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Part-15: Brokerage Operations

Micro Issues

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Trade Life Cycle

&

Straight Through Processing

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TLC What do we mean by `trade lifecycle?

All the steps involved in a trade from the

point of order receipt to trade executionthrough to settlement are referred to asthe lifecycle of the trade.

The management of all STOs require

that trades are processed in the mostefficient manner. This is reflected in their desire to achieve

STP.

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TLC (Cont) STP is achievable if the lifecycle is

begun by recording the details of each

trade in a timely and accurate fashionwithin the front office, and is handledefficiently and cost-effectively in theoperational areas of the STO.

A problem created early on in the cyclewill cost more to correct the further it isallowed to flow uncorrected.

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STP What is Straight Through Processing?

It is a term used to describe the objective ofmanaging trades throughout the lifecycleautomatically and without human intervention.

Historically there was little or no connectivitybetween the various systems within an STO.

This resulted in manual rekeying of individual

trade details at various points. Even where connectivity existed between internal

systems a lack of consistent reference dataprevented automatic passing of trade details fromsystem to system.

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STP (Cont) The objective of STP is the following.

Following trade execution Input the details of individual trades only once

And from that point until the completesettlement of the trade. Manage each of thesteps in a fully automated fashion.

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Elements of TLC Trading Activities

Trade Execution

Trade Capture (Front Office)

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Elements of TLC (Cont) Operational Activities:

Trade Capture (Back Office) Trade Enrichment Trade Validation Trade Agreement Transaction Reporting Settlement Instructions

The Role of the Custodian Pre Value Date Settlement Instruction Statuses Settlement Failure Trade Settlement Reflecting Trade Settlement Internally

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Order Flow Typical steps in the placement of an

institutional order with an STO. The institution decides to buy or sell a

specific security and contacts an STO withwhom it normally trades. The details of theorder are normally conveyed to the

relevant salesperson within the STO. The salesperson records the details of the

order either manually or electronicallywithin an order management system.

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Order Flow (Cont) The trader will respond to the salesperson

who placed the order advising whether ornot the trade has been executed and if soon what terms.

The salesman records the details of theexecution thereby closing the open order.

The salesman will contact the client usuallyby phone to advise whether the order hasbeen fulfilled. A formal trade confirmationwill be sent later via a medium of the

clients choice within a prescribed deadline.

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Trade Capture by the Front Office All trades executed by an STO must be

recorded formally within the STOs books and

records. The first step is to record the basic details of

each trade.

This is necessary to: Update the trading position for the specific

security

Update the average price of the current tradingposition so that when the next trade is executedthe trader knows whether a trading profit or loss

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Trade Capture (Cont) Traders normally use trading systems

designed specifically for managing their

positions and applying updated pricesto those positions.

The basic trade details must be

immediately conveyed to the middle orback office to allow operationalprocessing to commence.

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Components of a Trade In the case of a principal trade, the basic

components that are typically recorded by thetrader are: Trading book Trade date Trade time Value date

Operation Quantity Security Price Counterparty

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Trading Book The trading book has only internal

implications.

The purpose of assigning a trade to a specificbook is to assign internal responsibility andownership for the trade.

This results in

An update to the trading position within thespecific security

And an update to trading profits within the tradingbook.

Incorrect application of a trading book has noexternal impact.

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Trade Date

The trade date is the day that the two partiesagree to execute the trade.

It has internal as well as externalimplications.

It has an impact on the following aspects.

The date that a trading position is updated. If a trade is not recorded on the trade date the

trading position will remain incorrect until it isrecorded.

Besides, unless it is recorded the risk exposurewith the counterparty cannot be assessed.

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Trade Date (Cont)

Trading P&L Calculation The P&L impact of a trade cannot be calculated if

the trade is not recorded. Calculation of accrued interest

The trade date is connected to the value date ofthe trade and the value date is used in most

markets to calculate the accrued interest. If the trade date is incorrect, it can affect the

value date which could affect the accrued interestand consequently the Net Settlement Value.

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Trade Date (Cont)

Entitlement to income on equity Is most markets entitlement to dividends is related

to the trade date.

If the trade date is incorrect the buyer or theseller could lose his entitlement.

Trading systems typically assume that thetrade date is the same as the trade inputdate. Usually this poses no problems.

However precautions must be taken if there is a`late booking, that is the trade is being recorded

a day late or there is an `as-of trade like `as-of

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Trade Time

In many markets regulators require theSTO to record the exact hour and

minute that the trade was executed. This enables:

Monitoring the STOs activities to ensure

that the trades have been executed at the`best execution price. This hasimplications for the protection of theinvestor.

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Trade Time (Cont)

It enables the settling of disputes betweencounterparties regarding the basic details of thetrade such as quantity differences.

It enables market surveillance on the part of theregulator to identify abnormal trading activity.

Regulators also insist that all telephone

conversations made by traders are taped. When a dispute arises the trade time is used

to quickly identify and retrieve the relevanttape.

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Trade Time (Cont)

In some cases, the trade time is used as ameasure for trade reporting.

In the Eurobond market, the regulatorrequires that all trades executed by UK basedmembers of the Eurobond industry bodyThe International Securities Market

Association (ISMA)report details of theirtrade to ISMA via their system TRAX within30 minutes of trade execution. Fines are imposed on members who fail to meet

the deadline.

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Value Date

The value date is the intended date ofsecurities for cash.

This is known as the contractual settlementdate.

Note that the actual settlement date could

be different because of settlement failure. The period between the Trade Date and

the Value Date is known as the

Settlement Cycle.

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Value Date (Cont)

The longer the settlement cycle thegreater is the possibility of one of the

parties defaulting. For instance if a buyer is not required to

pay for many days following the trade he

may be tempted to default should themarket price of the security fall sharplybefore the value date.

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Operation

The term operation refers to thedirection of the trade

Is the STO a buyer or a seller Or in the case of a securities lending or

borrowing transaction, is the STO a lender

or a borrower.

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Quantity

The quantity refers to the number ofshares or bonds that have been bought

or sold. Standard tradable quantities may apply

to both shares and bonds.

Shares are often traded in Round Lots orBoard Lots.

Bond are traded in multiples of the

minimum denominational values.

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Security

When a trade is being executed wemust know precisely which security is

being traded. In the case of equities confusion can

arise in cases where an original security

and a second security with superficialsimilarity are validly in existence at thesame time.

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Security (Cont)

An example would be where new shares havebeen created in addition to the original

shares. The two may need to be identified separately

in a situation where the new shares may notbe equal in all respects until a later point in

time. For instance the next dividend may be payable

only on the original shares and not on the newshares.

Following the payment of the dividend the two

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Security (Cont)

In the case of bonds, some issuers suchas the World Bank may have hundreds

of bonds with details that are extremelysimilar such as: Issues with identical coupon and maturity

but with different currencies of issue

Issues with identical coupon and currencybut with different maturity dates

Issues with identical maturity and currencybut with different coupons.

