Chapter 6 Flashcards
0
Q
What is a repo?
A
A repo transaction is one where:
1. The motivation of the lender (of stock) is to borrow cash at a better rate of interest than it would if it borrowed on an unsecured basis
2. The motivation of the borrower (of stock) is to lend cash on a secured basis
A repo involves an exchange of cash for securities in both legs of the transaction, but this time the lender of cash is using the securities as collateral in case the borrower is unable to return the cash at the end of the loan period. The mechanism of the exchange of cash and collateral is that Party B ‘sells’ the securities to Party A under an agreement where A can repurchase them at a later date.
Collateral is in the form of government bonds
1
Q
What is stock lending?
A
The term stock lending is usually used to describe a transaction where.
1. The motivation of the borrower (of stock) is to acquire a specific quantity of a given stock to meet a commitment to deliver.
2. The motivation of the lender (of stock) is to provide the securities the borrower requires, and to attract collateral to protect itself against default, they usually charge a fee or interest.
The transaction has a start leg and an end leg.
1. On the value date of the start leg, the lender delivers securities to the borrower in exchange for collateral. The purpose of the cash collateral is to provide the lender with security in case the borrower does not return the securities that were borrowed
2. On the value date of the end leg, the securities are returned to the borrower and the collateral is returned to the lender. At the same time, the lender is paid a lending fee, and the borrower is paid interest on the collateral
A large number of equities and bonds are acceptable instruments
2
Q
What is the different purposes of stock loans vs repos?
A
In other words, the business purpose of a stock loan is to enable one party to lend securities to another and the business purpose of a repo is to allow one party to use securities as collateral for its cash borrowing
3
Q
Who is the beneficial (legal) owner of instruments in a stock loan?
A
The borrower or nominal owner
4
Q
Who is the nominal owner of instruments in a stock loan?
A
The borrower
5
Q
What is another term for tri-party repo?
A
Delivery by value DbV
The way that DbV works is that the market maker and an SLI agree that the market maker needs to borrow, say, £10,000,000 to finance its trading book ‘overnight’, i.e. for one day. Both parties input a special DbV transaction that just quotes this amount, and the collateral (say, £10,500,000) that the SLI needs. That evening Euroclear finds securities to the value of £10.5 million in the market maker’s account that are not needed for delivery to clients and transfers them, against payment, to the SLI’s account. The following day Euroclear returns the securities to the market maker, and the cash to the SLI. The market maker then re-evaluates its funding requirements for the next day and the process is repeated.
6
Q
What management process is accrual part of?
A
The risk management process
7
Q
What is accrual?
A
Accrual is an accounting term it is defined as a method of accounting in which each item is entered as it is earned or incurred, regardless of when actual payments are received or made.
8
Q
What is accrued interest?
A
Accrued interest is defined as the interest that has accumulated on a transaction since the last interest payment date or start date, up to BUT NOT INCLUDING the current date.
9
Q
What are the three forms of outsourcing recognised by SWIFT?
A
- Firms may connect via another customer, this is called a shared connection
- Firms may outsource the day-to-day operation of their connection to a third-party, called a service bureau
- In addition to the technical connectivity, firms may turn to a member/concentrator that
provides additional business services such as taking care of SWIFT administration and invoicing on their behalf.
10
Q
List the SWIFT message series
A
MT100 customer payments and cheques
MT200 financial institution transfers
MT300 foreign exchange, money markets and derivatives
MT400 collections and cash letters
MT500 securities markets
MT600 precious metals
MT700 documentary credits and guarantees
MT800 travellers cheques
MT900 cash management and customer status
11
Q
List and explain EUI status codes
A
UNM0 unmatched - you have sent an instruction but counterparty has not T+2 or later
UNM1 urgent unmatched settles tomorrow or earlier
CUNM - trade alleged but you sent no instruction
USEC trade matched but you have no stock to deliver
CSEC trade matched but counterparty has no stock to deliver
COLL trade matched but you don’t have sufficient cash
OTH other reason usually means that other party has insufficient cash or stock
OK
12
Q
Who is the beneficial owner in a stock loan
A
The lender
13
Q
How are settlement instructions usually transmitted?
A
Swift messages
Proprietary standard message developed by settlement agent
Email, fax, telex
14
Q
What value is the settle within tolerance threshold applied by Euroclear bank (ICSD)
A
USD 25.00
15
Q
Do SLIs usually act as agent or principal?
A
Usually principal, they make a small margin on collateral interest rates and stock lending fees
16
Q
What are the separate accounts known as where client assets are held by firms?
A
Nominee accounts
17
Q
What does PRIN 10 stipulate?
A
PRIN 10, states ‘A firm must arrange adequate protection for client’s assets when it is responsible for them’.
18
Q
Describe CASS 6.4.1
A
- A firm must not enter into arrangements for securities financing transactions in respect of safe custody assets held by it on behalf of a client or otherwise use such safe custody assets for its own account or the account of another client of the firm unless:
a. The client has given express prior consent to the use of the safe custody assets on specified terms; and
b. The use of that client’s safe custody assets is restricted to the specified terms to which the client consents - A firm must not enter into arrangements for securities financing transactions in respect of safe custody assets held by it on behalf of a client in an omnibus account held by a third party, or otherwise use safe custody assets held in such an account for its own account or for the account of another client unless, in addition to the conditions set out in 1.
a. Each client whose safe custody assets are held together in an omnibus account has given express prior consent in accordance with (1)(a) or
b. The firm has in place systems and controls which ensure that only safe custody assets belonging to clients who have given express prior consent in accordance with the requirements of (1)(a) are used. - For the purposes of obtaining the express prior consent of a retail client under this rule, the signature of the retail client or an equivalent alternative mechanism is required.
The effect of these rules is that client assets may not be used in stock lending or repo transactions without the express written agreement of the client concerned.
19
Q
What are the IT implications for firms participating in stock loans and repos?
A
- Manage collateral – that is to say they have to be able to:
a. Revalue securities to ensure that the collateral placed or received is adequate
b. Send messages to, and receive messages from, counterparties about collateral
requirement changes - Send the relevant instructions to settlement agents to settle the transactions
- Calculate collateral interest charges and stock lending fees
- Identify securities that are available to be used in stock lending and repo transactions and
- Ensure that the investment and custody records correctly reflect which holdings are out on
loan. This will ensure that holding on loan are not sold accidentally and that client reporting accurately reflects this.
