Acknowledgements xxiii

Part One

Chapter 1

Introduction to Operations 3

1.1 Introduction 3

1.2 Organisational Structure of an Investment Company 5

1.2.1 Front Office 5

1.2.2 Middle Office 6

1.2.3 Back Office/Operations 9

1.3 Operations’ Relationships 10

1.3.1 Clients – External 10

1.3.2 Clients – Internal 11

1.3.3 Counterparties 11

1.3.4 Suppliers 12

1.3.5 The Authorities 12

1.4 Other Business Functions 13

1.5 Summary 15

Chapter 2

Financial Instruments 17

2.1 Introduction 17

2.2 Why Do We Issue Financial Instruments? 18

2.3 Money Market Instruments 19

2.3.1 Euro-Currency Deposits 19

2.3.2 Certificates of Deposit 23

2.3.3 Commercial Paper 23

2.3.4 Treasury Bills 25

2.4 Debt Instruments 26

2.4.1 A Bond Defined 26

2.4.2 Bond Issuance 27

2.4.3 Types and Features of Bonds 27

2.4.4 Other Key Characteristics of Bonds 28

2.4.5 Types of Bond 29

2.4.6 Form of Bonds and Interest Payment 30

2.4.7 Maturity and Redemption Provisions 31

2.4.8 Calculations 32

2.4.9 Accrued Interest 33

2.4.10 First Short Coupon 37

2.4.11 First Long Coupon 38

2.5 Equity Instruments 38

2.5.1 Equity Defined 38

2.5.2 Classes of Equity 41

2.5.3 Equity Issuance 43

2.5.4 Pricing and Calculations 44

2.5.5 Examples of Local Taxes 45

2.5.6 Disclosure 45

2.5.7 Summary of Cash Market Instruments 46

2.6 Derivative Instruments 47

2.6.1 Introduction 47

2.6.2 Definitions 48

2.6.3 Derivative Usage 49

2.7 Exchange-Traded Derivatives 52

2.7.1 Introduction 52

2.7.2 The Role of the Derivatives Exchanges 53

2.7.3 Major Derivatives Exchanges 53

2.7.4 Open Interest and Trading Volumes 56

2.7.5 Futures 58

2.7.6 Options 64

2.7.7 Summary of Exchange-Traded Derivatives 71

2.8 OTC Derivatives 71

2.8.1 Introduction 71

2.8.2 Forwards 72

2.8.3 Swaps 76

2.8.4 Summary of OTC Derivatives 80

2.9 Summary 81

2.9.1 Financial Products in General 81

2.9.2 Cash Markets 81

2.9.3 Derivatives Markets 81

Chapter 3

Data Management 83

3.1 Introduction 83

3.2 Importance of Reference Data and Standardisation 84

3.2.1 Introduction 84

3.2.2 Basic Securities Transactions 84

3.3 Types of Reference Data 86

3.3.1 Required Reference Data 86

3.3.2 Data Requirements – Securities 87

3.3.3 Data Requirements – Counterparties and Customers 91

3.3.4 Data Requirements – Settlement Information 92

3.3.5 Sources of Reference Data 93

3.4 Data Management 94

3.4.1 What is Data Management? 94

3.4.2 Approaches to Data Management 94

3.4.3 Data Processing 95

3.5 Legal Entity Identification 95

3.5.1 Background to Legal Entity Identification 95

3.5.2 The “Legal Entity” 96

3.5.3 The Global Legal Entity Identifier System (GLEIS) 96

3.5.4 LEI Structure 97

3.6 Summary 99

Chapter 4

Market Participation 101

4.1 Introduction 101

4.2 Market Players 102

4.2.1 Retail Clients 102

4.2.2 Institutional Clients 103

4.2.3 Banks 115

4.2.4 Sell-Side Intermediaries 126

4.2.5 Market Regulators and Market Associations 129

4.3 Market Structure 131

4.3.1 Introduction 131

4.3.2 Regulated Markets 131

4.3.3 Alternative Trading Venues 135

4.3.4 Over-the-Counter Market 136

4.4 Summary 137

Part Two

Chapter 5

Clearing Houses and CCPs 141

5.1 Introduction 141

5.2 Overview of Clearing and Settlement 142

5.3 The Clearing House Model 143

5.4 The Central Counterparty Model 145

5.4.1 Risk Management 147

5.5 Features of CCPs and Clearing Houses 148

5.5.1 The Committee for Payment and Settlement Systems’ Statistics 148

5.6 Summary 150

Chapter 6

Securities Depositories (CSDs and ICSDs) 151