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Security (Cont)

At the time of trade execution the twoparties must be precisely aware of the

security that they are dealing in. To help avoid errors securities

identification code numbers such asISIN and CUSIP are assigned to eachsecurity.

The security being traded should haveits details held within the static data

repository.

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Security (Cont)

Trading systems normally display onlythose securities which pertain to the

particular trading book. The trader only needs to select the correct

security from the list.

If the details have not been set upwithin the static data trade capture willbe held up at the beginning of the TLCcausing delays and avoidable costs.

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Price

Price is an essential component of atrade

It is therefore important that the inputshould be exact

Equity prices are typically expressed as

a cash amount per share. Bonds are normally traded at a

percentage of the face value.

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Counterparty

Correct identification of thecounterparty is very important.

Confusion can arise if an STO tradeswith a group of companies consisting oftrading entities in different locations.

Being uncertain of the counterparty andits location can lead to Delays in settlement processing

Unmatched settlement instructions

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Counterparty (Cont)

When an STO trades with a mutualfund manager it is common to find that

at the point of placing an order and atthe time of execution the fund manageris yet to decide to which of its

underlying funds the trade should beallocated.

It may take a number of hours for the fundmanager to respond with allocation details.

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Counterparty (Cont)

Under these conditions the STO hasexecuted a trade with a counterparty

knowing that the final counterpartydetails will differ from the counterpartyknown at trade execution.

Normally the trade is recorded asexecuted with the parent counterparty,and later on, when the allocation detailsare known, the original trade is

replaced.

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Counterparty (Cont)

The counterparty with whom the tradewas executed should be held within the

static data repository. The trader only needs to select the

correct counterparty inclusive oflocation from the list.

If the data is not present at the outset,trade capture will be held up at thebeginning of the TLC.

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Front Office Trade Reference

The trading system should performvalidation that all necessary

components of a trade are presentbefore assigning a trade referencenumber to a trade.

Storage of the reference number allowsidentification and inspection of thedetails at any time after trade capture.

This is vital if the trade is subsequently

amended or cancelled.

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Subsequent Action

Once the trade is captured within atrading system the details should be

sent to the back office immediately foroperational processing.

If the STO does not have a tradingsystem the details are recordedmanually on a `dealing slip.

This will be collected and delivered tothe middle office or the settlement

department.

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Incorrect Capture

Incorrectly recorded trades may lead to: Inaccurate trade confirmations being sent to

counterparties This could lead to a loss of business

Inaccurate settlement instructions being sent tothe custodian This could lead to unmatched instructions with the

counterparty and require a subsequent amendment.

Or if the instructions nevertheless match and the tradesettles it could lead to a monetary loss.

Sometimes the STO may never even come to know thatthere was an error.

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Trade Capture within theSettlement System

In an automated environment, where thetrade has been sent by the trading system tothe back office system electronically, it is tobe expected that the trade will arrivesuccessfully in the receiving system. However it is possible that the trade fails to arrive

in the back office system.

It is therefore recommended that a trade-by-tradereconciliation is conducted to ensure that thetrades sent by the trading system have in factbeen received successfully by the back officewithin an appropriate time frame.

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Trade Capture(Cont)

As soon as the back office system receives a tradevalidation needs to be performed to confirm thatstatic data items like Trading book Security

Counterparty

are known.

If a check reveals a problemeg. Counterparty notknownthe problem should be highlighted andtreated as an exception requiring corrective action.

This will have the impact of temporarily haltingoperational processing.

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Trade Capture (Cont)

Once the trade details have beenchecked for validity, a settlement

system trade reference number will beassigned.

This is in addition to the trading system

trade reference number. The trade has now been accepted into

the settlement system and is now ready

for Enrichment.

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Trade Enrichment

Following trade capture within thesettlement system the details of a trade

require enrichment. What is enrichment?

It involves the selection, calculation, and

attachment to a trade of relevantinformation necessary to complete furtheressential actions.

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Trade Enrichment (Cont)

In an automated environment, tradeenrichment is achieved through

defaulting relevant informationautomatically from the store ofinformation held within static data.

This is known as Static Data Defaulting.

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Trade Enrichment (Cont)

Steps involved: The basic trade details are captured within

the settlement system The basic trade details are compared with

the information held within the static datarepository, and if the necessary

information is present in the repository, thedefault information is selected.

The selected defaults are attached to thebasic trade detail to form the enriched

trade.

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Trade EnrichmentComponents

In general, the trade componentsrequiring enrichment are:

Calculation of cash values Counterparty trade confirmation

requirements

Selection of custodian details Method of transmission of settlement

instructions

Determining the method of transactionre ortin for re ulator ur oses

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Trade Enrichment Components(Cont)

The components pertaining to onetransaction type may be only partially

similar to the components pertaining toanother transaction type.

We will list the trade enrichment

components of each transaction type.

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Principal Transaction

Required

Cash value calculation

Securities depot details Trade confirmation

Transaction reporting

Settlement instructions Securities accounting

Cash accounting

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Repo Transaction

Required





Cash accounting

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Securities Lending and Borrowing

Required





Cash accounting

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Trading Book Transfer

Required Cash value calculation

Securities accounting Cash accounting

Not Required



Settlement instructions

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Depot (Custodian) Transfer

Required Securities depot details


Not required Cash value calculation

Trade confirmation


Cash accounting

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Unsecured Borrowing andLending


Trade confirmation Settlement instructions

Cash accounting

Not required Securities depot details


Securities accounting

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Nostro Transfer


Settlement instructions Cash accounting


Trade confirmation



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Foreign Exchange


Trade confirmation Settlement instructions

Cash accounting




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Determining Factors in TradeEnrichment

Before enrichment of individual tradescan occur, consideration must be given

to the choices that an STO has forderiving the correct information toattach to a trade.

We will consider issues pertaining toeach component in detail.

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Calculation of cash values

In order to calculate all the cash relatedcomponents of a trade, it is necessary

to consider the following. Operation

That is Buying or selling/Borrowing or lending

This has implications for cash value calculations For instance client purchases of UK equity

attract stamp duty, but sales do not.

Only sellers of US securities are required to payan SEC fee.

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Calculation(Cont)

Security group Stamp duty is payable on Irish equities but not

on Japanese equities

Accrued interest is applicable to coupon payingbonds but not to ZCBs.

Counterparty Type Sales credits are normally calculated on trades

with institutional clients, but not on trades withother STOs.

Sales credits may be calculated differently fordifferent types of institutional clients.

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Selection of Custodian Details

The selection of the relevant custodian detailsfor both the trading company and the

counterparty will be affected by the followingissues. Trading company

If an STO processes the business of more than onetrading company

Different custodians may be used by each of thecompanies, even for the same security group.

The same custodian may be used by both tradingcompanies, distinguished by different account numbers foreach company at the custodian.

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Selection(Cont)

Transaction Type Different transaction types will determine the settlement

location of a trade. A principal trade will settle at a securities custodian,

whereas a foreign exchange trade is likely to settle overa main bank account. The custodian and the bank may not be the same entity.

Security Group US equities will settle at the NEW York Custodian

New Zealand government bonds will settle at theWellington custodian.