20
Q
In which IT system are stock lending facilities normally found?
A
The settlement system
21
Q
In what system is a cash flow projection model normally found?
A
Settlement system
22
Q
What is another name for a cash flow projection module?
A
Maturity ladder
23
Q
How many days is typically covered by a maturity ladder?
A
5 working days
24
Describe the interfaces of the settlement system.
1. It holds much of the reference data
2. It takes in real-time trade fees from the various front office systems and enriches them with
reference data, such as:
a. SSIs for trading parties and the firm itself
b. Rules and parameters to calculate trade proceeds, trade interest commission, fees
and expenses
3. It then decides on the appropriate format and delivery method of the settlement
instruction messages and transmits those messages to settlement agents
4. Between trade date and settlement date it receives status update messages from
settlement agents and updates its database with the latest trade statuses advised by the agents, it will then provide facilities for back office personnel to monitor potential settlement failures which may arise because of missing or incorrect SSIs, incorrect or
missing settlement instructions sent out, shortages of stock to deliver, etc.
5. On settlement date, it receives messages from the settlement agents informing it which
trades have either fully settled or partially settled, and updates its database with the outcome of those messages. It then provides the operations personnel with facilities to monitor and control actual settlement failures i.e. trades that have not settled by contractual value date
6. It provides facilities for the firm to manage its funding by means of management reports, such as a maturity ladder
7. The settlement system usually performs interest accruals
8. It feeds data to the corporate general ledger system, the regulatory accounting system,
and the reconciliation system
9. Depending on the configuration details at the individual firm, either the front office system
or the settlement system will handle regulatory trade reporting and central matching
10. It will usually be the system that controls corporate actions, dividends and coupon
processing, option expiry and exercise, etc.
11. It is usually the system that controls the mark-to-market activity
12. It may also supply data to a system or service designed to calculate VaR
13. It will also supply the firm’s management with a wide variety of management information,
such as statistics about settlement failures, their reasons and cost. These may be needed by asset class trading book, settlement agent, or any combination of these entities
25
What system normally performs interest accruals?
The settlement system
26
For what type of trades does the settlement system require to calculate the accrued interest?
Purchase / sale of bonds
Stock borrowing, lending and repos
Money market loans or deposits
27
What is interest accrual?
Accounting for the interest that will be paid on the next coupon date (bond) or the termination date (stock loans/repos/money market loans and deposits)
Definition Accrual is an accounting term it is defined as a method of accounting in which each item is entered as it is earned or incurred, regardless of when actual payments are received or made.
Accrued interest is defined as the interest that has accumulated on a transaction since the last interest payment date or start date, up to BUT NOT INCLUDING the current date.
28
What does the mark to market process stipulate for the posting of accrued interest amounts?
A firm needs to account for this interest expense each day that it occurs, not all in one amount at the end of the loan period.
1. It is the convention that no interest is payable or receivable on the start date of a transaction but is payable at the end date.
2. The daily accrual convention is one day’s interest on Mondays through Thursdays, and three days interest is to be accrued on Fridays unless any or all of the days of the weekend following fall into the next month. If that is the case, the system should accrue to the month- end date. If there were a public holiday on the Monday following, then four days interest would be accrued on the Friday unless the Monday fell into the next calendar moth,
3. The firm's financial month-end date of could fall on a weekend, then the firm would account for the total interest up to the month end
29
Name the three options for outsourcing swift connectivity to a third party?
1. Shared connection
2. Service bureau - day to day operation
3. Member concentrator - provides additional business services - swift admin and invoicing
30
What type of APIs does SWIFTNet link incorporate?
XML based APIs ensures technical interoperability between users. It is licensed to members and software providers
It provides customer application to access SWIFTNet services
Local application to communicate with remote application
Local and remote to handle end-to-end integrity, authentication and confidentiality
Local and remote apps to retrieve info from trusted time service
Local and remote apps to support load balancing
Local and remote apps to communcate securely using SWIFTNet PKI
31
What does SWIFT key exchange ensure?
```
Authenticity
Integrity
Non repudiation
Confidentiality
Access control
```
32
How is access control handled by SWIFT?
The access for an individual to their private key, stored in a smart card, is controlled through a private password.
33
What are SWIFT messages typically used for?
Sending settlement instructions, order messages, confirmations, affirmations. Etc
34
What are the typical stages in sending a SWIFT settlement instruction?
1. Trades are captured in the relevant front office system and forwarded to the firm’s settlement system
2. The settlement system enriches the trade with SSI details, and any other relevant reference data, and formats a settlement instruction message. This, in turn, is forwarded to the firm’s SWIFT Gateway application, where:
a. The Gateway product validates the trade according to SWIFT’s network validation rules which deal with field specifications (e.g. whether alpha or numeric content is required, whether fields are mandatory, or optional etc.). If a message fails validation then it is sent to a repair queue.
b. The Gateway product provides facilities for manual authorisation of this instruction before it is sent out. The firm is able to set up business rules in the Gateway product to control policies, e.g. the firm may require more levels of authorisation for FoP.
c. The Gateway product allows direct input through a user interface. This allows users to set up business rules in the Gateway product, manually authorise transactions and repair transactions when necessary.
d. Once the message has been validated and authorised, it is then encrypted and sent to SWIFT, The message will, in fact, be received at one of SWIFT’s European hubs (there is more than one of these for business resilience reasons), but this fact is transparent to the sender.
Validated
Authorised / manually repaired if necessary
Encrypted
Sent
35
What steps are carried out on a SWIFT message when received by SWIFT?
At SWIFT
1. The message is received at the European hub, and time-stamped with the date and time of receipt
2. It is then network-validated. If network validation is successful, SWIFT sends an ACK message back to the sender confirming that it is able to process the message. If the message fails network validation, then SWIFT sends a NACK (not acknowledged) message back to the sender. This process is known as ACK/NACK protocol.