6.1 Introduction 151

6.2 Historical Context 151

6.3 Definitions 154

6.3.1 Domestic (Local/National) CSDs 154

6.3.2 International CSDs 154

6.4 Central Securities Depositories 154

6.4.1 Features of CSDs and ICSDs 154

6.4.2 Functions of CSDs 155

6.4.3 The Changing World of CSDs 158

6.4.4 CSD Links and Interoperability 161

6.5 International Central Securities Depositories 163

6.5.1 Background 163

6.5.2 Features of the ICSDs 164

6.5.3 Clearstream Banking Luxembourg (CBL) 164

6.5.4 Euroclear Bank (EB) 165

6.6 Linkages – Exchanges, Clearing Systems and CSDs 167

6.6.1 United States of America 168

6.6.2 Europe 169

6.6.3 Rest of the World 170

6.7 CSD Associations 171

6.7.1 Introduction 171

6.7.2 Americas’ Central Securities Depositories Association (ACSDA) 171

6.7.3 Asia-Pacific CSD Group (ACG) 171

6.7.4 Association of Eurasian Central Securities Depositories (AECSD) 172

6.7.5 European Central Securities Depositories Association (ECSDA) 172

6.7.6 Africa and Middle East Depositories Association (AMEDA) 172

6.8 Summary 173

Chapter 7

Securities Clearing 175

7.1 Introduction 175

7.2 Generic Clearing Cycle 176

7.2.1 Trade Capture 176

7.2.2 Trade Enrichment and Validation 177

7.2.3 Trade Reporting 177

7.2.4 Confirmation and Affirmation 178

7.2.5 Clearing Instructions 178

7.2.6 Forecasting – Cash 179

7.2.7 Forecasting – Securities 180

7.3 Trade Capture 182

7.3.1 Dealer’s Blotter 182

7.3.2 Trade Input 182

7.3.3 Trade Output 183

7.4 Trade Enrichment and Validation 184

7.5 Regulatory Reporting 186

7.5.1 Background 186

7.5.2 Transaction Reporting 186

7.5.3 Transaction-Reporting Mechanism 187

7.5.4 Trade Repositories 188

7.6 Confirmation and Affirmation 188

7.6.1 Confirmations 189

7.6.2 Affirmation 190

7.7 Clearing Instructions 194

7.7.1 Types of Instruction 194

7.7.2 Instruction Validation 196

7.7.3 Instruction Matching 196

7.8 Forecasting – Cash 199

7.8.1 Introduction 199

7.8.2 Timing Issues 199

7.8.3 Cash Forecasting Methodology 200

7.8.4 Funding Uncertainties 201

7.8.5 Benefits of Predictive Forecasting 202

7.9 Forecasting – Securities 203

7.9.1 Introduction 203

7.9.2 Securities that are Available for Delivery 204

7.9.3 Securities that are Not Available for Delivery 204

7.10 Summary 205

Chapter 8

Settlement and Fails Management 207

8.1 Introduction 207

8.2 The Different Types of Settlement 208

8.2.1 Gross Settlement 209

8.2.2 Net Settlement 210

8.3 Delivery versus Payment 211

8.3.1 Definition of DVP 212

8.3.2 DVP Models 213

8.3.3 Settlement Instructions for DVP 214

8.4 Free of Payment Settlement 215

8.4.1 Settlement Instructions for Free of Payment 215

8.4.2 Where Settlement Takes Place 216

8.4.3 Settlement Conventions 216

8.5 Settlement Fails 217

8.5.1 Overview of Settlement Failure 217

8.5.2 Why Transactions Fail to Settle 218

8.6 The Move to Shorter Settlement Cycles 228

8.6.1 Background 228

8.6.2 Project Status 228

8.7 Summary 229

Chapter 9

Derivatives Clearing and Settlement 231

9.1 Introduction 231

9.2 Regulatory Changes 232

9.2.1 Background 232

9.2.2 Financial Stability Board (FSB) 232

9.2.3 Reform Requirements 233

9.3 Exchange-Traded Derivatives Contracts 234

9.3.1 Introduction 234

9.3.2 Derivatives Exchange and Clearing System 235

9.3.3 Give-Up Agreements 235

9.3.4 Clearing Process 236

9.3.5 Margin Calculations 237

9.3.6 Initial Margin – Eligible Assets 239

9.4 Cleared OTC Derivatives Contracts 240