Counterparty Where there is a choice of settlement locations, a

counterparty may choose. Some counterparties mayselect the settlement location on a trade-by-trade basis.

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Counterparty Trade ConfirmationRequirements

An STO will normally issue a tradeconfirmation to its institutional clients,

as a part of its service. But it may not issue confirmations to

other STOs with which it trades.

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Determining the method ofTransaction Reporting

The types of security in which an STOtrades may require that the STO carries

out its transaction reporting viadifferent methods.

For instance, a UK based STO may be

required to report UK equities via oneroute, and its international bondtransactions via another route.

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Method of Transmission ofSettlement Instructions

The methods used to transmitsettlement instructions will depend on

the following. Trading Company

Where an STO processes the business of morethan one trading company each company may

have a preferred but different method oftransmission.

For instance company A may choose totransmit via telex while company B may choose

to transmit via SWIFT.

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Transmission (Cont)

Custodian Custodians typically have a preference for the

method of communication between themselvesand the STO.

l l

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Failure to Apply Static DataDefaults

In an automated environment, failure tofully enrich a trade may be intentional

or unintentional.

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Intentional Failure

In a situation where the default of aparticular trade component is best appliedmanually, the STO may choose to set no

automatic default of static data. For instance Italian Government bonds can

settle domestically in Milan or internationallyin Euroclear or Clearstream.

An STO may choose to settle an individualtrade in or other location depending upon thecircumstances. If no general rule can be applied then it is not

possible to automate the default.

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Unintentional Failure

In an automated environment it is notpossible to default static data

automatically if such data is missing fora particular component.

For instance a specific counterparty isset up within both the trading system

and the settlement system, but nocustodian details are set up within thesettlement system for thatcounterparty.

E i h t f C t t

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Enrichment of CounterpartyCustodian Details

An STO needs to calculate its counterpartyscustodian details in addition to its owncustodian details.

When a trade is executed by an STO, it isnecessary to determine where it wishes tosettle the trade. This is particularly true if it trades in many

markets. It must also determine how the counterparty

wishes to settle the trade This information will be required on the settlement

instruction issued by the STO

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Example

WSIL an STO has bought 5,000,000 NewsCorporation shares from PTIF.

WSIL first needs to assess how it wishes tosettle the trade from its own perspective. It needs to determine its appropriate custodian

based on the individual security or security group.

In this case the equity is Australian. So the decision is taken to settle at Custodian A in

Sydney.

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Example (Cont)

A similar decision needs to be taken byWSIL regarding where it believes PTIF

will settle the trade according to theinformation received from PTIF andheld within WSILs static data.

The custodian to be used by thecounterparty will appear on the settlementinstruction that will be sent by WSIL to itscustodian.

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Example (Cont)

This is essential information. Otherwise WSILs custodian will not know

with whom the trade is to settle. Merely stating PTIF does not provide the

answer.

The information required to match and

settle the instruction sent by WSIL is The account number at the relevant depository

of the Australian custodian being used by PTIF Let us assume it is Custodian B in Melbourne.

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Example (Cont)

Following trade execution between WSIL andPTIF the trade would be captured within the trading system

then captured within the settlement system followed by trade enrichment within the

settlement system.

In the process WSIL would have calculated The custodian that it wishes to use And PTIFs custodian

The sequence of steps taken would be asfollows.

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Example (Cont)

WSIL issues a settlement instruction toits custodian telling

Custodian A in Sydney to receive 5,000,000News Corporation ordinary shares, againstpayment of the relevant cash amount

From Custodian B Melbourne whosedepository account number is 5532896.

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Example (Cont)

PTIF issues a settlement instruction toCustodian B asking it to deliver shares againstthe relevant cash amount to Custodian A Whose account number at the depository is

5023598.

Custodian A should update its records with

the details of the instruction received fromWSIL

Custodian B should update its records withthe details of the instructions received from

PTIF.

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Example (Cont)

Each custodian should aim to achieve amatch of their clients settlement

instructions with the counterpartyscustodian.

If the information does not match thecustodians have no authority to changeany aspect of the clients settlementinstruction.

They must however advise the client about

the status of the instruction.

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Example (Cont)

If there is a mismatch WSIL would needto investigate.

If its static data is accurate in allrespects

And if the trade is properly enriched The number of unmatched instructions will

be minimized.

However settlement instructions may beunmatched for other reasons Such as price or quantity differences

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Trade Validation

Having executed, captured andenriched a trade it is now complete and

further taskes such as Issuing a trade confirmation

Reporting the trade to the regulatory

authorities Issuing settlement instructions can

proceed.

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Trade Validation (Cont)

However many STOs adopt a finalcheck of the data contained within a

fully enriched trade to reduce thepossibility of incorrect information beingsent to the outside world.

This is known as Trade Validation.

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Fundamental Risks

The basic risks associated with trades arethat an STO may make a loss

This could happen directly While buying

By paying more cash than the market value By paying the correct amount but without simultaneous

receipt of securities

While selling By receiving less cash than the market value By delivering securities without simultaneous receipt of

cash

This could happen indirectly By losing clients due to provision of slow and

inaccurate service.

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Reasons

These risks can arise as a result of thefollowing issues Trading error: The trader makes a mistake at the

time of execution He trades at a price that is significantly different from

the market price

Or he agrees to settle on an FoP basis

Trade recording error The trade has been captured with one or more

components that differ from those that were in factexecuted

Eg.: 10 MM shares were purchased but is has been

recorded as 1 MM.

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Reasons (Cont)

Trade enrichment error The calculation of trade cash values is incorrect

For instance the number of days of accruedinterest on a bond is incorrect

Trade validation is a task that isdesigned to detect such situations on a

trade by trade basis.

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Basic Trade Validation

The trade components ought to beviewed from the following perspectives.

Trading book May be restricted to specific transaction

types (eg. Principal only)

May be restricted to specific instrumentgroups (eg. Japanese securities)

May be restricted to specific traders

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Validation (Cont)

Trade Date Should be `today for a new trade

Cannot be in the future Should be today or in the recent past for

an amended trade

Should be a business day

Cannot be after the value date Trade Time

Cannot be in the future

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Validation (Cont)

Value Date Is normally the standard settlement cycle for the

security group eg. T+3 for US securities

May be shorter or longer than the standard (if thetrader has agreed at the time of execution andhas recorded that date)

Should be a business day in the location ofsettlement

Cannot be earlier than the trade date

Cannot be earlier than the primary value date of anew issue

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Validation (Cont)

Operation This typically cannot be validated

Settlement personnel have no means of knowing

whether the trader should be buying or selling;borrowing or lending

Quantity Cannot be less than the minimum denomination of

a bond

Must be in multiples of the minimum denominationof a bond

Is normally in multiples of a round lot for equities

May be an odd lot for equities

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Validation (Cont)

Security Cannot be a matured bond

Cannot be an expired warrant

Must be clearly distinguishable from othersecurities

Price

Must be expressed according to the security group Share price must be an amount per share

Bond price must be either a percentage relevant to facevalue or a yield

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Validation (Cont)

Counterparty Must be clearly distinguishable from others

Must include location

Trade cash value Must be quantity x price plus or minus other costs

such as stamp duty

Accrued days must be relevant to last couponpayment date and value date

Accrued interest must be relevant to quantity,accrued days, and coupon rate

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Validation (Cont)

Trade confirmation

Should be sent to institutional clients

Should not be sent to STOs if for instancean electronic trade matching system is inplace

Companys and CounterpartysCustodian

Must be relevant to the security group

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Additional Trade Validation

In order to have the ultimate level of controlregarding the information that is about to besent to the outside world, the following typesof validation measures are taken by someSTOs in addition to the basic trade validationsteps.