3. Once ‘ACK’d, swift identifies that this message is destined for a firm in Tokyo, so it forwards it to one of its Asia Pacific hubs in real-time.
4. The Asia Pacific hub then verifies whether the Tokyo firm is online to SWIFT. If it is, it forwards it to the member; if the member is not online, it stores the message until it detects that the member firm is online.
Received/time stamped
Network validated ACK/NACK
Forwarded to appropriate hub
Forwarded to firm if online
36
What steps are carried out by a receiving firm on a swift message?
1. The message is received at this member firm’s Gateway system and decrypted.
2. The Gateway system then uses business rules that have been set up in this system to tell it
what to do with the message. For example, if it is a settlement instruction message sent by one of the firm’s custody clients, it may need to be forwarded to one business application. If it is an FX trade confirmation, sent by a counterparty, it may need to be forwarded to another business application.
3. There will be some messages where the identity of the destination system will not be clear to the Gateway system. This may be due to the quality of the data in the incoming message, lack of clarity and coverage in the business rules entered into the Gateway system, or for some other reason. For this reason Gateway systems provide a human interface that incorporates the ability to display messages held in a repair queue and manually dispose of them, as well as the ability to input the business rules in the first place.
Received/decrypted
Processing decisions made
Allow manual interface to address messages in repair queue
37
Which organisation has been appointed as the registration authority for financial services messages?
SWIFT
38
How are FIN messages represented
Tagged data
39
What are FIN messages often referred to as?
MT messages
40
What is the SWIFT standards guide?
SWIFT distributes SWIFT Standards Guide to all its members; this provides the rules for interpretation of an incoming message and the population of an outgoing message, as well as the network validation rules that apply to the message type.
41
What is the ISO standard for tagged data messages in SWIFT?
ISO 7775
42
What is the ISO standard for data dictionary data in SWIFT messages?
ISO 15022
43
What is the ISO standard for SWIFT XML based messages, also known as SWIFTML or MX series messages?
ISO 20022
| Uses a data dictionary and XML standards
44
What is ISO 20022?
An enhanced approach to standards based on business entity interaction, behavioural models, and XML schema based message data models for the transactional messages supporting these models.
45
What standard have all messages developed by SWIFT since 2004 been based on?
ISO 20022
46
How can corporate customers communicate via swift with their banks who are swift members?
SCORE
| MA-CUG
47
What is SWIFTNet FileAct?
This is SWIFT’s interactive communications service that is utilised for the sending of files between parties, and, in effect, will supersede the existing FIN service, for example, providing support for the transmission of mass payments or reporting information. Although, it is file-based, the initiator of the file transfer will also send a request first, and wait for the response across the IP network before sending the file and waiting for the subsequent acknowledgement, in this way; it can be shown to be an interactive service.
48
What is SWIFTNet InterAct?
This is SWIFT’s interactive communications service that is based on the exchange of request and response messages between two parties. The exchange of messages can be either synchronous or asynchronous. Effectively, this means that it can be used either for direct application-to-application transactional messaging, as is the case of CLS Bank which is based on this service; or it can be utilised in a ‘push’ architecture to provide real-time status and other information. This will also form the basis of the successor to the FIN service.
49
What is the FIX protocol?
The Financial Interface eXchange (FIX) protocol was initiated in 1992 by a group of institutions and brokers interested in streamlining their trading process. It is an open message standard, controlled by no single entity, that can be structured to match the business requirements of each firm.
FIX does not impose a single type of carrier (e.g. it will work with leased lines, private networks, internet, etc.), nor a single security protocol. It is, however, important to note that FIX is not a network in itself and that communication is made directly between each broker/institution pair by prior bilateral agreement. Thus a fund management institution may have 50 or 60 connections to brokers worldwide, some via the internet, others via direct dial or leased connections, and still others connected via private networks such as Omgeo or Autex.
In summary, each broker/institution connection can be thought of as a two-way conversational link taking place between applications at each end. These applications are often referred to as FIX engines and can operate either as stand-alone or fully integrated solutions.
The structure of the organisation is based around a series of committees comprised of interested parties within the broking and institutional communities. These committees are focused on business, technical and regional issues, with working groups examining the impact of new technology, such as XML, and potential expansion of the protocol to cover other users, such as exchanges and Electronic Crossing Networks (ECN).
The protocol is defined at two levels: session and application. The session level is concerned with the delivery of data, while the application level defines business-related data content. Broadly, business messages cover the communication between brokers and institutions of the following information:
1. Indications of interest
2. Orders and order acknowledgement
3. Fills
4. Account allocations
5. News, email, program trading lists; and
6. Administrative messages
The protocol has been deliberately designed to support both domestic and cross-border trading in a varied spread of instrument and security types, such as:
1. Equities
2. Bonds
3. Depositary Receipts
4. Derivatives
5. Futures
6. Foreign exchange-trading
Because the FIX standards are ‘open source’, they may be downloaded from the FIX protocol website (www.fixprotocol.org)
50
What is FpML?
FpML (Financial products Markup Language) is an XML message standard for the OTC derivatives industry.
All categories of privately negotiated derivatives will eventually be included within the standard. The standard is managed by the ISDA on behalf of a community of investment banks that make a market in OTC derivatives. The standard is freely licensed, so any firm that trades the instruments that it supports may use it in their own software.
The current version is Version 5, Service Pack 2, which was released in April 2009. The core scope includes the products of Foreign Exchange (FX), Swaps, and Options, Interest Rate Swaps, Inflation Swaps, Asset Swaps, Swaptions, Credit Default Swaps, Credit Default Swap Indices, Credit Default Swap Baskets, Tranches on Credit Default Swap Indices, Equity Options, Equity Swaps, Total Return Swaps and many others. The core processes include trading, valuation, confirmation, novations, increases, amendments, terminations, allocations, position reporting, cash flow matching, a formal definition of party roles, as well as trade notification between asset managers and custodians.
FpML is distinct from similar financial standards such as SWIFT because it provides no network or specification of a transport mechanism.
51
What is XBRL?
XBRL is an abbreviation for Extensible Business Reporting Language. This is an XML message standard for exchanging information about corporate data such as balance sheets and profit and loss accounts between the company concerned and its auditors, regulators, customers, research analysts and other interested parties. XBRL standards are compatible with ISO 20022.
