New Hire Analyst & Associate Training - Summer 2020

Life Cycle of a Trade

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Life Cycle of a Trade

Chapter Goals
• Understanding the onboarding process – what does a client need to
know before they can trade?
• Decode the onboarding jargon (KYC, AML, GIIN, LEI, FATCA, CRS)
• Trade capture process
• Understand the trade reporting process

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Life Cycle of a Trade

Most of the analyst work is pre and post trade

• An increasingly large part of the job of a Sales professional and
Operations professionals is dealing with the pre-trade onboarding and
managing the post trade process
• For traders, managing the trade capture and risk processes is critical.
Ensuring compliance with reporting requirements is important
• As an analyst or the most junior person on the desk, this will typically
be your role sort out these issues

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Life Cycle of a Trade

Trade Life Cycle

Pre- Client Client

Quote
Trade Onboarding Coverage

Trade Trade Hedge

Capture,
Confirm

Post- Affirm,
Confirm,
Settle / Reg
Trade Match,
Clear Reporting

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Life Cycle of a Trade

Roles and Responsibilities

Front Office Mid-Office Back Office

• Salespeople • Desk Aligned • Function aligned

◽Own Client • Sales Middle Office ◽Settlements

Responsibilities ◽Leads post-trade ◽Wires
• Traders with client middle-
office ◽Collateral
◽Own Product Risk
• Client On-Boarding
• Trading Middle Office
◽Risk Management
◽P&L

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Life Cycle of a Trade

Client Onboarding
• The on-boarding process is continuous:
◽Each fund is a client, not the asset manager. So each new fund needs
to be onboarded
◽There are continuous customer due diligence requirements
◽Requirements for Know-Your-Client and Anti-Money-Laundering has
increased over recent years. Many existing clients need to be
onboarded to the current standards
• Rules and penalties for onboarding failures are significant. Both the
front-office and middle-office are responsible for ensuring a client is
fully onboarded before the client can trade

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Life Cycle of a Trade

Client Onboarding System Flows

Client Data Relationship KYC / AML FATCA
• Legal Name, • Business leads • Know Your • US Tax
Address Client Rules
and Compliance
• Legal Hierarchy opportunity • Anti-Money
(Owners) tracking Laundering

Central Client
Credit Systems Database

Legal Systems Tax Reporting

Trading Systems
Systems
Documentation
Systems Trade Reporting
Systems
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Life Cycle of a Trade

Know-Your-Client (KYC) and Anti-Money Laundering

(AML)
• Banks have regulated KYC or Know-Your-Client requirements where they need
to collect and verify client information prior to establish a trading relationship
• The goal of Anti-Money Laundering is to prevent terrorist financing and illegal
activity financials from entering financial system. KYC is an important first step
to prevent anti-money laundering

Low & Medium

Risk Customer Due
Diligence

Gather & Verify OFAC Sanctions Conduct Risk

Information Screening Assessment

Enhanced Due
High Risk
Diligence

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Life Cycle of a Trade

LEIs – Legal Entity Identifier

• Prior to LEIs – most banks have their own internal identifiers for clients
and there was no common way to link up specific clients across banks,
exchanges and clearinghouses
• An LEI is an 20 digit ID number for an entity that can be used across
multiple banks and platforms.
• An LEI is issued after confirming the official legal name and address
• Why does this matter? Think of an Asset Manager with hundreds of mutual
funds and separate accounts, how do you match the exact entity?
◽ A bank may abbreviate: State Street Global All Cap Equity ex-U.S. Index
Fund in a number of ways, including:
◽ State St -Global All cap Equity ex US Index Fund
◽ SSGA – Global xUS All Cap Equity Index Fund

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Life Cycle of a Trade

FATCA and CRS

FATCA - USA
• Foreign Account Tax Compliance Act
• Designed to provide information to
the IRS to protect against tax evasion
• Financial Institutions agree to provide
information to the IRS
• Clients need to submit a W-9 (for US
entities) or a W8-BEN (for non-US
entities) – and certify what type of
entity they are
CRS - International
• Common Reporting Standard for the
exchange of tax information to fight
against tax evasion
• Financial Institutions must determine
each client’s tax residence. This is
typically done with a certification and
a verification of a tax ID
• Countries that adopt CRS have a two-
way information share
• The US has not adopted CRS. The US
will receive information on US
persons via FATCA

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Life Cycle of a Trade

GIIN Number
• A Global Intermediary Identification Number can be used by non-US
Financial Institutions that are already registered with the IRS
• The GIIN Number is 15 digits in the following format

5 Digit Financial
Institution Type

6 Digit FATCA 3 Digit

Number
666666.55555.22.333 Country ID

2 Digit FATCA Code

LE = Lead, SL = Single, ME= Member,

BR = Branch, SP = Sponsoring Entity

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Life Cycle of a Trade

Client Suitability
• When clients are onboarded, they will need to be classified for suitability. What level of
financial knowledge do they have and what products are appropriate?