Any trade falling within or more of thefollowing categories should be treated as anexception and held pending validation. This means that such trades will not be handled

on an STP basis.

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Additional Validation (Cont)

Trades due to settle on an FoP basis Extreme caution needs to be taken when settling

on an FoP basis

All such trades should be held for validation

Trades with a cash value at or above acertain figure

To give specific focus to all trades that aredeemed to be large, all trades with a netsettlement values of a given figure or greater, orthe currency equivalent of that figure or greater,should be held for validation.

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Trades in a Specific Transaction Type All trades in a specific transaction type may be

required to be held for validation to ensure

correctness before transmission to the outsideworld.

Trades with a specific counterparty This is likely to be required for trades with

institutional clients May be necessary because the client is new

Or could be because an existing client has complainedabout the accuracy of information or speed of service

provided on past trades.

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Trades in a Specific Market or SecurityGroup

Where an STO is trading in particularmarket for the first time it may Wish to recheck that trade cash values are

accurate

That custodian details are correct for all tradeson securities within a group

This may prove necessary for a limitedperiod only until it is proved that newtrades are correct routinely.

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Trades Due to Settle at a SpecificCustodian

If an STO has recently changed custodiansat a financial centre it may wish to verifyall trades destined for settlement at thatcustodian

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Trade Price Outside of market Price

As a precautionary measure an STO may

decide to validate all trades to ensure thatprices are reasonable.

Because price is a major factor in derivingthe Net Settlement Values, there is a

danger of an STO making overpayment onpurchases or receiving underpayment onsales.

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If the current market price is accessible and atolerance is set against the current market price(to allow for typical validity) then only those

trades falling outside the set tolerance should beheld for validation.

When such trades are identified management mayneed to be informed. The management should

decide as to how tight the tolerance should be. Too tight a tolerance may mean that many trades are

being held for validation thereby preventing STP

Too loose a tolerance may mean that incorrect prices arebeing processed undetected.

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Trades in a Specific Trading Book

The management may wish to monitor the

trading activity of a particular trading book Trades with trade dates in the past

Any new trade that has a trade date in the

past may be held for validation to ensurethat it is valid.

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Trades with value dates in the past Any new trade with a value date in the past

should be held for validation for this is an

indication that something is seriously wrong. If settlement should have occurred in the past this

is highly likely to result in a cost to the STO.

All amended trades Some STOs may wish to monitor all amended

trades to ensure that trades recorded withincorrect quantity or price have been amendedcorrectly.

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All Cancelled Trades The need for outright cancellation should be

minimum and an STO may wish to check the

detail before issuing information such as cancelingtrade confirmations and canceling settlementinstructions to the outside world.

Validation provides the STO with a high

degree of control resulting in reducedinaccuracies.

But there is a compromise between sufficient

control and STP.

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Manual Trade Validation

Due to the number of tradecomponents manual validation is likely

to result inA limited number of components being

validated so as not to adversely affectmeeting external deadlines

Occasional human error resulting in thefailure to identify a risk or an error

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Manual Validation (Cont)

In order to identify problematic tradesmanual validation needs to be undertaken bythe more knowledgeable members of themiddle or back office using their `experiencedeye to scan the components of a trade andtheir knowledge to sense whether or not a

trade is acceptable. But a significant amount of manpower would

be required to validate all trades to the fullestextent due to the sheer volume of trades

executed by an STO.

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Manual Validation (Cont)

In order to meet the combineddemands of

STP Servicing clients accurately and speedily

Issuing settlement instructions by thenecessary deadlines

Transaction reporting within requireddeadlines

extensive validation is possible only byusing efficient and intelligent systems.

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Automated Trade Validation

The processing of trades can be highlyautomated while achieving satisfactory levelsof STP and control over trades requiring

additional validation. An STO could decide that all trades should be

handled on an STP basis unless identified tobe held for validation.

Trades held for validation are referred to as`exceptions and are therefore subject to`exception handling.

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Automated Validation (Cont)

The trigger that causes trades to betreated as exceptions is the setting ofrules within the settlement system.

All or some of the rules studied earliercould be set up within the settlementsystem.

After each trade has been enriched thesystem would compare the trade detailswith the relevant rules.

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If the trade passes the validation checkit would be allowed to continue

immediately and can be regarded ashaving been processed on an STP basis.

If the trade fails the validation check it

will be treated as an exception and willbe held for validation.

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When a trade is held for validation it istemporarily suspended and no actions

such as Issuance of a trade confirmation

Or issuance of a settlement instruction

should occur until the trade has beenreleased from its exception state.

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Flow

We will summarize the flow of trades wherehandled on an STP basis and where anexception is found.

The trade is captured, enriched and is nowsubject to validation. The details of the trade are compared with

preset validation rules.

If all rules are passed the trade will beforwarded immediately for actioning of otheroperational tasks such as Trade agreement and Transaction reporting

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Flow (Cont)

If the trade fails the validation check it will be heldfor validation and routed for exception handling

The trade will be forwarded to the appropriateauthorizer depending on the reason for being

withheld Having been investigated and found to be correct the

trade is authorized. The trade within the exception handling system is

updated and released to the settlement system The trade is now forwarded for actioning of

operational tasks. If the trade is found to require amendment or

cancellation further action may be required by thefornt office staff.

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Flow (Cont)

Further automation may be employedwhere resolution of an exception has

not occurred within an acceptabletimeframe.

The management of an STO may

decide for instance that unresolvedexceptions that are for example 45minutes old should be escalated to amore senior staff member.

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Trade Agreement

Once a trade has passed validation a numberof tasks can commence.

The action that is regarded as most urgent is

the act of gaining agreement of the tradedetails with the counterparty. Trade agreement can be achieved through:

Issuance of outgoing trade confirmation to thecounterparty

Receipt of incoming trade confirmation from thecounterparty

Trade matching Trade affirmation

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Trade Agreement (Cont)

In a generic sense trade agreement isachieved by the STO communicating

the details of each trade to itscounterparty whereupon thecounterparty should check the detailand revert to the STO if:

It recognizes the trade but the detailsdiffer

Or if does not recognize the trade

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The communication needs to contain allthe basic trade details as a minimum

plus The cash value calculations and optionally

The settlement details including STOs and the counterpartys custodian details

Their account numbers

And whether the trade is to settle on a DvP orFoP basis

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Matching of buyers and sellers detailsis in many cases effected through two

routes Trade Agreement: Agreement of trade

detail between the two parties

And additionally

Settlement Instruction Matching: Thecustodians of the buyer and the sellerattempt to match settlement instructions

prior to delivery of securities and payment

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These two exercises are similar in that thetrade details are matched prior to the valuedate.