Historically the standard has been used only to transmit accounting data, but there are now moves to adopt it as a standard for the company concerned to announce corporate action data to the securities markets.
52
What is Python and what is it's proposed usage in the securities industry?
Python is an open-source, dynamic programming language that is used in a wide variety of application domains. It is available for all major operating systems: Windows, Linux/Unix, OS2 and Mac among others.
In 2010, the US Securities and Exchange Commission (SEC) published a proposal that, among other things, outlined the implementation and use of a Python program that would annotate asset-backed securities, allowing potential investors to have periodic access to an ABS’s pool asset performance, including the interest rate, level of prepayments, defaults and losses-given-defaults.
The Waterfall computer program as it is called in the proposal would provide potential investors with detailed information about these securities. By doing so, the program would effectively reduce (but not eliminate) an investors’ dependency on third-party analysis by providing updated information typically available only in the prospectus. This means that those investment banks that issue asset-backed securities would need to use the Waterfall program to provide updated information to investors.
53
What is R and what are its typical uses?
R
R is an open-source programming language and software environment for statistical computing and graphics. The R language has become a de facto standard among statisticians for developing statistical software, and is widely used for statistical software development and data analysis. Itcontains a number of built-in mechanisms for organising data, running calculations on the information and creating graphical representations of data sets. Statisticians, engineers and scientists are free to improve the software’s code or write variations for specific tasks. Packages written for R add advanced algorithms, coloured and textured graphs, and mining techniques to dig deeper into databases.
54
What typed of data must firms reconcile?
1. Cash accounts connected with all types of transaction
2. Cash balances that arise from all types of transaction
3. Stock and derivative quantities connected with all types of transaction
4. Stock and derivative balances (positions) that arise from all types of transaction
55
What is internal reconciliation?
Internal reconciliation is the act of reconciling data held in one of the firm’s business applications (such as its settlement system) with data held on one or more of its other business application systems.
56
What is external reconciliation?
External reconciliation is the act of reconciling data, such as cash movements on nostro accounts and stock movements on depot accounts, with the settlement agents that operate those accounts on the firm’s behalf.
57
What is CASS 6.5.4?
CASS 6.5.4 – reconciliation basic rules in stock lending / repos
1. Carrying out internal reconciliations of the safe custody assets held for each client with the safe custody assets held by the firm and third parties is an important step in the discharge of the firms’ obligations.
2. A firm should perform such internal reconciliations:
a. As often as necessary, and
b. As soon as reasonably practicable after the date to which the reconciliation relates to ensure the accuracy of the firm’s records and accounts
c. Reconciliation methods which can be adopted for these purposes include the ‘total count method’ which requires that all safe custody assets be counted and reconciled as at the same date.
3. If a firm chooses to use an alternative reconciliation method (for example the ‘rolling stock method’) it needs to ensure that:
a. All of a particular safe custody asset are counted and reconciled as at the same date; and
b. All safe custody assets are counted and reconciled during a period of six months
58
What is CASS 6.5.5?
CASS 6.5.5 – alternative method
A firm that uses an alternative reconciliation method must first send a written confirmation to the UK regulator from the firm’s auditor that the firm has in place systems and controls which are adequate to enable it to use the method effectively.
59
What is CASS 6.5.6?
CASS 6.5.6 – third party reconciliation
A firm must conduct, on a regular basis reconciliations between its internal accounts and records,
and those of any third parties by whom those safe custody assets are held.
60
What is CASS 6.5.7?
CASS 6.5.7 – ensure reporting by third party
Where a firm deposits safe custody assets belonging to a client with a third party, in complying with the requirements of CASS 6.5.6, the firm should seek to ensure that the third party will deliver to the firm, a statement as at a date of dates specified by the firm which details the description and amounts of all the safe custody assets credited to the account, and that this statement is delivered in adequate time to allow the firm to carry out the periodic reconciliations required in CASS 6.5.6.
61
What is CASS 6.5.8?
CASS 6.5.8 – basic rules reconciliation with third party – frequency / timing
A firm should perform the reconciliation required by CASS 6.5.6:
1. As regularly as necessary, and
2. As soon as reasonably practicable after the date to which the reconciliation relates:
To ensure the accuracy of its internal accounts and records against those of third parties by whom
safe custody assets are held.
62
What is CASS 6.5.9?
CASS 6.5.9 – independent person
Whenever possible, a firm should ensure that reconciliations are carried out by a person (for example an employee of the firm) who is independent of the production or maintenance of the records to be reconciled.
63
What is CASS 6.5.10?
CASS 6.5.10 – correction of discrepancies
A firm must promptly correct any discrepancies which are revealed in the reconciliations envisaged by this section, and make good, or provide the equivalent of any unreconciled shortfall for which there are reasonable grounds for concluding that the firm is responsible.
64
What is CASS 6.5.11?
CASS 6.5.11 – suspense / error account considerations
Items recorded or held within a suspense or error account fall within the scope of discrepancies
65
What is CASS 6.5.12?
CASS 6.5.12 – shortfall responsibilities
A firm may, where justified, conclude that another person is responsible for an irreconcilable shortfall despite the existence of a dispute with that other person about the unreconciled item. In those circumstances, the firm is not required to make good the shortfall but is expected to take reasonable steps to resolve the position with the other person.
66
What does section 7.6.2 and 7.6.6 of the client money rules state?
ule 7.6.2 states that:
A firm must maintain its records and accounts in a way that ensures their accuracy, and in particular their correspondence to the client money held for clients. And Rule 7.6.6 explains the role that reconciliation plays in meeting these requirements:
1. Carrying out internal reconciliations of records and accounts of the entitlement of each client for whom the firm holds client money with the records and accounts of the client money the firm holds in client bank accounts and client transaction accounts should be one of the steps a firm takes to satisfy its obligations under CASS 7.6.2 R, and where relevant SYSC 4.1.1 R and SYSC 6.1.1 R.
