The life cycle of the TradeTrade Life Cycle

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-zon

e/trade-life-cycle-events

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