◽ Are they a retail investor? Would they understand a complex derivative?

◽ Are they a Hedge Fund that trades complex derivatives as their business?

◽ What about a corporate cash treasury? Or a government investment fund?

• Most banks will have defined suitability tiering and define products by those tiering. For
example:

◽ Cash equities is a vanilla product suitable to all investors

◽ Equity Swaps are a complex product suitable to most investors

◽ An Equity Option contingent on Interest Rates is a complex product only suitable for the most
sophisticated investors

• In addition, there may be additional documentation to support certain products (attesting to be

a Qualified Institutional Buyer or QIB to buy 144A Investments

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Life Cycle of a Trade

Client Documentation
ISDA / CSA – OTC Derivatives MRA/GMRA - Repo
• ISDA – International Swaps Derivatives
Association
• (Global) Master Repurchase
Agreement
• Agreement to trade swaps
• GMRA is English Law, MRA is NY Law
• Sets of definitions (equities, fixed income)
• Bilateral agreement between client and
bank legal entity (you may have separate MSLA – Sec Lending
agreements for bank vs. securities entity)
• CSA is the credit support annex
• Master Securities Loan Agreement

◽ Agreement for eligible collateral

MSFTA – MBS
◽ Haircuts for securities
• Master Securities Forward Transaction
◽ Currencies for cash & interest rates Agreement
◽ Frequency of margining and thresholds
to post collateral • Used for WI When-Issued, TBAs (MBS),
Dollar Roll (MBS)
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Life Cycle of a Trade

OTC vs. SEFs vs. Exchange

OTC Trades SEFs Exchanges
• Over the counter • Swap Execution • Traditionally how
trades are Facilities were equities, futures and
traditionally how mandated by Dodd- certain equity options
trades occur in Fixed Frank for certain trade
Income (cash and derivatives
• Exchange connects
derivatives)
• Designed to provide buyers and sellers
• Counterparties reach price transparency to
• Exchange report
out to banks and the markets, showing
trading data (volume,
request prices multiple dealer prices
prices, etc)
at one time
• Reporting
requirements • SEFs report trade data
introduced with Dodd
Frnak

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Life Cycle of a Trade

Derivative Life Cycle

• Call or chat • Trade on an

with broker Voice Execution SEF Execution electronic
platform

Counterparty Bank
• Trade Capture • Trade Capture

• Affirmations • Affirmations

Clearing • Where do you clear?

Reporting • Which side reports?

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Life Cycle of a Trade

Post-Trade Events

Payment Events Collateral Events Valuation

Expiry / Maturity Termination Amendments

Novations

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Life Cycle of a Trade

Novations
Hedge Fund executes a swap
Hedge Fund Dealers A with Dealer A. Dealer A had the
best price

Dealers A Hedge Fund looks to exit the

swap position. It asks for quotes
Hedge Fund Dealers B in the opposite direction. Dealer
C has the best price
Dealers C

Dealers A Hedge Fund trades with Dealer

C and has opposite cash flows.
Hedge Fund
Dealers C Hedge Fund then asks Dealer A
if they can novate their trade to
Dealer C and asks Dealer C if
Dealers A Dealers C they can novate their trade to
Dealer A.
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Life Cycle of a Trade

ISDA Agreements are counterparty specific

National Widget Co. Citibank N.A.

Citigroup Global
National Widget Co.
Markets

National Widget LLC. Citibank N.A.

Citigroup Global
National Widget LLC.
Markets

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Life Cycle of a Trade

Dodd Frank requirements split legal entities by

regulator jurisdiction
Bank Level Entity Securities Level Entity

• E.g. Citibank N.A. , same legal entity as • E.g. Citigroup Global Markets, same
the deposit taking entity entity that you trade bonds with

• Most CFTC regulated derivatives • SEC Regulated Derivatives

• Commodities • Single Name CDS

• Interest Rate Derivatives • Single Stock Equity Derivatives

• Credit Index Derivatives (more than • Many derivatives linked to Asset

10 components or names) Backed Securities

• Equity Index Derivatives (more than

10 components or names)