2. A firm should perform such internal reconciliations:
a. As often as necessary; and
b. As soon as reasonably practicable after the date to which the reconciliation relates; to ensure the accuracy of the firms records and accounts.
c. The standard method of internal client money reconciliation sets out a method of reconciliation of client money balances that the FSA believes should be one of the steps that a firm takes when carrying out internal reconciliations of client money
67
What do rules 7.6.14 and 7.6.15 state regarding discrepancies?
Rules 7.6.14 and 7.6.15 sets out what the firm’s obligations are if it finds a discrepancy in such reconciliation.
Rule 7.6.14 states:
‘When any discrepancy arises as a result of the reconciliation between a firm’s internal records and those of third parties that hold client money, the firm must identify the reason for the discrepancy and correct it as soon as possible, unless the discrepancy arises solely as a result of timing differences between the accounting systems of the party providing the statement or confirmation, and that of the firm.’
And Rules 7.6.15 states:
‘While a firm is unable to resolve a difference arising from a reconciliation between a firm’s internal records and those of third parties that hold client money, and one record or a set of records examined by the firm during its reconciliation indicates that there is a need to have a greater amount of client money or approved collateral than is in fact the case, the firm must assume, until the matter is finally resolves, that the record or set of records is accurate and pay its own money into a relevant account’.
68
What risks is the firm exposed to by not carrying out adequate external reconciliation?
1. Fraudulent activity by its employees or others – this is the reason that the FSA recommends that ‘Whenever possible, a firm should ensure that reconciliations are carried out by a person (for example an employee of the firm) who is independent of the production or maintenance of the records to be reconciled’.
2. Losses due to processing errors made within the firm
3. Losses due to processing errors made outside the firm, for example, by settlement agents and trading parties
69
What sort of transactions might a settlement agent make against a firms account?
bank charges and interest. When these appear they must be posted into the general ledger by means of a journal voucher.
70
How often do large firms reconcile their settlement agents bank statements?
Daily
71
What types of swift messages are used in reconciliation?
MT950
Statement message
To reconcile nostro balances and transactions
- ------
MT940
Customer Statement message
To reconcile nostro balances and transactions
- ------
MT535
Statement of Holdings
To reconcile the balances of each security at the depot
--------
MT536
Statement of Transactions
To reconcile the actual settlements of stock that have taken place at the depot
- -------
72
How are settlement instructions usually transmitted?
Swift messages
Proprietary standard message developed by settlement agent
Email, fax, telex
73
What value is the settle within tolerance threshold applied by Euroclear bank (ICSD)
USD 25.00
74
Do SLIs usually act as agent or principal?
Usually principal, they make a small margin on collateral interest rates and stock lending fees
75
What are the separate accounts known as where client assets are held by firms?
Nominee accounts
76
What does PRIN 10 stipulate?
PRIN 10, states ‘A firm must arrange adequate protection for client’s assets when it is responsible for them’.
77
Describe CASS 6.4.1
1. A firm must not enter into arrangements for securities financing transactions in respect of safe custody assets held by it on behalf of a client or otherwise use such safe custody assets for its own account or the account of another client of the firm unless:
a. The client has given express prior consent to the use of the safe custody assets on specified terms; and
b. The use of that client’s safe custody assets is restricted to the specified terms to which the client consents
2. A firm must not enter into arrangements for securities financing transactions in respect of safe custody assets held by it on behalf of a client in an omnibus account held by a third party, or otherwise use safe custody assets held in such an account for its own account or for the account of another client unless, in addition to the conditions set out in 1.
a. Each client whose safe custody assets are held together in an omnibus account has given express prior consent in accordance with (1)(a) or
b. The firm has in place systems and controls which ensure that only safe custody assets belonging to clients who have given express prior consent in accordance with the requirements of (1)(a) are used.
3. For the purposes of obtaining the express prior consent of a retail client under this rule, the signature of the retail client or an equivalent alternative mechanism is required.
The effect of these rules is that client assets may not be used in stock lending or repo transactions without the express written agreement of the client concerned.
78
What are the IT implications for firms participating in stock loans and repos?
1. Manage collateral – that is to say they have to be able to:
a. Revalue securities to ensure that the collateral placed or received is adequate
b. Send messages to, and receive messages from, counterparties about collateral
requirement changes
2. Send the relevant instructions to settlement agents to settle the transactions
3. Calculate collateral interest charges and stock lending fees
4. Identify securities that are available to be used in stock lending and repo transactions and
5. Ensure that the investment and custody records correctly reflect which holdings are out on
loan. This will ensure that holding on loan are not sold accidentally and that client reporting accurately reflects this.
79
In which IT system are stock lending facilities normally found?
The settlement system
80
In what system is a cash flow projection model normally found?
Settlement system
81
What is another name for a cash flow projection module?
Maturity ladder
82
How many days is typically covered by a maturity ladder?
5 working days
83
Describe the interfaces of the settlement system.
1. It holds much of the reference data
2. It takes in real-time trade fees from the various front office systems and enriches them with
reference data, such as:
a. SSIs for trading parties and the firm itself
b. Rules and parameters to calculate trade proceeds, trade interest commission, fees
and expenses
3. It then decides on the appropriate format and delivery method of the settlement
instruction messages and transmits those messages to settlement agents
4. Between trade date and settlement date it receives status update messages from
settlement agents and updates its database with the latest trade statuses advised by the agents, it will then provide facilities for back office personnel to monitor potential settlement failures which may arise because of missing or incorrect SSIs, incorrect or
missing settlement instructions sent out, shortages of stock to deliver, etc.
5. On settlement date, it receives messages from the settlement agents informing it which
trades have either fully settled or partially settled, and updates its database with the outcome of those messages. It then provides the operations personnel with facilities to monitor and control actual settlement failures i.e. trades that have not settled by contractual value date
6. It provides facilities for the firm to manage its funding by means of management reports, such as a maturity ladder
7. The settlement system usually performs interest accruals
8. It feeds data to the corporate general ledger system, the regulatory accounting system,
and the reconciliation system
9. Depending on the configuration details at the individual firm, either the front office system
or the settlement system will handle regulatory trade reporting and central matching
10. It will usually be the system that controls corporate actions, dividends and coupon
processing, option expiry and exercise, etc.
