Week 5b Lecture - Introduction To Investment & Investment Banking IV

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)
2
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.
3
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.
4
Learning Objectives

• Client order

(SSI)
5 Settlement (CLS)
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
6
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
7
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
8
Learning Objectives

• Client order

(SSI)
9 Settlement (CLS)
Trade Order Flow
10
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.
11
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.
12
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
13
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
14
(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
15
(SSIs)
Functions of Omgeo AlertTM
2.
(B)
1. 3.
(A)
4.
Omgeo AlertTM demo: http://www.omgeo.com/demos/alert2/
16
(SSIs)
Example of SSI Data
17
Learning Objectives

• Client order

(SSI)
18 Settlement (CLS)
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
19
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”.
20
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

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
22
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
23
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.
24
From the website http://www.banque-france.fr/gb/publications/telechar/rsf/2002/et7_1102.pdf Temasek Polytechnic • School of Informatics & IT
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.
25
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
26
SWIFT VIDEO (Optional)
Online learning: Download the following file from OLE

Tutorial 8: Investments (Online learning: SWIFT)
Complete all 4 modules
27

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Intro to Investment & Investment Banking

1 Settlement & Systems II

By the end of the lecture students will be able to

 Demonstrate understanding of the trading business and its

 Demonstrate understanding of payment and settlement

Key Principles of STP

By the end of the lecture students will be able to

 Demonstrate understanding of the trading business and its

 Demonstrate understanding of payment and settlement

What is a client order?

3. A specific quantity or money value

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

Example 1: Client’s Order

Order Type Buy

Example 2: Client’s Order

Order Type Sell

By the end of the lecture students will be able to

 Demonstrate understanding of the trading business and its

 Demonstrate understanding of payment and settlement

Stage 1: Investor places an order with broker

Stage 2: Forward order to stock exchange order queue

Stage 3: Exchange confirms execution

Stage 4: Broker confirms execution to the investor

Stage 5: Investor checks process within own system

Stage 6: Trade details forwarded to back-office system

Stage 7: Sent settlement instructions to agent

Stage 8: Agent settles trade and reports to broker

Stage 9: Broker records that settlement has occurred

Standard Settlement Instructions (SSIs)

Benefits of Standard Settlement Instructions (SSIs)

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

Example of SSI Data

By the end of the lecture students will be able to

 Demonstrate understanding of the trading business and its

 Demonstrate understanding of payment and settlement

Settlement risk in foreign exchange settlement

Settlement risk in foreign exchange settlement

• Settlement risk comprises of credit risk and liquidity risk.

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

Continuous Linked Settlement (CLS)2

Temasek Polytechnic • School of Informatics & IT

Payment principles under CLS

Bank A’s account: Bank B’s account:

Bilateral and multilateral netting

Bilateral and multilateral netting

Bilateral and multilateral netting

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

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

Online learning: Download the following file from OLE

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