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Intro to Investment & Investment Banking

1 Settlement & Systems II


Temasek Polytechnic • School of Informatics & IT
Learning Objectives

By the end of the lecture students will be able to

 Demonstrate understanding of the trading business and its


supporting systems and processes
• Straight-through processing
• Client order

 Demonstrate understanding of payment and settlement


processes and systems
• Trade order flow and Standard Settlement Instructions
(SSI)
• Foreign exchange settlement and Continuous Linked
Settlement (CLS)

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Temasek Polytechnic • School of Informatics & IT
Straight-Through-Processing

Straight-Through-Processing (STP)
A set of workflows and systems that enable trade transactions to
move seamlessly through the processing cycle, without manual
intervention.

Source: Andrew Bradford, (2008). The Investment Industry for IT Practitioners. John Wiley & Sons. P46.

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Temasek Polytechnic • School of Informatics & IT
Straight-Through-Processing

Key Principles of STP


1. Transaction is input into the bank’s systems only once
2. Automated interfaces (links) between all systems
• Data will flow from one system to another
3. Transaction processing cycle consists of a set of logical
workflows. Each stage is dependant on the previous stage.
4. Intervention should be avoided; but systems be flexible to
handle exception cases efficiently.
5. Principles 1 to 4 also apply to systems between various
firms.

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Temasek Polytechnic • School of Informatics & IT
Learning Objectives

By the end of the lecture students will be able to

 Demonstrate understanding of the trading business and its


supporting systems and processes
• Straight-through processing
• Client order

 Demonstrate understanding of payment and settlement


processes and systems
• Trade order flow and Standard Settlement Instructions
(SSI)
• Foreign exchange settlement and Continuous Linked
5 Settlement (CLS)
Temasek Polytechnic • School of Informatics & IT
Client orders

What is a client order?


1. An instruction to buy or sell
2. A specific instrument
• stock, bond, currency etc

3. A specific quantity or money value


• Sell 1,000 DBS shares
• Buy EUR 500,000, Sell USD

4. At a specific price (relating to that instrument)


5. Stop loss – Sell when the market price falls to a certain level
6. “Good till cancelled” (“open order”) – No time limit to complete order
7. Expiry date – Cancel order if cannot complete by expiry date
8. “Fill or kill” – Order must be completed in full otherwise should be cancelled.
• Buy 6,000 UOB shares, order will be cancelled if broker can only obtains 3,000
shares

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Source: Microsoft Powerpoint clipart Temasek Polytechnic • School of Informatics & IT
Client Orders

Example 1: Client’s Order


Buy 10,000 DBS shares at $10.50 on 30 Dec 2008. Complete order.
Sell if drop till $8.00.

Order Type Buy


Instrument Type Shares – DBS
Quantity / Amount 10,000
Price $10.50
Stop-loss $8.00
Good till cancelled / Open order No
Expiry date 30 Dec 2008
Fill or kill Yes
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Temasek Polytechnic • School of Informatics & IT
Client Orders

Example 2: Client’s Order


Sell EUR50,000 buy USD at EUR/USD 1.44.

Order Type Sell


Instrument Type Currency - EUR
Quantity / Amount 50,000
Price EUR/USD 1.44
Stop-loss Not applicable
Good till cancelled / Open order Yes, no expiry
Expiry date No applicable
Fill or kill No

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Temasek Polytechnic • School of Informatics & IT
Learning Objectives

By the end of the lecture students will be able to

 Demonstrate understanding of the trading business and its


supporting systems and processes
• Straight-through processing
• Client order

 Demonstrate understanding of payment and settlement


processes and systems
• Trade order flow and Standard Settlement Instructions
(SSI)
• Foreign exchange settlement and Continuous Linked
9 Settlement (CLS)
Temasek Polytechnic • School of Informatics & IT
Trade Order Flow

Source: Andrew Bradford, (2008). The Investment Industry for IT Practitioners. John Wiley & Sons. P77.
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Temasek Polytechnic • School of Informatics & IT
Trade Order Flow

Stage 1: Investor places an order with broker


(A) Order placed electronically – automatically recorded in the broker’s
front-office system.
(B) Order placed via telephone – Broker needs to enter data into system.