But the timing is usually different. Trade agreement is necessary immediately after

trade execution to ensure that the correctcounterparty has been recorded by the STO andthat the details agree This is from a risk mitigation perspective

Settlement instruction matching is typicallyeffected at any time between trade execution and

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Reducing the STOs Risk

For each executed trade the STOremains at risk of its trading P&L being

incorrect if the trade and its detail hasnot been agreed or matched by thecounterparty within a reasonabletimeframe.

The P&L remains subject to change until itis proven that all trades have been agreedby the counterparties.

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Reducing Risk (Cont)

Because of the risk the objective is to gainagreement of the trade detail as soon aspossible after trade execution.

To reiterate, the situation is as follows: The trader has just executed a trade with the

counterparty

The trade has been recorded within the trading

system The trade has been captured within the settlement

system

The trade has been validated internally

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Reducing Risk (Cont)

But there is no guarantee that: The counterparty with whom the trade has

been captured is the same as thecounterparty with whom the trade wasexecuted

The trade details Quantity

Price

Net settlement value

Will be agreed to by the counterparty

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Risk Reduction (Cont)

From an STOs perspective failing to seekagreement of trades with its counterpartiessoon after trade execution will inevitably Result in the identification or errors during the

settlement instruction matching process

Which in a T+3 cycle is unlikely to bring errors tolight until the day following the trade date at the

earliest.

The longer a trade remains unmatched afterexecution the greater is the risk of price

movement and subsequent loss

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Time is an important factor.

Assume that trader believes he sold 15 MMshares at a price of HKD 22.59 on trade date

15 June for value date 18thJune. On 17 June it becomes apparent through the

settlement instruction matching process thatthe counterparty believes it bought at HKD

22.55 and investigation proves that the otherparty is correct. The trade will have to be amended to the correct

price

This will have a negative impact on the P&L

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Take a worse example

On 17 June the counterparty does notrecognize the trade at all.

If this results in the trade being cancelledoutright The STO will have a positive position of 15MM

shares If the price were to have fallen in the interim the

trader would have failed to realize a profitableopportunity.

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Trade Agreement Methods

The method of agreement of trade detailsbetween the parties to a trade variesaccording to Local regulations

Market practice

Type of counterparty

Generally agreement of trades executed withother STOs is likely to be handled differentlyfrom trades with institutional clients .

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Method-I

Issuance of outgoing tradeconfirmations

It is highly likely that an STO will berequired to issue a trade confirmation to itsinstitutional clients particularly where atrade affirmation facility is not being used

It is likely that an STO will want to issue aconfirmation to other STOs particularlywhere a trade matching facility is not beingused.

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Method-II

Receipt of incoming confirmations fromcounterparties

The STO may receive confirmations fromother STOs

It is unlikely to receive confirmations frominstitutional clientsAs such clients are the recipients of service

from the STO.

Method-III

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Trade Matching

Trade matching is a term used for themandatory electronic matching of tradedetails between STOs and other members ofstock exchanges/markets such as agents forinvestors (excluding institutional clients).

Both parties are required to input the tradedetails to a central matching facility.

The matching results are provided to both

parties. Where trades have been executed electronically

the trade detail is usually considered to have beenalready compared and matched.

Method-IV

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Trade Affirmation

This relates to the optional electronicmatching of trade details between STOs

and institutional clients. The trade details are input by the STO

to a trade affirmation facility and the

institutional client agrees or disagrees. Both parties must elect to subscribe to

such a service.

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Outgoing Trade Confirmations

Trade confirmations to Institutional Clients Where an STO has executed a trade with an

institutional client (for instance over the

telephone) the client is likely to require the receiptof a confirmation within a mutually agreed timeframe such as 1-2 hours. This timeframe is likely to shrink as settlement cycles

shrink.

The confirmation represents formal confirmationof trade details which must be received by theclient within an agreed time frame and whichmust be completely accurate.

Outgoing Confirmations

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(Cont)

Under some circumstances it may not bepossible for an STO to issue a confirmationwithin the required timeframe.

Institutional clients like fund managersusually place an order to buy or sell a specificquantity of a specific security within a limitedprice. Once the trade is executed the STOs salesperson

will report the details of the execution to the fundmanager informally, usually via telephone.


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(Cont)

Following trade execution the fundmanager will allocate the total trade to

one or many of its underlying funds. In practice the fund manager will

usually not convey to the STO the

names of the underlying funds untilsome time after trade execution.


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(Cont)

For example an STO has sold USD50MM World Bank 6.50% bonds

maturing 1st

February 2018 to QRSFund Managers at a price of 98.625%.

QRS will require the total quantity of

bonds to be allocated to its underlyingfunds as shown below.

ll

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Allocation

Fund Name Quantity Price

QRS Healthcare

Growth Fund

12,000,000.00 98.625

QRS Global BondGrowth Fund

10,000,000.00 98.625

QRS European

Income Fund

25,000,000.00 98.625

QRS PacificIncome Fund

3,000,000.00 98.625

TOTAL 50,000,000.00

Outgoing Confirmations(C )

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(Cont)

The fund manager usually requires thereceipt of trade confirmations for each of theunderlying funds. For ultimately it is the underlying funds that have

purchased or sold the securities and not theparent.

The STO needs to decide whether to recordthe trade with the parent. It knows that this will have to be replaced by oneor many trades with the underlying funds at some

point later in the day.


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(Cont)

If the trade is recorded in the name ofthe parent immediately after execution,

the STO would have reflected thefactual situation.

If not the settlement system will not

reconcile with the trading systemthetrading positions will differ.


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(Cont)

Some STOs treat these situations as follows. The original trade is captured in the trading

system and fed to the settlement system. Eg. Sold USD 50 MM of bonds to QRS Fund Managers at

a price of 98.625% The original trade is captured within the

settlement system but is treated as a trade withthe parent, awaiting allocation to the underlyingfunds. The trade is simply held in the knowledge thatallocations will be advised by the fund manager at the

earliest. No trade confirmation is usually issued to the parent.

Outgoing Confirmations(C t )

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(Cont)

The fund manager advises the STO of theallocations.

The original trade is replaced by one or more

trades. This may happen both in the trading as well as the

settlement system or only in the settlement system.

From the settlement system formal tradeconfirmations can now be generated andtransmitted to the fund manager at the underlyingfund level.


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(Cont)

In order to gain agreement of trade details,the STO normally issues a trade confirmationto other STOs with which it has traded. There could be exceptions if an electronic trade

matching system is being used.

Confirmations to institutional clients areregarded as a part of the service.

But confirmations to other STOs are used toconfirm that the trade details are correct assoon as possible after trade execution.


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(Cont)

The issuing STO hopes that therecipient STO will check the detail upon

receipt, and respond without delay if itsis found to be incorrect.