11. It is usually the system that controls the mark-to-market activity
12. It may also supply data to a system or service designed to calculate VaR
13. It will also supply the firm’s management with a wide variety of management information,
such as statistics about settlement failures, their reasons and cost. These may be needed by asset class trading book, settlement agent, or any combination of these entities
84
What system normally performs interest accruals?
The settlement system
85
For what type of trades does the settlement system require to calculate the accrued interest?
Purchase / sale of bonds
Stock borrowing, lending and repos
Money market loans or deposits
86
What is interest accrual
Accounting for the interest that will be paid on the next coupon date (bond) or the termination date (stock loans/repos/money market loans and deposits)
Definition Accrual is an accounting term it is defined as a method of accounting in which each item is entered as it is earned or incurred, regardless of when actual payments are received or made.
Accrued interest is defined as the interest that has accumulated on a transaction since the last interest payment date or start date, up to BUT NOT INCLUDING the current date.
87
What does the mark to market process stipulate for the posting of accrued interest amounts?
A firm needs to account for this interest expense each day that it occurs, not all in one amount at the end of the loan period.
1. It is the convention that no interest is payable or receivable on the start date of a transaction but is payable at the end date.
2. The daily accrual convention is one day’s interest on Mondays through Thursdays, and three days interest is to be accrued on Fridays unless any or all of the days of the weekend following fall into the next month. If that is the case, the system should accrue to the month- end date. If there were a public holiday on the Monday following, then four days interest would be accrued on the Friday unless the Monday fell into the next calendar moth,
3. The firm's financial month-end date of could fall on a weekend, then the firm would account for the total interest up to the month end
88
Name the three options for outsourcing swift connectivity to a third party
1. Shared connection
2. Service bureau - day to day operation
3. Member concentrator - provides additional business services - swift admin and invoicing
89
What type of APIs does SWIFTNet link incorporate?
XML based APIs ensures technical interoperability between users. It is licensed to members and software providers
It provides customer application to access SWIFTNet services
Local application to communicate with remote application
Local and remote to handle end-to-end integrity, authentication and confidentiality
Local and remote apps to retrieve info from trusted time service
Local and remote apps to support load balancing
Local and remote apps to communcate securely using SWIFTNet PKI
90
What does SWIFT key exchange ensure?
```
Authenticity
Integrity
Non repudiation
Confidentiality
Access control
```
91
How is access control handled by SWIFT?
The access for an individual to their private key, stored in a smart card, is controlled through a private password.
92
What are SWIFT messages typically used for?
Sending settlement instructions, order messages, confirmations, affirmations. Etc
93
What are the typical stages in sending a SWIFT settlement instruction?
1. Trades are captured in the relevant front office system and forwarded to the firm’s settlement system
2. The settlement system enriches the trade with SSI details, and any other relevant reference data, and formats a settlement instruction message. This, in turn, is forwarded to the firm’s SWIFT Gateway application, where:
a. The Gateway product validates the trade according to SWIFT’s network validation rules which deal with field specifications (e.g. whether alpha or numeric content is required, whether fields are mandatory, or optional etc.). If a message fails validation then it is sent to a repair queue.
b. The Gateway product provides facilities for manual authorisation of this instruction before it is sent out. The firm is able to set up business rules in the Gateway product to control policies, e.g. the firm may require more levels of authorisation for FoP.
c. The Gateway product allows direct input through a user interface. This allows users to set up business rules in the Gateway product, manually authorise transactions and repair transactions when necessary.
d. Once the message has been validated and authorised, it is then encrypted and sent to SWIFT, The message will, in fact, be received at one of SWIFT’s European hubs (there is more than one of these for business resilience reasons), but this fact is transparent to the sender.
Validated
Authorised / manually repaired if necessary
Encrypted
Sent
94
What steps are carried out on a SWIFT message when received by SWIFT?
At SWIFT
1. The message is received at the European hub, and time-stamped with the date and time of receipt
2. It is then network-validated. If network validation is successful, SWIFT sends an ACK message back to the sender confirming that it is able to process the message. If the message fails network validation, then SWIFT sends a NACK (not acknowledged) message back to the sender. This process is known as ACK/NACK protocol.
3. Once ‘ACK’d, swift identifies that this message is destined for a firm in Tokyo, so it forwards it to one of its Asia Pacific hubs in real-time.
4. The Asia Pacific hub then verifies whether the Tokyo firm is online to SWIFT. If it is, it forwards it to the member; if the member is not online, it stores the message until it detects that the member firm is online.
Received/time stamped
Network validated ACK/NACK
Forwarded to appropriate hub
Forwarded to firm if online
95
What steps are carried out by a receiving firm on a swift message?
1. The message is received at this member firm’s Gateway system and decrypted.
2. The Gateway system then uses business rules that have been set up in this system to tell it
what to do with the message. For example, if it is a settlement instruction message sent by one of the firm’s custody clients, it may need to be forwarded to one business application. If it is an FX trade confirmation, sent by a counterparty, it may need to be forwarded to another business application.
3. There will be some messages where the identity of the destination system will not be clear to the Gateway system. This may be due to the quality of the data in the incoming message, lack of clarity and coverage in the business rules entered into the Gateway system, or for some other reason. For this reason Gateway systems provide a human interface that incorporates the ability to display messages held in a repair queue and manually dispose of them, as well as the ability to input the business rules in the first place.
Received/decrypted
Processing decisions made
Allow manual interface to address messages in repair queue
96
Which organisation has been appointed as the registration authority for financial services messages?
SWIFT
97
How are FIN messages represented
Tagged data
98
What are FIN messages often referred to as?
MT messages
99
What is the SWIFT standards guide?
SWIFT distributes SWIFT Standards Guide to all its members; this provides the rules for interpretation of an incoming message and the population of an outgoing message, as well as the network validation rules that apply to the message type.
100
What is the ISO standard for tagged data messages in SWIFT
ISO 7775
101
What is the ISO standard for data dictionary data in SWIFT messages?
ISO 15022
102
What is the ISO standard for SWIFT XML based messages, also known as SWIFTML or MX series messages?
ISO 20022
| Uses a data dictionary and XML standards
103
What is ISO 20022?
An enhanced approach to standards based on business entity interaction, behavioural models, and XML schema based message data models for the transactional messages supporting these models.