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Life Cycle of a Trade

Eligible Collateral for Margining

• Each Credit Support Annex (CSA) for an ISDA will specify what
collateral is eligible for margining. Only eligible collateral on the
schedule will count for margining

Cash Valuation Percentage

USD Cash 100%
EUR Cash 100% Valuation Percentages
US Treasuries • 1 – Haircut
Less than 1 year 99% • Typically similar to repo haircuts
1 year to 5 year 97% • Percentages fixed for life of the
5 year to 10 year 95% agreement
USD Corporate Bonds 70%
rated A- or Higher

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Life Cycle of a Trade

Cash collateral
• Cash collateral is the most broadly accepted type of collateral
• Cash collateral will earn interest as specified on the CSA
◽Fed Funds for USD is typical, although different index rates and
spreads are possible
• Some agreements will allow for cash in more than one currency
• For uncleared Initial Margin rules, cash collateral not in the termination
currency is subject to an “FX Haircut”
• For variation margin, there is typically no haircut on cash

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Life Cycle of a Trade

Minimum Transfer Amounts

• Each agreement will have a minimum transfer amount
• If you had a minimum transfer amount of $5 million, collateral will only
exchange hands if the margin call was greater than $5 million
• This is to reduce the number of payments that need to be made
between counterparties
• In addition, for counterparties posting securities collateral, this
prevents odd sized lots from being transferred

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Life Cycle of a Trade

Initial Margin Rules

One side posts Initial Margin

• Pre-2016 bilateral transactions

Initial
• Cleared transactions Margin

Variation
Hedge Fund Margin Bank

Both sides posts Initial Margin

• Non-cleared transactions, Initial

Margin
phased in
Variation
Hedge Fund Margin Bank
Initial
Margin

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Life Cycle of a Trade

Immediately before and after the trade

•Establish what you are trading

Quote (security or derivative),
direction and prices

•Agree on a price to trade

Trade •Derivatives: Salesperson send Dodd-Frank

disclosures and Dodd-Frank Mid
•Trader hedges

•Salesperson sends a written (e-

Recap mail or chat) overview of the
trade details to the client and a
separate version to the trader

•Trader enters details into a Risk

Management System
Capture •Salesperson enters details with
client information and
markup/sales credits

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Life Cycle of a Trade

Right after the trade, On Trade Date

•Add client specific details on
settlement or custody details
Trade
•Adds confirmation requirements
Enrichment and regulatory reporting
requirements on the trade

•Error check to make sure all the details

Trade entered in are correct
Validation •If not, flag for immediate correction

Trade •Both the bank and the client /

Matching / counterparty submit details for
the trade to be matched
Affirmation

Regulatory •For trades that are reportable,

details are sent to a central
Reporting source managed by a regulator

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Life Cycle of a Trade

Why do trades need to be captured?

Risk Management Confirmations

• Traders know their • Clients receive trade
positions confirmations

Trade Capture
Financial Reporting Credit
• Management • Alerts credit officers
knows their P&L to credit risk

Settlement Regulatory Reporting

• Collect payment and Collateral / Payments • Regulators know what
deliver payments has been traded
• Margin and
derivative payments

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Life Cycle of a Trade

Straight Through Processing

• Straight Through Processing (STP) aims to reduce the number of human
interactions needed
• Human interactions add cost, can delay processes for trade reporting and
increase operational risk
• There is always a continual review of processes to see what can be
automated or how can we get different systems to “talk to each other” and
eliminate the need for teams to review

Trade Add Validate Send

Risk Management
Capture Static Data Downstream
Data Financial Ledger

Confirmations

Reg Reporting
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Life Cycle of a Trade

What is static data?

• Static data forms the key data that all the post-trade systems need
• Static data does not change from minute to minute, but needs to be updated
periodically
• Static Data Includes Internal Data:
◽ Trading Books, Trader Codes
◽ Counterparty List with Internal Codes
• Static Data includes external data:
◽ Stock Tickers
◽ CUSIPs and related Bond information
◽ Currency List
◽ Holiday Calendars
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Life Cycle of a Trade

Standard Settlement Instructions (SSI)

• Static Data also includes client details such as settlement instructions
• Most clients and counterparties will provide standard settlement
instructions prior to trade.

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Life Cycle of a Trade

What happens when you have bad static data?