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C t t (C t )

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Content (Cont)

Trading capacitythe capacity in which theSTO has traded (principal or agent)

Transaction typeprincipal, repo, FOREX etc.

OperationBuying/selling;Lending/borrowing Trade datedate of trade execution Trade timetime of trade execution

Value datecontractual settlement date Quantityquantity of shares, or quantity of

bonds with currency

C t t (C t )

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Content (Cont)

Securitythe exact, unmistakable descriptionof the security

Security referenceISIN, CUSIP etc.

Pricequoted according to type of security(share or bond) Principalquantity x price Accrued daysrelevant number of days of

accrued interest Accrued interestcash value of accrued

interest

C t t (C t )

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Content (Cont)

NSVthe cash value to be paid/received

Our depotthe STOs settlement location ofsecurities

Our NostroThe STOs settlement location ofcash

Your depotthe counterpartys settlementlocation of securities

Your NOSTROthe counterpartys settlementlocation of cash

C t t (C t )

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Content (Cont)

Settlement basisDVP or FOP

Exchange/marketexchange or marketwhere a trade has been executed

Rulesa statement that the trade is subjectto rules of the exchange/market

Signoff by the STOfull name and locationof the STO

Transmission timea clear statement of thedate and time of transmission

N f C i

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No. of Copies

Some counterpartiestypicallyinstitutional clientsmay require thereceipt of one or more copies of a

confirmation for each trade. If multiple copies are required

The counterparty may require all copies to

be sent to the same destination Or to different destinations via different

transmission methods

No of Copies (Cont )

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No of Copies (Cont)

The different destinations may include

The counterpartys head office

Its bank Its accountant

To enable automation of this service

this information needs to be held withinthe STOs static data

Incoming Confirmations

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Incoming Confirmations

Some of the counterparties with whom anSTO trades may issue confirmations. Usually this is the case if the counterparty is

another STO. Institutional clients typically expect only to receive

confirmations.

After receiving an incoming confirmation an

STO needs to check whether to expendresources checking the details contained inthe confirmation with its own records.

Incoming Confirmations(Cont )

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(Cont)

To gain trade agreement and to avoidrisk, it is better to check the

confirmation on receipt. This will highlight whether the STO and the

counterparty agree or disagree.

Risks of failing to check

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Risks of failing to check

Decisions are sometimes taken not tocheck incoming confirmations.

For trades where agreement will not beachieved by another means this couldresult in monetary loss for the STO.

Example

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Example

A telex confirmation has been received by anSTO from a counterparty on the afternoon ofthe trade date. The trade is due to settle T+3 The STO decides not to check the incoming

confirmation.

However a discrepancy comes to light a dayprior to the value date. Investigation reveals that the counterpartys priceor quantity was incorrect.

The counterparty has to consequently amend its detail.

Example (Cont )

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Example (Cont)

It look as if the STO has incurred no cost. It was the counterparty that recorded the trade

details erroneously.

But if the counterparty subsequently realizesthat a trade confirmation was sent and thatthe receiving STO failed to highlight thediscrepancy It may seek some form of compensation.

Trade Matching with STOs

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Trade Matching with STOs

Trade matching is a generic term used todescribe an electronic method of comparingthe trade detail of both seller and buyer.

The process typically includes: The transmission of trade details by both parties

to central trade matching facility by a specifieddeadline

The application by the matching facility of thecurrent statusmatched or unmatched.

TRAX

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TRAX

ISMA based in Zurich is a self regulatoryorganization and trade association

responsible for regulating and enforcingrules governing the orderly functioningof the international securities market.

During the 1980s ISMA was primarilyfocused on the Eurobond market.

TRAX (Cont )

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TRAX (Cont)

In the Eurobond market, prior to 1989,when an STO traded with another STO,

agreement was attempted but notnecessarily achieved by the issuance ofconfirmations, normally in the form oftelexes.

The situation was inefficient and full ofrisk.

TRAX (Cont )

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TRAX (Cont)

In 1989, ISMA introduced TRAX.

It is a real-time trade matching

mechanism covering all internationallytraded debt and equity securities.

All ISMA members are required to send amessage to TRAX so as to be received byTRAX within 30 minutes of trade execution.

TRAX (Cont )

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TRAX (Cont)

If a message is not received by TRAX within a30 minute deadline, a fine is imposed on theSTO. The fine is on a sliding scale. The later the message is received, the larger is the

fine.

ISMA also imposes fines for other non-compliance reasons such as Failure to provide all necessary trade details Failure to act on a no-matching advice within a

reasonable timeframe.

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TRAX (Cont )

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TRAX (Cont)

A TRAX message conveys the details ofthe trade to a central matching facility

that compares both sellers and buyerstrade details.

After comparison a real-time report isgenerated that details the currentstatus of each trade.

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The TRAX System

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The TRAX System

An STO executes a trade with a counterpartyboth of whom must be ISMA membersornon-member users of the system.

Both parties send their trade details to TRAX

TRAX searches for a match and then appliesthe status

The trade status is then made available toboth the parties.

The TRAX System (Cont )

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The TRAX System (Cont)

The receipt of a status other than `matchedrequires immediate investigation by the STO,resulting in one of the following actions. The STO leaves its trade details intact and the

counterparty amends it details

The STO amends its trade details

The STO cancels the trade

The counterparty cancels or denies the trade


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TRAX will apply the following trade statusesfor messages sent by the STO

Matchedthe STOs and the counterpartysdetails have been compared and found toagree

UnmatchedThe STO has input its tradedetails, but the counterparty has not inputmatching trade details.

Denied AdvisoryThe counterparty does notrecognize the trade and has stated that isdenies knowledge of the trade


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The following trade statuses will be applied tomessages not sent by the STO.

AdvisoryTrade detail has been input by the

counterparty. The receiving STO must eitherinput trade details or else state `denied.

DeniedIf the STO does not recognize the

advisory trade, it can state `denied.

Other Trade Matching Services

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Other Trade Matching Services

In the US the National SecuritiesClearing Corporation (NSCC) has atrade comparison service.

Automation

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Automation

In modern settlement systems the followingaspects of trade matching messages canusually be automated

The decision to issue the message pre or posttrade validation

The decision whether to issue a message or notaccording to the type of security - Eurobondversus US T-bond

The decision whether to issue a message or notdepending upon the counterpartyISMAmembers as opposed to non-ISMA members.

Automation (Cont )

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Automation (Cont)

The following can also be automated The transmission of the message to the trade

matching facility

The receipt of the message status from thefacility

The updating of the relevant trade record(internally with the STOs books and records) with

the trade matching status The highlighting of trades with a status other than

`matched.

Trade Affirmation withInstitutional Investors

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Institutional Investors

Institutional investors are able to havetrades confirmed to them by STOs andbrokers electronically, via OmgeosOasys Global system.

The advantage is that an institutionbased in Tokyo can have its tradesconfirmed electronically by an STObased in Toronto.