104
What standard have all messages developed by SWIFT since 2004 been based on?
ISO 20022
105
How can corporate customers communicate via swift with their banks who are swift members?
SCORE
| MA-CUG
106
What is SWIFTNet FileAct?
This is SWIFT’s interactive communications service that is utilised for the sending of files between parties, and, in effect, will supersede the existing FIN service, for example, providing support for the transmission of mass payments or reporting information. Although, it is file-based, the initiator of the file transfer will also send a request first, and wait for the response across the IP network before sending the file and waiting for the subsequent acknowledgement, in this way; it can be shown to be an interactive service.
107
What is SWIFTNet InterAct
This is SWIFT’s interactive communications service that is based on the exchange of request and response messages between two parties. The exchange of messages can be either synchronous or asynchronous. Effectively, this means that it can be used either for direct application-to-application transactional messaging, as is the case of CLS Bank which is based on this service; or it can be utilised in a ‘push’ architecture to provide real-time status and other information. This will also form the basis of the successor to the FIN service.
108
What is the FIX protocol?
The Financial Interface eXchange (FIX) protocol was initiated in 1992 by a group of institutions and brokers interested in streamlining their trading process. It is an open message standard, controlled by no single entity, that can be structured to match the business requirements of each firm.
FIX does not impose a single type of carrier (e.g. it will work with leased lines, private networks, internet, etc.), nor a single security protocol. It is, however, important to note that FIX is not a network in itself and that communication is made directly between each broker/institution pair by prior bilateral agreement. Thus a fund management institution may have 50 or 60 connections to brokers worldwide, some via the internet, others via direct dial or leased connections, and still others connected via private networks such as Omgeo or Autex.
In summary, each broker/institution connection can be thought of as a two-way conversational link taking place between applications at each end. These applications are often referred to as FIX engines and can operate either as stand-alone or fully integrated solutions.
The structure of the organisation is based around a series of committees comprised of interested parties within the broking and institutional communities. These committees are focused on business, technical and regional issues, with working groups examining the impact of new technology, such as XML, and potential expansion of the protocol to cover other users, such as exchanges and Electronic Crossing Networks (ECN).
The protocol is defined at two levels: session and application. The session level is concerned with the delivery of data, while the application level defines business-related data content. Broadly, business messages cover the communication between brokers and institutions of the following information:
1. Indications of interest
2. Orders and order acknowledgement
3. Fills
4. Account allocations
5. News, email, program trading lists; and
6. Administrative messages
The protocol has been deliberately designed to support both domestic and cross-border trading in a varied spread of instrument and security types, such as:
1. Equities
2. Bonds
3. Depositary Receipts
4. Derivatives
5. Futures
6. Foreign exchange-trading
Because the FIX standards are ‘open source’, they may be downloaded from the FIX protocol website (www.fixprotocol.org)
109
What is FpML?
FpML (Financial products Markup Language) is an XML message standard for the OTC derivatives industry.
All categories of privately negotiated derivatives will eventually be included within the standard. The standard is managed by the ISDA on behalf of a community of investment banks that make a market in OTC derivatives. The standard is freely licensed, so any firm that trades the instruments that it supports may use it in their own software.
The current version is Version 5, Service Pack 2, which was released in April 2009. The core scope includes the products of Foreign Exchange (FX), Swaps, and Options, Interest Rate Swaps, Inflation Swaps, Asset Swaps, Swaptions, Credit Default Swaps, Credit Default Swap Indices, Credit Default Swap Baskets, Tranches on Credit Default Swap Indices, Equity Options, Equity Swaps, Total Return Swaps and many others. The core processes include trading, valuation, confirmation, novations, increases, amendments, terminations, allocations, position reporting, cash flow matching, a formal definition of party roles, as well as trade notification between asset managers and custodians.
FpML is distinct from similar financial standards such as SWIFT because it provides no network or specification of a transport mechanism.
110
What is XBRL?
XBRL is an abbreviation for Extensible Business Reporting Language. This is an XML message standard for exchanging information about corporate data such as balance sheets and profit and loss accounts between the company concerned and its auditors, regulators, customers, research analysts and other interested parties. XBRL standards are compatible with ISO 20022.
Historically the standard has been used only to transmit accounting data, but there are now moves to adopt it as a standard for the company concerned to announce corporate action data to the securities markets.
111
What is Python and what is it's proposed usage in the securities industry?
Python is an open-source, dynamic programming language that is used in a wide variety of application domains. It is available for all major operating systems: Windows, Linux/Unix, OS2 and Mac among others.
In 2010, the US Securities and Exchange Commission (SEC) published a proposal that, among other things, outlined the implementation and use of a Python program that would annotate asset-backed securities, allowing potential investors to have periodic access to an ABS’s pool asset performance, including the interest rate, level of prepayments, defaults and losses-given-defaults.
The Waterfall computer program as it is called in the proposal would provide potential investors with detailed information about these securities. By doing so, the program would effectively reduce (but not eliminate) an investors’ dependency on third-party analysis by providing updated information typically available only in the prospectus. This means that those investment banks that issue asset-backed securities would need to use the Waterfall program to provide updated information to investors.
112
What is R and what are its typical uses?
R
R is an open-source programming language and software environment for statistical computing and graphics. The R language has become a de facto standard among statisticians for developing statistical software, and is widely used for statistical software development and data analysis. Itcontains a number of built-in mechanisms for organising data, running calculations on the information and creating graphical representations of data sets. Statisticians, engineers and scientists are free to improve the software’s code or write variations for specific tasks. Packages written for R add advanced algorithms, coloured and textured graphs, and mining techniques to dig deeper into databases.
113
What typed of data must firms reconcile?
1. Cash accounts connected with all types of transaction
2. Cash balances that arise from all types of transaction
3. Stock and derivative quantities connected with all types of transaction
4. Stock and derivative balances (positions) that arise from all types of transaction
114
What is internal reconciliation?
Internal reconciliation is the act of reconciling data held in one of the firm’s business applications (such as its settlement system) with data held on one or more of its other business application systems.
115
What is external reconciliation?
External reconciliation is the act of reconciling data, such as cash movements on nostro accounts and stock movements on depot accounts, with the settlement agents that operate those accounts on the firm’s behalf.