• Processing Errors:
◽Delayed confirmations
◽Unmatched transactions
◽Settlement failures
◽Incorrect calculations (fees, accrued interest, P&L)
◽Increased operational costs

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Life Cycle of a Trade

Trade Enrichment
• Trade Enrichment takes the data that is captured and adds static data
from other systems
• Front Office Salespeople and Traders do not enter the settlement
instructions on each trade, it should come from the Standard Settlement
Instruction static data

Trade Recap Enriched Data

Trade Date: 6/5/2020
Value Date: 6/8/2020
Counterparty: Hedge Fund ABC
Counterparty ID: 12345
Trade: 10 YR Interest Rate Swap
Direction: WSP Pays Fixed
Notional: USD100,000,000
Fixed Rate: 3.21% S 30/360
Floating Rate: 3mL
Trader: Joe Smith
Hedge Fund ABC LEI
Hedge Fund ABC Settlement Details
Hedge Fund ABC Collateral Agreement Details
Hedge Fund ABC Reporting Agreement
Today’s 3 month LIBOR reset
Holiday Calendar, All the schedule payment dates
Conventions on the Swap
Reporting requirement on the swap
Trade Joe Smith’s Trader ID
Trade Joe Smith’s Trading Book ID

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Life Cycle of a Trade

Trade Validation
Trade Validation is a series of checks to make sure the trade being
captured meets minimum quality control requirements
• Is the security/derivative recognized in the system?
• Is the counterparty onboarded?
• Is the counterparty under credit limits?
• Is the trader allowed to trade in the specified trading book?
• Is the trading book allowed to trade the security/product?
• Is the settlement or value date a proper date, including holidays?

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Life Cycle of a Trade

Trade Allocations
• For asset managers trades, we typically think of a Blackrock or a
Fidelity as one client. They have one set of execution traders and one
set of mid-office and back-office teams
• However, the asset managers are managing cash for a number of funds
• If Blackrock is buying $10 million of securities, they don’t all go to one
fund, they are divided into a number or funds. Each fund is a buyer
• The asset manager would provide a list of allocations, out of their $10
million trade, they provide a breakout of which securities go to which
fund
• The end trade is not 1 trade with Blackrock, but potentially 10 or 100
trades with a number of Blackrock funds

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Life Cycle of a Trade

Confirmations
• Trade confirmation are official records of a trade
• Immediately following the trade, a salesperson can send a recap to the
client of the trade. However, the recap is simply a salesperson e-mail or
chat summarizing the terms of the trade. At that point, the transaction
details are not yet booked into the risk management system
• Once the transaction is booked and recorded into the risk management
system, including allocations for asset managers, the official
confirmation is released
• Depending on the product, the confirmations maybe automatically
released (cash equities) or flagged for front-office review (equity
derivatives)

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Life Cycle of a Trade

Affirmations
• Affirmations serve a key purpose to ensure the client’s understanding of the
details of the trade matches what has been recorded into the bank’s risk
management system
• Imagine if the salesperson had a typo in their recap and the client knew of a
different price or settlement amount. The affirmations process ensures
there are no discrepancies
• Each traded product has different conventions on how the client can
confirm their agreement:
◽ Derivative transactions are typically signed by both parties
◽ OTC Bond Transactions are typically affirmed via a Bloomberg VCON
◽ Exchange traded cash equities are typically matched and affirmed in a
system called Oasys

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Life Cycle of a Trade

Trade Matching
• Trade matching is when both parties of the transaction need to enter in the details of
the trade into a system
• Both parties need to know the exact same details of the trade to be matched.
Requiring both parties to enter in the details reduces the likelihood of a dispute in
the transaction terms
• Bonds settled in Euroclear (non-US system) need to be matched prior to settlement.
◽ Both the buyer and seller need to enter in the key details of the transaction exactly
the same (same bond, same notional, same price, same settlement date, same
buyer/seller account number)
◽ Once trades that are matched, on the day of the settlement the cash and securities
are moved from the buyer and seller and the transaction is settled
◽ If the transaction is not matched, the trade fails and the security does not move

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Life Cycle of a Trade

Trade Instruction: Bonds

Buyer Seller
• Need to have cash in • Need to have Bond in
hand hand, ready to
deliver
• Instructions
• Instructions
◽ Who to buy from?
◽ Who to deliver to?
◽ Settle Date? When ◽ Settle Date? When
to Buy? to Deliver?
◽ Amount of ◽ Amount of
Payment Payment
◽ Bond Identifier ◽ Bond Identifier
(CUSIP or ISIN) (CUSIP or ISIN)

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Life Cycle of a Trade

Cash Payments: Derivatives

• A derivative doesn’t “settle” and there are a number of payments for
bilateral derivatives
• The derivative confirmation will specify who is the calculation agent.
This is typically the investment bank for trades between a bank and a
client
• The calculation agent will specify the payments and payment dates on a
swap:
◽E.g. –If the client is paying 3 month LIBOR on an Interest Rate Swap,
the calculation agent will calculate the 3 month LIBOR payment every
3 months and instruct the client to pay that amount