Trade Affirmation (Cont )

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Trade Affirmation (Cont)

Unlike trade matching for STOs which istypically regulated by an exchange orlocal regulator, the decision tosubscribe to the Oasys Global systemhas to be taken by each institutionalinvestor.


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Strictly speaking there is a differencebetween Trade Matching and Trade

Affirmation. In trade matching, both parties input

details at the same time to a centralfacility.

In trade affirmation, the STO inputs itstrade details to which the institutionalinvestor affirms or responds.


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Institutions that choose to subscribe toOasys Global usually encourage STOs touse the system in order to ensure thatas many trades as possible are affirmedvia this route and to realize the full valeof the subscription.

Illustration

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Illustration

Step-1: An STO executes a trade with afund manager.At this point he knows only the name of

the fund manager and not the names ofthe underlying funds.

Step-2: The basic trade detail for the

counterparty is input to Oasys Globalwhich forwards the detail to the fundmanager.

Illustration (Cont )

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Illustration (Cont)

Step-3: The fund manager will check thetrade details with his own records and iffound correct the trade in Oasys Global will

be affirmed as correct and the details ofallocation to the underlying funds will beinput.

Step-4: The STO will replace the originaltrade by trades with the underlying funds.

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The receipt of a trade status other thanagreed requires that the STO investigatewithout delay. The salesperson within the STO will have to be

informed.

If the record of the trade detail is found to beincorrect the STOs books and records will require

amendment. The revised input will have to be re-input to Oasys

Global.

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The use of a system like Oasys Globalrequires that the history of eachindividual trade be recorded in case ofthe need to investigate past events.

Other trade affirmation services in theU.S. include Omgeos TradeMatchsystem.

Automation

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Automation

The following aspects of tradeaffirmation messages can normally beautomated. The decision whether to issue the message

pre or post trade validation

The decision whether to issue a messageor not. For example a message need be sent only if

the counterparty is an Oasys Global subscriber.

Automation (Cont)

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Automation (Cont)

Furthermore, the following can also beautomated. The transmission of the message via Oasys Global.

The receipt of message statuses from OasysGlobal.

The updating of the relevant internal trade record.

The highlighting of trades with a status other than

matched.

Transaction Reporting

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Following the execution of a trade theexchange/member is required to reportto the appropriate regulator the detailsof each transaction, within a pre-specified timeframe after execution.

This is referred to as Supervision orSurveillance.

Transaction Reporting(Cont)

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(Cont)

There are different methods forreporting.

The chosen method depends on the localregulator.

One way is for the computerizedexchange to forward the trade details to

the regulator on behalf of the stockexchange member.


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(Cont)

Or a part of the message sent by a membermay be used for reporting purposes. For example if TRAX were to be used the relevant

information would be forwarded by ISMA to theregulator.

Or else a settlement instruction sent to adepository may be forwarded to the regulator

Eg. CREST in the U.K.

Transaction Components

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a sact o Co po e ts

The usual trade information requiring submission tothe regulator is: CapacityPrincipal or Agent

Trade date

Trade time Vale date

OperationBuy or sell

Quantity

Security

Price Counterparty


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( )

Upon receipt, the regulator will analyzethe details and attempt to identifyunusual patterns of trading which mayhave been caused by

Market manipulation

Insider trading

Errors on the part of the STO


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( )

One objective of surveillance is toidentify trading activity that falls outsidethe norm.

Another objective is to identify breachesof trading rules.

Yet another objective is theidentification of insider trading.


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p g

In some markets automation is used tosearch for abnormal trading patterns. On the NYSE a computer system named

StockWatch is used to identify abnormal tradingactivity.

At the Australian Stock Exchange a system calledSOMA is set up with limits representing normal

market activity This enables any reported transactions that fall outside

the limits to be identified automatically.

After Detection

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When a regulator detects dubiousactivity he will begin an investigation

Typically all transactions executed by themember in the specific security will beexamined.

The members books and records will be

examined. Key personnel may be interviewed.

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After Detection (Cont)

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( )

Punishment can be severeincludingprison sentences for insider trading.

Members may be expelled; their licenseto trade may be suspended.

Investors who have suffered financial

losses may be eligible forcompensation.

Settlement Instructions

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Settlement instruction is a generic term usedto describe the mechanism by which tradesettlement is initiated between the seller and

the buyer. The instructions are normally generated and

transmitted from the STOs settlement systemto the appropriate custodian from the list ofthe STOs custodians depending on thesecurity that has been traded.

Settlement Instructions(Cont)

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( )

Upon receipt of the instruction thecustodian will attempt to match thedetail with the custodian of thecounterparty and apply a statusMatched or Unmatched.

On the value date he will then attemptto exchange securities and cash withthe counterpartys custodian.

Risks associated withsettlement instructions

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In a manual system the generation ofsettlement instructions should be restricted toa select group.

In an automated environment trade capturewithin the STOs trading system should berestricted to authorized traders.

If trade validation is through settlement

instructions should be allowed to flowthrough in order to achieve STP unlesscertain conditions are applicable.

Risks (Cont)

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( )

As far as possible the STO should avoidsettling on an FoP basis.

That is, the trades as far as possible,should settle on a DvP basis.

FoP settlement may be with or withoutrisk to the STO.

FoP with Risk

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The STO delivers securities prior to thereceipt of cash from the counterparty.

Or the STO pays the NSV prior to thereceipt of securities from thecounterparty.

FoP without Risk

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The STO delivers the securities onlyafter confirmation of receipt of cashfrom the counterparty.

Or the STO pays the NSV only afterconfirmation of receipt of securitiesfrom the counterparty.

Risks (Cont)

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No back office should take unilateraldecisions that puts the company at risk. These decisions are best left to those with

the appropriate level of authority. When the back office is advised by a

trader or a salesperson to take risk, the

operations areas of some STOs insist onwritten authorization from the head oftrading.

Risks (Cont)

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STOs must minimize the possibility of thetransmission channel between itself and thecustodians being accessed by those who may

seek to attempt fraud. An STO is likely to select a particular

custodian if it feels that the custodianssettlement instruction transmission system is

sufficiently securewhere high levels ofencryption are used to prevent outsiders fromdeciphering the coded message.

Risks (Cont)

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An instruction that has been issued butnot received by the custodian is nodifferent from an instruction that hasnot been transmitted.

There is a risk of financial loss in suchcases because settlement typically cannot

occur until settlement instructions arematched with the counterpartys custodian.

Risks (Cont)

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To minimize risk STOs typically requirethe relevant custodian to acknowledgereceipt of the instruction.

In an automated system instructionsissued can be compared againstacknowledgements received.

If an acknowledgement is missing, it willbe highlighted as an exception.

Risks (Cont)

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STOs trade and settle on a global basis They will consequently have custodians in

many different time zones.

Each custodian will impose a deadline,which will be relevant to the value date ofthe trade.

Thus the STO must remain aware of the

appropriate deadlines pertaining to eachcustodian.