116
What is CASS 6.5.4?
CASS 6.5.4 – reconciliation basic rules
1. Carrying out internal reconciliations of the safe custody assets held for each client with the safe custody assets held by the firm and third parties is an important step in the discharge of the firms’ obligations.
2. A firm should perform such internal reconciliations:
a. As often as necessary, and
b. As soon as reasonably practicable after the date to which the reconciliation relates to ensure the accuracy of the firm’s records and accounts
c. Reconciliation methods which can be adopted for these purposes include the ‘total count method’ which requires that all safe custody assets be counted and reconciled as at the same date.
3. If a firm chooses to use an alternative reconciliation method (for example the ‘rolling stock method’) it needs to ensure that:
a. All of a particular safe custody asset are counted and reconciled as at the same date; and
b. All safe custody assets are counted and reconciled during a period of six months
117
What is CASS 6.5.5
CASS 6.5.5 – alternative method
A firm that uses an alternative reconciliation method must first send a written confirmation to the UK regulator from the firm’s auditor that the firm has in place systems and controls which are adequate to enable it to use the method effectively.
118
What is CASS 6.5.6
CASS 6.5.6 – third party reconciliation
A firm must conduct, on a regular basis reconciliations between its internal accounts and records,
and those of any third parties by whom those safe custody assets are held.
119
What is CASS 6.5.7
CASS 6.5.7 – ensure reporting by third party
Where a firm deposits safe custody assets belonging to a client with a third party, in complying with the requirements of CASS 6.5.6, the firm should seek to ensure that the third party will deliver to the firm, a statement as at a date of dates specified by the firm which details the description and amounts of all the safe custody assets credited to the account, and that this statement is delivered in adequate time to allow the firm to carry out the periodic reconciliations required in CASS 6.5.6.
120
What is CASS 6.5.8
CASS 6.5.8 – basic rules reconciliation with third party – frequency / timing
A firm should perform the reconciliation required by CASS 6.5.6:
1. As regularly as necessary, and
2. As soon as reasonably practicable after the date to which the reconciliation relates:
To ensure the accuracy of its internal accounts and records against those of third parties by whom
safe custody assets are held.
121
What is CASS 6.5.9
CASS 6.5.9 – independent person
Whenever possible, a firm should ensure that reconciliations are carried out by a person (for example an employee of the firm) who is independent of the production or maintenance of the records to be reconciled.
122
What is CASS 6.5.10
CASS 6.5.10 – correction of discrepancies
A firm must promptly correct any discrepancies which are revealed in the reconciliations envisaged by this section, and make good, or provide the equivalent of any unreconciled shortfall for which there are reasonable grounds for concluding that the firm is responsible.
123
What is CASS 6.5.11
CASS 6.5.11 – suspense / error account considerations
Items recorded or held within a suspense or error account fall within the scope of discrepancies
124
What is CASS 6.5.12
CASS 6.5.12 – shortfall responsibilities
A firm may, where justified, conclude that another person is responsible for an irreconcilable shortfall despite the existence of a dispute with that other person about the unreconciled item. In those circumstances, the firm is not required to make good the shortfall but is expected to take reasonable steps to resolve the position with the other person.
125
What does section 7.6.2 and 7.6.6 of the client money rules state?
ule 7.6.2 states that:
A firm must maintain its records and accounts in a way that ensures their accuracy, and in particular their correspondence to the client money held for clients. And Rule 7.6.6 explains the role that reconciliation plays in meeting these requirements:
1. Carrying out internal reconciliations of records and accounts of the entitlement of each client for whom the firm holds client money with the records and accounts of the client money the firm holds in client bank accounts and client transaction accounts should be one of the steps a firm takes to satisfy its obligations under CASS 7.6.2 R, and where relevant SYSC 4.1.1 R and SYSC 6.1.1 R.
2. A firm should perform such internal reconciliations:
a. As often as necessary; and
b. As soon as reasonably practicable after the date to which the reconciliation relates; to ensure the accuracy of the firms records and accounts.
c. The standard method of internal client money reconciliation sets out a method of reconciliation of client money balances that the FSA believes should be one of the steps that a firm takes when carrying out internal reconciliations of client money
126
What do rules 7.6.14 and 7.6.15 state regarding discrepancies?
Rules 7.6.14 and 7.6.15 sets out what the firm’s obligations are if it finds a discrepancy in such reconciliation.
Rule 7.6.14 states:
‘When any discrepancy arises as a result of the reconciliation between a firm’s internal records and those of third parties that hold client money, the firm must identify the reason for the discrepancy and correct it as soon as possible, unless the discrepancy arises solely as a result of timing differences between the accounting systems of the party providing the statement or confirmation, and that of the firm.’
And Rules 7.6.15 states:
‘While a firm is unable to resolve a difference arising from a reconciliation between a firm’s internal records and those of third parties that hold client money, and one record or a set of records examined by the firm during its reconciliation indicates that there is a need to have a greater amount of client money or approved collateral than is in fact the case, the firm must assume, until the matter is finally resolves, that the record or set of records is accurate and pay its own money into a relevant account’.
127
What risks is the firm exposed to by not carrying out adequate external reconciliation?
1. Fraudulent activity by its employees or others – this is the reason that the FSA recommends that ‘Whenever possible, a firm should ensure that reconciliations are carried out by a person (for example an employee of the firm) who is independent of the production or maintenance of the records to be reconciled’.
2. Losses due to processing errors made within the firm
3. Losses due to processing errors made outside the firm, for example, by settlement agents and trading parties
128
What sort of transactions might a settlement agent make against a firms account?
bank charges and interest. When these appear they must be posted into the general ledger by means of a journal voucher.
129
How often do large firms reconcile their settlement agents bank statements?
Daily
130
What types of swift messages are used in reconciliation?
MT950
Statement message
To reconcile nostro balances and transactions
- ------
MT940
Customer Statement message
To reconcile nostro balances and transactions
- ------
MT535
Statement of Holdings
To reconcile the balances of each security at the depot
--------
MT536
Statement of Transactions
To reconcile the actual settlements of stock that have taken place at the depot
- -------