Stage 2: Forward order to stock exchange order queue


(A) Usually done automatically by the broker’s front-office system. Human
intervention not required unless trading volume of not of normal
market size for the security.

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Temasek Polytechnic • School of Informatics & IT
Trade Order Flow

Stage 3: Exchange confirms execution


(A) Exchange sends message to broker’s front-office system to confirm
execution.
(B) System has a set of business rules to verify / validate orders.
(C) If there is a discrepancy, trade details are displayed and the relevant
parties will decide on actions to be taken.

Stage 4: Broker confirms execution to the investor


(A) Usually done automatically.

Stage 5: Investor checks process within own system


(A) No discrepancy, affirms back to broker.
(B) If there is a discrepancy, takes it up with broker. Usually human
intervention is required ie not automated.

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Temasek Polytechnic • School of Informatics & IT
Trade Order Flow

Stage 6: Trade details forwarded to back-office system


(A) Executed only upon completion of stage 5.

Stage 7: Sent settlement instructions to agent


(A) Acknowledgement from settlement agent is required.
(B) Broker will be informed of any potential problem which would delay
settlement. Eg, Seller do not have securities to deliver or buyer do not
have enough cash for settlement etc

Stage 8: Agent settles trade and reports to broker


(A) Usually done automatically.

Stage 9: Broker records that settlement has occurred

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Temasek Polytechnic • School of Informatics & IT
Standard Settlement Instructions
(SSIs)

Standard Settlement Instructions (SSIs)


• Main driver of STP process from trade agreement to final settlement.
• Provides details to all parties involved on how the trade will be
settled.

Benefits of Standard Settlement Instructions (SSIs)


• Facilitate straight through processing
• Reduce trade failure and settlement delay.
• Share account and settlement instructions between all trade parties
• Ensure complete and standardized settlement instructions

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Temasek Polytechnic • School of Informatics & IT
Standard Settlement Instructions
(SSIs)

Omgeo AlertTM
• A centralized database of SSIs of over 9,000 participants.
• Validate data as it is entered
• Automatically generate confirmation messages to relevant parties
• Data can be viewed by all parties involved via a web browser
• Inform all parties if there is any amendment to settlement details

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Temasek Polytechnic • School of Informatics & IT
Standard Settlement Instructions
(SSIs)
Functions of Omgeo AlertTM

2.
(B)
1. 3.

(A)

4.

Omgeo AlertTM demo: http://www.omgeo.com/demos/alert2/

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Temasek Polytechnic • School of Informatics & IT
Standard Settlement Instructions
(SSIs)

Example of SSI Data

Source: Andrew Bradford, (2008). The Investment Industry for IT Practitioners. John Wiley & Sons. P92.

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Temasek Polytechnic • School of Informatics & IT
Learning Objectives

By the end of the lecture students will be able to

 Demonstrate understanding of the trading business and its


supporting systems and processes
• Straight-through processing
• Client order

 Demonstrate understanding of payment and settlement


processes and systems
• Trade order flow and Standard Settlement Instructions
(SSI)
• Foreign exchange settlement and Continuous Linked
18 Settlement (CLS)
Temasek Polytechnic • School of Informatics & IT
Foreign Exchange Settlement

Settlement risk in foreign exchange settlement


1

Example:
• Two counterparties in a FX
transaction, Bank A & Bank B.
• Bank A sells Bank B USD1mil
@ USD/YEN 100

Deliver Receive
Bank A US$1mil ¥100mil
Bank B ¥100mil US$1mil

1Macha Bronner. (2002). Banque De France. “The CLSTM system: reducing settlement risk in foreign exchange transactions”.
From the website http://www.banque-france.fr/gb/publications/telechar/rsf/2002/et7_1102.pdf

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Temasek Polytechnic • School of Informatics & IT
Foreign Exchange Settlement

Settlement risk in foreign exchange settlement


• Arises when one party delivers before receipt of payment.

