anticipated external costs – where an STO
expects to be charged by an external entity
on a per transaction basis such as the cost
of

Processing of a settlement instruction by a
custodian

Transmitting a trade confirmation
 Internal operating costs – The management
of an STO may take the view that the trader
should bear the internal operational cost of
processing each transaction. In such cases
the total cost of items such as office space,
213
systems costs, payroll etc. are divided by
Net Settlement Value
 The NSV is the final cash amount
of a trade which is to be paid by
the buyer or received by a seller.
 It is derived by calculating the GCV
and adding or subtracting any
additional trade amounts.

214
Example-1
 An STO has sold 1,000,000 shares
at a price of GBP 2.46 to an
institutional client.
 Calculation:
 1,000,000 x 2.46 = GBP 2,460,000
 Add commission GBP 1,500
 Add stamp duty GBP 12,300
 ADD PTM Levy GBP 0.25
 NSV GBP 2,473,800.25 215
Example-2
 An STO has purchased 1,000,000
shares at a price of GBP 2.46
 Calculation:
 1,000,000 x 2.46 GBP
2,460,000
 Deduct commission GBP -1,500
 Deduct PTM Levy GBP -0.25
 NSV GBP
2,458,499.75 216
Example-3
 An STO has purchased USD
30,000,000 of 5.25% bonds at a
price of 103.65%.
 Calculation:
 USD 30,000,000 x 103.65% USD
31,095,000
 Add accrued interest (200 days) USD
875,000
 NSV USD 31,970,000217
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 (Cont…)
 Static data is required not only by
the settlement department. The
following areas of operation also
use such data:
 Order management
 Equity, bond and repo trading
 Corporate actions
 Reconciliation
 Risk management 219
Static Data (Cont…)
 The term `static data’ implies that
the information does not change.
 The majority of static data items
are static and not subject to
change.
 However certain aspects of static
data are subject to periodic change
or updating.
220
Static Data (Cont…)
 The challenge for an STO is t:
 Gather the relevant data
 Store it securely
 Update it when necessary
 Utilize it appropriately
 The STO has to ensure that for
every trade only the appropriate
information is attached to the
trade from the entire store of data.
221
Static Data (Cont...)
 Typically an STO holds a vast
amount of static data.
 Large STOs may be holding within
their systems thousands of securities
and hundreds of counterparties.
 It is essential to select the correct
information in a timely fashion if
delays and costs are to be avoided.

222
Static Data (Cont…)
 In an automated environment
when a trade has been executed
and recorded into a trading
system, the trade will be received
by the settlement system will at
that point in time typically contain
only the essential trading
information.
223
Static Data (Cont…)
 For a principal trade such trading
information includes:
 Trading book
 Trade data
 Trade time
 Value date
 Operation
 Quantity
 Security
 Price
 Counterparty
224
Static Data (Cont…)
 In order to process the trade in an
operational sense the trade needs
to be enriched with more
information.
 Fully functional settlement
systems not only hold the
necessary static data but also have
the capability to automatically
enrich trades with the appropriate225
Trading Companies
 In order to automate the
processing of trades it is necessary
doe static data to be held
regarding the trading company’s
(STO’s) own details.
 An STO may be required to process
the business of more than one
trading company.
 So information that is specific to each
trading company will require setting 226
up within the static data.
Trading Companies
(Cont…)
 The trading activity of each
company must remain segregated
and separately identifiable for
regulatory purposes.
 Management would also require
separate accounting and P&L for
each company.

227
Counterparties
 STOs need to hold static data
relating to all their counterparties,
to enable automated enrichment
of trades and subsequent actions
such as
 Production of trade confirmations
 And settlement instructions
containing the counterparty’s
custodian details.
228
Trading Books
 A trading book within an STO
represents groups of traders who
trade in individual securities within
specific security groups.
 It is normal for each trading book
to be set up within the STO’s static
data, and to have individual
securities or security groups
attached. 229
Hierarchy of P&L
Calculations

All European Trading

All European Equities All 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 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 237
Countries and Codes
Country Code
Australia ASX
Belgium SVM
Canada CUSIP
Germany WKN
Japan Quick
Switzerland Valoren
UK Sedol
USA CUSIP
CUSIP stands for Committee on Uniform
Securities Identification Procedures
238
Sources of Static Data
 Counterparties:
 When an STO trades with a
counterparty for the first time it is
usual for the STO and the
counterparty to swap custodian
details directly, for each market in
which they may execute trades
between themselves.
 Additionally the STO will need to
gather all other appropriate pieces of
information from the counterparty 239
such as the required medium of trade
Counterparties (Cont…)
 Counterparty information should
be considered as private
information, whereas information
on securities is publicly available.
 Consequently information such as
the custodian used by a party for a
particular kind of trade is unlikely
to be freely available.
240
Counterparties (Cont…)
 There is a reason why such
information is considered to be
private.
 Openly publicizing the custodian is
like publicizing one’s bank account or
credit card details.
 The worry is that assets may be
removed from an account without
authorization by the account holder.
241
Counterparties (Cont…)
 Historically the process of gathering
such information was a manual
exercise.
 These days such information is available
electronically for subscribers to a
service called `Alert’ provided by
Omgeo.
 The advantage is that updation of an
STOs counterparty static data can be
automated thereby preventing errors.
242
Securities
 For those STOs that trade around
the globe, the details of securities
in which they trade will be derived
from many sources in numerous
locations.
 The decision as to which method to
employ regarding the gathering of
accurate and timely security static
data is typically a difficult one. 243
Securities (Cont…)
 When a security is being brought
to the market it is normal for the
issuer to produce a prospectus or
offer document.
 The information contained in the
prospectus is publicly available.
 At this point the custodians and
CSDs typically set up details of the
issue in their own static data 244
Securities (Cont…)
 Some STOs gather their securities
related static data directly from the
prospectus.
 Another option is to request the
necessary information from a custodian
or CSD.
 There are a number of companies who
specialize in gathering and distributing
securities static data to those who
subscribe to such a service.
 They are known as security data 245
Data Vendors
 Reuters
 Telekurs
 Standard & Poor’s
 JJ Kenny
 Bloomberg
 FT Interactive data
Data is provided by electronic feed
or via the Internet.
246
Efficient Management of
Static Data
 The best method of gathering,
storing, and updating static data
involves the use of an internal
central repository of data.
This reduces the risk of conflicting
data in the various processing
systems.
 The system works as follows.
247
Efficient…(Cont…)
 Securities static data pertaining to
securities and counterparties is
obtained from a number of sources.
 The STO stores the static data internally
and compares the information for any
discrepancies. This process is known as
Data Cleansing.
 The Central Static Data Repository then
releases the data to the relevant
internal systems.
248
Controlling Access
 The effort and cost of setting up
accurate static data makes the
protection of the data very critical.
 In an environment where any
member of the staff is allowed to
change the data, mistakes may be
made despite the best of
intentions.
249
Controlling Access
(Cont…)
 Incorrect changes to the coupon rate –
will lead to an incorrect cash value
transaction.
 Wrong address of a counterparty – trade
confirmations may not be received on
time
 Wrong modifications to the
counterparty’s custodian details –
settlement instruction issued by the
STO will not match the counterparty’s
instruction.
250
Controlling Access
(Cont…)
 In order to prevent errors many STOs
protect their static data by restricting
access to staff.
 Any changes made by someone with
access rights will ideally be verified by a
colleague.
 This is known as the `Four Eyes’ principle
 Following a successful change details of
the change should be traceable by
keeping records of
 The staff members
 The time and date of change
 And the items that were changed 251