Settlement Instruction Types

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Settlement of trades occurs in one oftwo ways

DvP

Or FoP

DvP

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DvP is the simultaneous and irreversibleexchange of securities and cash

Where DvP is the mode of settlement It is normal to issue a single instruction to

the relevant custodian requesting Delivery of securities versus payment

Or receipt of securities versus payment

FoP

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FoP refers to the non-simultaneousexchange of securities and cash.

For FoP settlement it is normal for twosettlement instructions to be generated.

FoPWhen the STO is Buying

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A settlement instruction needs to be issued tothe STOs custodian to receive the securitiesagainst nil cash value

A separate instruction needs to be issued tothe STOs bank (Nostro) to make payment.

The second instruction would depend on

whether settlement is to occur with orwithout risk.

FoPWithout Risk

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The instruction will be submitted to thebank only after receiving confirmationof receipt of securities by the custodian.

This is known as `Upon Receipt

FoPWith Risk

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In this case the instruction will need tobe transmitted in time for cash to bepaid to the counterparty on the valuedate, irrespective of the receipt ofsecurities.

FoPWhen the STO is Sellingwithout Risk

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In this case a settlement instructionneeds to be issued to the custodian todeliver the securities against nil cashvalue.

If the STO is not to be at risk, thisinstruction will be transmitted only after

having received confirmation of receiptof cash by the Nostro.

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Pre-Advice

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Irrespective of whether the STO isselling with or without risk, a c ash pre-advice may need to be issued to thebank advising it to expect to receivepayment.

Content of SettlementInstructions

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A settlement instruction tells thecustodian to carry out precisecommands such as: To whom securities have to be delivered From whom payment is to be received

Or

From whom securities have to be received To whom payment has to be made

Content(Cont)

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The quantity of securities to be received ordelivered

The net settlement value to be paid or

received The earliest date that the instructions are

to be carried out.

Typical Instruction

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From: name of the issuing STO

To: name of the STOs custodian

Depot Account Number Nostro Account Number

Trade Reference: the STOs settlement

system trade reference number Deliver/Receive

Typical Instruction (Cont)

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Settlement Basis: DvP or FoP Value Date Quantity

Security Reference: ISIN; CUSIP etc. Settlement Currency Net Settlement Value Counterparty Depot Counterparty Nostro Transmission Time: A clear statement of the date and time of

transmission

Other Components

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Trade components such as: Trade date

Price

Accrued daysAre also usually included in a settlement instruction.

In the event of the instruction being unmatched thisallows the custodian to communicate with the

counterpartys custodian to identify thediscrepancy.

Methods of Transmission

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Modern methods of transmitting settlementinstructions include the followingcharacteristics.

The automatic generation of settlementinstructions by settlement systems

The automatic transmission of instructionsindividually or in batches

Electronic exchange of test keys Settlement instructions in standardized formats

Methods(Cont)

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Secure transmission environment due tohigh levels of message encryption

High speed of transmission

Predictable cost of transmission

Enables STP

Methods(Cont)

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A widely used electronic settlementinstruction mechanism is SWIFT.

In order to utilize the SWIFT networkboth the STO transmitting thesettlement instruction and thedestination custodian must subscribe to

SWIFT.

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Format (Cont)

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SWIFT has numerous categories ofsettlement instructions and messagesfor different purposes

Some relate to securities

Others relate only to cash movements

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Format (Cont)

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Series 5: Securities Related

MT540: sent to a custodian to receive FoP

MT541: sent to a custodian to receiveversus payment

MT542: sent to a custodian to deliver FoP

MT543: sent to a custodian to deliver

versus payment

Format (Cont)

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EUCLID

It uses a numbering convention thatdistinguishes between settlement with

another Euroclear participant as opposedto settlement with a Clearstreamparticipant.

Format (Cont)

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Euclid settlement instructions E01: Receive free or versus payment from

a Euroclear participant

E02: Deliver free or versus payment to aEuroclear participant

E03C: Receive free or versus payment froma Clearstream participant

E07C: Deliver free or versus payment to aClearstream participant

Format (Cont)

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CEDCOM

Clearstreams proprietary system CEDCOMhas a settlement instruction numbering

method that does not distinguish thesystem the counterparty is using.

Format (Cont)

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Example of CEDCOM instructions 41: Receive versus payment from a

Clearstream oe Euroclear participant

41F: Receive free of payment from aClearstream or Euroclear participant

51: Deliver versus payment to aClearstream or Euroclear participant

51F: Deliver free of payment to aClearstream or Euroclear participant

Format (Cont)

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CREST

Is the system over which UK and Irishsettlements are effected

Codes used by CREST

ADVN: Delivery Input

ASDN: Stock deposit input

ASWN: Stock withdrawal input

Deadlines

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All custodians will quote a deadline bywhich settlement instructions must bereceived by them relevant to the value

date. The method of transmission is also likely to

affect the deadline imposed by the

custodian.

Deadlines (Cont)

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Assume that the settlement processingoccurs in Bangkok during daylight hoursof the value date.A custodian in Bangkok may impose a

deadline of say 8 a.m. Bangkok time onthe value date Provided the instruction in transmitted in an

electronic form. This normally allows for matching of

instructions with the counterpartys custodian.

Deadlines (Cont)

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If a NYC based dealer buys shares in aThai equity for settlement on a T+3basis He must issue the instructions by close of

business on T+2 (EST) in order to meetthe deadline imposed by the Bangkokcustodian This is to take into account the time differencebetween the two cities.

Deadlines (Cont)

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Euroclear and Clearstream begin tooperate their overnight settlementprocessing during the evening of the

day prior to the value date. The deadline for the receipt of

settlement instructions imposed by

Euroclear is 19:45 Central EuropeanTime on the day prior to the value date.

Deadlines (Cont)

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Deadlines exist so that the dealers areaware of the time by which instructionsmust be received in order for the trade

to settle on the value date. If instructions are received after the

deadline, the custodian may still acceptthe instruction However it cannot be processed on the

value date.

Deadlines (Cont)

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From the standpoint of the ICSDsdeadlines for transmission via SWIFT orvia the proprietary systems are identical

because the format is standardized andthe information can be automaticallycaptured into the custodians system.

Deadlines (Cont)

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However transmission via telex is not ina standardized format and requires thecustodian to rekey the information.

Thus a considerably earlier deadline isimposed for instructions transmitted bytelex.

Deadlines (Cont)

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Dealers effecting cross border tradingand settlement must be conscious ofthe deadlines of each custodian.

They would need to take extra care if usinga mixture of electronic and non-electronicmethods of transmission.

Deadlines (Cont)

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It is recommended that settlementinstructions be generated andtransmitted as soon as possible after

trade validation on the trade date. This gives maximum time to resolve any

discrepancies prior to the value date.

Deadlines (Cont)

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Another reason not to delay instructionsis the possibility that a software orcommunication fault can occur before

the deadline, thereby preventingautomatic transmission.

Validation

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As for trade validation, some dealerswish to review and authorize certaintypes of settlement instructions prior to

transmission to the custodian. This requires the setting up of validation

rules within the settlement system.

Validation (Cont)

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At the point of transmission the systemwould compare the trade detail with therelevant rules: If the instruction passes

Documents

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