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Life Cycle of a Trade

Settlement
• OTC Transactions are directly settled between the Investment Bank and the
client
• Almost all transactions are settled DVP Delivery Versus Payment, which
means the security transfers ownership once the cash is received
• If either the payment account does not have funds, or if the delivery account
does not have the security, the transaction will fail. Meaning the transaction
will not proceed. There are fees and penalties with securities failures
• The alternative to DVP is Free of Payment, abbreviated FOP. FOP is rarely
used, and typically only used if payment is made in a different system
• Timing of settlement is important, there are typically end-of-day cutoffs for
various settlement and cash management systems

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Life Cycle of a Trade

Settlement Date Deadlines

• In an ideal situation, all the securities are matched up and settled early on in the day and there
are no fails

• In reality – the settlement timeframe is compressed into a short period of time

◽ Securities to be settled may only arrive in the seller’s account the same day (Investment Bank
bought and sold the same bonds)

◽ Funds to settle the account may not be available until later in the day (awaiting funds from
other transactions to settle)

• As settlement cutoff times approach, there is increasing pressure to fix or correct any
instructions that are preventing settlement

3:15PM EST 3:45PM EST Collateral 6:00PM EST

Fedwire Close DTC Close Optimization Moneywire Close
• Fed’s cash and • Final net balances • Banks allocate / • Cutoff time to move
government published reallocate collateral funds
securities settlement and financing for cash
system • Trades not settled, settlement for the day
failed
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Life Cycle of a Trade

Clearing
• Exchange transactions are generally cleared. The exchange matched the
two sides and you don’t know who has the other side of your position
• Both sides would face the clearinghouse, and there are a number of
different clearing houses (e.g. NSCC, LCH, ICE, CME etc.)
• Following the Dodd-Frank Act, many OTC derivatives are now required
to be cleared
• Clients using a clearinghouse need to have an agreement to clear with a
member firm
• Large Investment Banks are generally clearing firms, and most clients
have clearing agreements with a Investment Bank to manage the
clearing process of their trades. The clearing firm does not need to be
the same firm as the executing firm
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Life Cycle of a Trade

FX Settlements
• FX settles using bank wires, there is no exchange and no physical security to
exchange
• There are cutoff times for currency settlement, the latest time you can send
a wire and have it credit to the bank account for the same business day.
Interest is earned overnight for the day based on the cash that is in the
account at the end of the day
• If you need to send JPY to Japan before their close but need to wait until the
US markets are open to receive USD, there is intraday risk
• Continuous Linked Settlement (CLS) is used to mitigate some of the
intraday risk. CLS operates on paired FX settlement, similar to DVP for
bonds, but uses an intermediary currency to mitigate some of the time zone
differences. Instead of USD->JPY, USD->CHF->JPY and settle JPY with CHF
and have a remaining CHF->USD trade to settle in the US day

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Life Cycle of a Trade

US Fixed Income: TRACE Reporting

• TRACE is FINRA’s Trade Reporting and Compliance Engine
• The goal of TRACE is to have price transparency in OTC Securities
• Broker/Dealers need to report prices to FINRA within 15 minutes of
trade execution
• Key details include:
◽CUSIP
◽Size
◽Volume
◽Price

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Life Cycle of a Trade

Cash Equities: Off Exchange Reporting

• Equity trades for listed equities that occur off exchange need to be
reported. The details of all these trades for the consolidate tape of
transactions for the security
• For trades that occur over an ATS (Alternative Trading System) or ECN
(Electronic Communications Network), the platform will report the
trades
• For transactions executed internally within a bank (matching one client
with another, or matching with trading flow at your bank), these
transactions would need to be reported
• Block trades, larger than typical sized trades in the market and are
allowed to be privately negotiated. Due to the size, they do not need to
be traded on the exchange. These are typically traded and reported
after hours to avoid moving markets on these securities
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Life Cycle of a Trade

Derivatives Reporting
• Both the US Dodd-Frank and European EMIR requires reporting of
certain derivative trades
• Reporting provides to a central repository and general public some
details of the swap being trade. E.g. Derivative Type, Notional, Price
• The reporting details fulfil the regulatory requirement. The details are
generally vague enough not to disclose the full details of the trade. E.g.
“Equity Swap on a Custom Index” vs. “Equity Swap on a set of Apple
Suppliers”
• Who is the reporting party? US – generally swap dealers are reporting
parties

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