• Settlement risk comprises of credit risk and liquidity risk.


 Credit risk: one counterparty is insolvent and defaults on its obligations.
 Liquidity risk: one counterparty is illiquid and cannot meet its obligations on due date
but could do so at a later date.

• Technically, should only last for a few hours due to time zone differences. In
reality, it exists for a few days.

• Led to the development of “Payment versus payment” concept used in


“Continuous Linked Settlement”.

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Temasek Polytechnic • School of Informatics & IT
Continuous Linked Settlement (CLS)

Continuous Linked Settlement (CLS)2


• Market-standard for foreign exchange settlement
• Supervise and regulated by the Federal Reserve as a
bank
• Settles 17 different currencies
• Account for 95% of daily traded value
• Settles matched FX trades on a payment versus payment
(PvP) basis
• Bi-laterally and multi-laterally nets all obligations per value
date
• Eliminates FX settlement risk in the world’s single largest
market

21http://www.cls-group.com/Products/Settlement/Pages/default.aspx
2

Temasek Polytechnic • School of Informatics & IT


Continuous Linked Settlement (CLS)

Payment principles under CLS

• Each counterparty holds a multi-currency with CLS Bank, with a sub-account for
each type of currency.
• Transactions cannot be carried out unless parties involved have sufficient
amount in their accounts to settle the trade. (remove settlement risk)
• Settlement is final and irrevocable.
• In our example:

Bank A’s account: Bank B’s account:


1. Debit US$1mil a. Debit ¥100mil
2. Credit ¥100mil b. Credit US$1mil

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Temasek Polytechnic • School of Informatics & IT
Continuous Linked Settlement (CLS)

Bilateral and multilateral netting

Source: Macha Bronner. (2002). Banque De France. “The CLSTM system: reducing settlement risk in foreign exchange transactions”.
From the website http://www.banque-france.fr/gb/publications/telechar/rsf/2002/et7_1102.pdf

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Temasek Polytechnic • School of Informatics & IT
Continuous Linked Settlement (CLS)

Bilateral and multilateral netting

Under a bilateral netting system, there is one payment for each pair of counterparties
and each currency. Amount to pay and receive are the net balance of the transactions
between each pair of counterparties.
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Source: Macha Bronner. (2002). Banque De France. “The CLSTM system: reducing settlement risk in foreign exchange transactions”.
From the website http://www.banque-france.fr/gb/publications/telechar/rsf/2002/et7_1102.pdf Temasek Polytechnic • School of Informatics & IT
Continuous Linked Settlement (CLS)

Bilateral and multilateral netting

Under a multilateral netting system, each bank has to make or receive one payment
in each currency. Amount to pay and receive are the net balance of the transactions in
that currency with all its counterparties.

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Source: Macha Bronner. (2002). Banque De France. “The CLSTM system: reducing settlement risk in foreign exchange transactions”.
From the website http://www.banque-france.fr/gb/publications/telechar/rsf/2002/et7_1102.pdf Temasek Polytechnic • School of Informatics & IT
References

• Andrew Bradford, (2008). The Investment Industry for IT


Practitioners. John Wiley & Sons. Chapter 9.

• Macha Bronner. (2002). Banque De France. “The CLSTM


system: reducing settlement risk in foreign exchange
transactions”. From the website http://www.banque-
france.fr/gb/publications/telechar/rsf/2002/et7_1102.pdf

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Temasek Polytechnic • School of Informatics & IT
SWIFT VIDEO (Optional)

Online learning: Download the following file from OLE


Tutorial 8: Investments (Online learning: SWIFT)
Complete all 4 modules

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Temasek Polytechnic • School of Informatics & IT