Trade Life Cycle
The life cycle of the Trade
Trade
Trade is exchange of financial securities
and products like stocks, bonds,
commodities, currencies and derivatives
or any other valuable financial instrument
for cash and as a promise to pay the
stated currency in the respective country
of exchange
Trade Life-Cycle
Trade life-cycle are the different stages by
which a trade flows through.
It is regarded as a series of logical steps which
are represented in such a manner where the
trade is allowed to go through keeping track of
it's related objective and importance.
Front Office
Trade gets initiated at FO. The order gets
placed and entity will price the instrument and
give the quote to the counterparty.
If the counterparty agrees to the details of the
trade and is willing to enter into the deal, the
trade gets executed.
Front Office …contd
The trade is then captured in the trading desk usually
using a deal capture system.
The deal capture system validates all the necessary
trade economics before assigning a trade reference
number.
An acknowledgement is being sent to the counterparty
with the trade details who confirms it back.
Middle Office
MO performs the limits and risk management.
The Limits are being calculated at a business hierarchy level.
The usual hierarchy would be at a Portfolio level and
subsequently aggregating to a Trader Level, a Desk Level, an
Entity Level, and finally to a Group Level.
Validations are being done on the trade captured, and in case
of any discrepancy, an exception is being raised.
Middle Office …contd
The MO plays a vital role in the exception
management. The trade gets enriched by static data
like the standard settlement instructions of the
counterparty, Custodian details, City holidays, etc.
Such static data details are important for the
completion and settlement of the trade. The allocation
of the trade is done in the MO and finally the trade is
being pushed to the BO and the trade goes live.
Back Office
The BO mostly deals with the operational
activities like record keeping, confirmation,
settlement and regulatory reporting.
Trade Events
Setting up Master Agreement
It is a standardized contract between the
counterparties and should be there in place
before the two parties enter into a deal. For
derivative contracts, the Master Agreement is
drafted according to ISDA protocols.
Define Product Characteristics
Every Deal has to be defined by some primary
characteristics called the primary economics of
the trade. In case of a Plain Vanilla Interest
Rate Swap, the economics of trade would be
as follows: -
Pre – Trade Negotiation
In this stage the client tries to reach a
preliminary agreement with the bank. This
stage may include documentation, indication
of the interest rate and defines the criteria for
executing a trade which may include the credit
support and the bank policies which the
counterparty has to abide by.
Request for Quote
The client will ask for a quote to the bank, say
the fixed rate against LIBOR.
Provide Quote: The bank will provide the quote
which may be through their traditional
channels like phone, fax and email, or through
standardized channel as provided by Swaps
wire
Request Trade Pricing Inputs
The Client will ask inputs which will help to
price the product. It may relate to volatility of
the underlying in some cases. The trade is
priced after matching every detail of the trade.
For an IRS, both the parties will agree to the
rates when the Net Present Value of the swap
is zero.
Execution of Trade
When both the parties agree to the details of
the trade and are willing to enter into the deal,
the trade gets executed.
Confirmation
The bank would draft an inception document
capturing all the trade details and send it to the
counterparty to get it confirmed.
The counterparty will check the details of the trade
and sign it back confirming the trade on its behalf.
The communication of confirmation can be
through SWIFT, Telex, Fax, or through other
similar medium of financial information exchange.
Allocation of Trade
Some trades have to be allocated to various
sub entities. This is called allocation of trade
and is done for flexibility of Profit & Loss
Booking.
Creation of Standard Identifier
Every trade will be stored with the help of a
unique Trade ID which is used to identify the
trade.
Amendments
The trade can be amended by the consent of
both the parties. The amendment can be done
in terms of the economics of the trade. If a
trade is being booked incorrectly, then the
amendments can be done to the booked trade
with the agreed changes and it can be re-
booked.
Counterparty Changes
Novation can be explained by an example. Suppose A and
B has entered into a trade, and then C wants to enter and
take A's position, or A wants to exit and let C take its
position, then whoever is at an advantageous position will
receive some novation fee. The most important thing is
there should be consent from B for C to come in, through a
Consent Letter, and B is called the remaining party. The
assignment of the new counterparty can be done by the
bank or the new counterparty can be assigned by the
counterparty himself
Give Ups
In a Give up Trade, the client will execute a
transaction at a price supplied by an executing
broker but then faces the prime broker as the
counterparty. The prime broker mirrors the
transaction with the executing broker as the
counterparty and effectively intermediates
between the two
Partial Termination
A trade is partially terminated when there is a
change in the notional of the trade and it is not
pre-fixed according to the agreement
Full Termination
This indicates the full termination of the deal
before the maturity of the trade. This may or
may not entail a termination fee.
Rate Fixing
The Floating Rate has to be fixed every period
for the cash flow settlement of the floating rate
leg. The fixing rule can be defined and it may
differ on a trade to trade basis. The Floating
Rate may be fixed in advance or at the end of
the period according to the fixing rule set for
the trade.
Cash Flow Settlement
Every settlement term, there will be cash flow
that the entity will pay and receive. The cash
flow will happen according to the standard
settlement instructions. In case of the Interest
Rate Swap, it will be the Pay Flow and
Receive Flow
Fee
A trade may have scheduled and non-
scheduled fee event. A payment of brokerage
or option premium might be booked as a fee
for the records.
Revaluation
The trade can be revalued at intermediate
stage according to the market interest rates at
that point of time. That is, the future cash flows
are discounted to find out the present value
and then the NPV is calculated to find out the
position of the entity on that particular trade.
This is done for accounting purpose
Conclusion
The entire Trade Life Cycle is a labyrinth of
complex functions where the trade passes
through a stream of different events. There is a
lot of manual intervention in all these events
and this increases the time bucket for
processing and settlement of the various
functions
References
http://www.coolavenues.com/finance-
zone/trade-life-cycle-events
http://www.coolavenues.com/finance-
zone/trade-life-cycle-events?page=0,1