9.4.1 Types of OTC Derivative that are Cleared Centrally 241

9.4.2 Trading Platforms 242

9.4.3 Trade Repositories 244

9.4.4 Central Counterparties 244

9.5 Non-Cleared OTC Derivatives Contracts 245

9.5.1 Documentation 245

9.5.2 Non-Cleared OTCD Processing 248

9.5.3 Trade Capture 248

9.5.4 Confirmation 249

9.5.5 Settlement 250

9.5.6 Collateral 251

9.5.7 Event Monitoring 254

9.5.8 Reconciliation 254

9.6 Summary 255

Part Three

Chapter 10

Custody and the Custodians 259

10.1 Introduction 259

10.2 Custody 260

10.2.1 What is Custody? 260

10.2.2 Forms of Securities 260

10.2.3 Ownership Transfer – Bearer Securities 261

10.2.4 Ownership Transfer – Registered Securities 262

10.3 Holding Securities 263

10.3.1 Register in the Custodian’s Name 263

10.3.2 Nominee Account 264

10.3.3 CSD Nominee 266

10.3.4 Safekeeping Methods – Summary 267

10.4 The Custodians 267

10.4.1 Custody in a Local Market 267

10.4.2 Custody in Global Markets 271

10.4.3 Custody in the EuroMarkets 277

10.5 Target2Securities (T2S) 279

10.5.1 Introduction 279

10.5.2 Eurosystem 280

10.5.3 How T2S Will Work 281

10.5.4 Migration Plan 282

10.5.5 Further Information 282

10.6 Summary 283

Chapter 11

Corporate Actions 285

11.1 Introduction 285

11.2 Types of Corporate Action Event 286

11.2.1 Voluntary or Mandatory Events 286

11.2.2 Predictable or Announced Events 287

11.3 Participation in Corporate Actions 287

11.3.1 Fund Manager 287

11.3.2 Global Custodian 287

11.3.3 Local/Sub-Custodian 288

11.3.4 Local Central Securities Depository 288

11.3.5 International Central Securities Depository 288

11.3.6 Data Vendors 288

11.3.7 Receiving/Paying Agent 288

11.4 Entitlements, Key Dates and Claims 289

11.4.1 Entitlement 289

11.4.2 Record Date 290

11.4.3 Ex-Dividend Date 290

11.4.4 Payment Date 292

11.4.5 Claims 292

11.4.6 Key Dates for Bonds 294

11.5 Corporate Action Event Processing 294

11.5.1 Introduction 294

11.5.2 Cash Dividend 296

11.5.3 Optional Stock Dividend 298

11.5.4 Fixed-Income Bond Coupon 300

11.5.5 Floating-Rate Note (FRN) Coupon and Rate Reset 302

11.5.6 Bond Redemption 305

11.5.7 Bond Conversion 307

11.5.8 Capitalisation (Bonus) Issue 309

11.5.9 Rights Issue 310

11.5.10 Other Examples of Event Types 314

11.6 Information Flows 315

11.6.1 Introduction 315

11.6.2 The Communication Problem 315

11.6.3 Global Communication Chain 316

11.6.4 Local Communication Chain 318

11.6.5 International Central Securities Depository Chain 319

11.6.6 Summary 320

11.7 Corporate Action Risks 320

11.7.1 Introduction 320

11.7.2 Data/Information Capture Risk 321

11.7.3 Replacement Risk 322

11.7.4 Decision-Making/Election Risk 322

11.7.5 Reputational Risk 322

11.7.6 Reconciliation Risk 323

11.8 Industry Initiatives 323

11.8.1 Introduction 323

11.8.2 The International Securities Services Association (ISSA) 323

11.8.3 Giovannini Group 324

11.8.4 European Central Securities Depositories Association (ECSDA) 325

11.9 Corporate Governance and Proxy Voting 328

11.9.1 Introduction 328

11.9.2 Relations with Shareholders 328

11.9.3 Proxy Voting 329

11.9.4 Relations with Preference Shareholders 331

11.9.5 Relations with Bondholders 331

11.9.6 Company in Bankruptcy or Administration 331

11.9.7 Disclosure Reporting 332

11.10 Withholding Tax 333

11.10.1 Introduction 333

11.10.2 The Problem of Double Taxation 335

11.10.3 Double Taxation Treaties 335

11.10.4 Tax Reclaims 336

11.11 Impact on Other Departments 337

11.11.1 Introduction 337

11.11.2 Front Office 337

11.11.3 Clients 338

11.11.4 Settlements 338

11.11.5 Securities Lending and Borrowing 338

11.11.6 Reconciliations 339

11.11.7 Pricing and Valuation 339

11.11.8 Reference Data 340

11.12 Summary 340

Appendix 11.1: Corporate Action Event Type Categories 340

Appendix 11.2: Voluntary and Mandatory Events for Equities and Bonds 341

Chapter 12

Securities Financing 343

12.1 Introduction 343

12.2 Types of Securities Financing 344

12.2.1 Securities Lending and Borrowing 344

12.2.2 Repurchase Agreements 344

12.2.3 Sell/Buy-Backs 345

12.2.4 Summary of Securities Financing Transactions 345

12.3 The Players and Their Motivations 346

12.3.1 Introduction 346

12.3.2 The Buy Side 346

12.3.3 The Sell Side 347

12.3.4 Borrowing to Cover Short Positions 348

12.3.5 Borrowing Cash to Finance Inventory 349

12.3.6 Temporary Transfer of Ownership 350

12.3.7 Summary 352

12.4 Intermediaries 352

12.4.1 The Relationship between Lender and Borrower 352

12.4.2 Agent Intermediaries 352

12.4.3 Principal Intermediaries 353

12.4.4 Choices for the Lenders and Borrowers 353

12.5 Agreements and Code of Guidance 354

12.5.1 Introduction 354

12.5.2 Securities Lending Agreements 354

12.5.3 Repurchase Agreements 355

12.5.4 Code of Guidance 356

12.6 Securities Lending Lifecycle 356

12.6.1 Phase 1: Loan Initiation 357

12.6.2 Phase 2: Loan Maintenance 361

12.6.3 Phase 3: Loan Closure 367

12.6.4 Lending Fees 368

12.7 Repurchase Agreement Lifecycle 370

12.7.1 Motivations 370

12.7.2 Repurchase Agreement Types 371

12.7.3 Sell/Buy-Backs 374

12.7.4 Settlement 376

12.8 Collateral and Margin 379

12.8.1 Terminology 379

12.8.2 Types of Collateral 380

12.8.3 Repurchase Agreements (and Sell/Buy-Backs) 380

12.8.4 Securities Lending 381

12.8.5 Delivery by Value (DBV) 381

12.8.6 Repo Exposure, Haircuts and Margin 382

12.9 Default and Close-Out Provisions 384

12.9.1 Introduction 384

12.9.2 Event of Default 384

12.9.3 Consequences of an Event of Default 385

12.10 Central Counterparty (CCP) Services 386

12.10.1 Introduction 386

12.10.2 The Options Clearing Corporation (OCC) 386

12.10.3 Eurex Clearing 387

12.10.4 LCH.Clearnet 387

12.10.5 Clearstream Banking Luxembourg (CBL) 388

12.10.6 Euroclear Bank 388

12.11 Summary 389

Appendix 12.1: Credit Ratings – Long Term 390

Appendix 12.2: Delivery by Value (DBV) Class List 391

Appendix 12.3: Technology Vendors 392

Part Four

Chapter 13

Accounting for Securities 395

13.1 Introduction 395

13.1.1 Accounting and Why We Need It 395

13.2 The Accounting Equation 397

13.2.1 Key Financial Statements 397

13.3 The Accounting Lifecycle for Securities 400

13.3.1 Introduction 400

13.3.2 Trade Date 401

13.3.3 Settlement Date 402

13.3.4 Revaluation 403

13.4 Gains and Losses 405

13.4.1 Introduction 405

13.4.2 Fair Value (Mark-to-Market) 405

13.4.3 Amortised Cost 407

13.4.4 Calculation Conventions 410

13.5 The Accounting Lifecycle for Derivatives 411

13.5.1 Introduction 411

13.5.2 Exchange-Traded Derivatives 412

13.5.3 OTC Derivatives 415

13.6 Summary 416

Appendix 13.1: Closing Prices for Singapore Equities (SGX) 416

Chapter 14

Reconciliation 417

14.1 Introduction 417

14.2 Importance of Reconciliation 418

14.2.1 Internal vs. External Records 418

14.2.2 Ownership vs. Location 419

14.3 Types of Reconciliation 421

14.3.1 Reconciliation Methods 422

14.3.2 Reconciliations – Worked Examples 423

14.4 Automation of Reconciliations 427

14.5 Summary 428

About the Author 429

Index 431