Below are the important Life Cycle Events for Trades (especially OTC Derivatives trades)
Amendment: Trade attributes or Contact terms can be modified before maturity date of the trade through mutual agreement with the counterparty. Post amendment, the trade contract may have to undergo post-trade processing again with the new contract details. Amendment can be off two types
⦁ Economic Amendment: When any economic attribute of the trade is changed with mutual agreement with the other party. Economic attributes include notional amount, notional currency, effective date, Rates, Spreads, and End Date etc. This is a price forming event as change in economic parameters affect price of the OTC derivatives contract.
⦁ Non-Economic Amendment: When any other attribute is changed rather than any Economic attributes. For examples: Trade Date, Party location, party name etc. This is not a price forming event as it does not impact price.
Partial Termination: When a trade is partially terminated or Notional amount is decreased with mutual agreement with the counterparty, like notional amount is decreased from USD 10 Million to USD 5 Million. This happens when both the parties agree to decrease their exposure in the OTC Derivatives contract. Cash flow and price of the derivatives are adjusted based on reduced Notional amount. This is a price forming event as price is changed due to this.
Full Termination: When a trade is fully terminated or Notional amount is decreased to zero with mutual agreement with the counterparty, like notional amount is decreased from 10 M USD to 0. This happens when both the parties agree to terminate the trade completely and settle the outstanding amount if any. This is a price forming event and one party may have to pay termination fee to terminate the contract. Agreement is signed to terminate the contract, date of which is used as an agreement date.
Cancel: Sometimes trades are booked in trade booking system incorrectly which requires cancellation of the trade completely in the system. This Cancel event is used to cancel an incorrectly booked trade so that there is no impact on other systems like settlement system, P&L system etc. Normally, confirmation never happened for these trades as these are booked incorrectly in the system.
Cancel-Rebook: Sometimes trades are booked with some incorrect parameters which cannot be corrected through normal amendment or modify event. For this case, Cancel-Rebook event is used in which the trade is first cancelled and another trade is rebooked with the correct details. Rebooked trade is linked with the Cancelled trade id to track the link between the trade ids. For example: If Party1 or Party2 information is entered incorrectly, then Cancel-Rebook event is used because party information belonging to different legal entities can’t be corrected using amendment easily without impacting other systems.
Exercise: This event occurs when the buyer of the option exercise his right provided by the option. This helps the option buyer either to buy/sell an underlying asset or get into an OTC derivatives contract. Exercise dates depend on the type of option. For example
⦁ Buyer can exercise an option only at the time of maturity for American option
⦁ Buyer can exercise an option at any time for a European Option
⦁ Buyer get some different date durations for exercise for a Bermudan option
Expiry/Maturity: Expiry/Maturity refers to the end of an option contract when it reaches to its maturity date. Every option contract has an expiry date where the contract is automatically terminated if not exercised by the buyer. Every other OTC derivatives contract has a maturity date on which the contract is automatically terminated.
Novation: Novation (also known as Assignment) is the process of transferring an existing contract from one party to another party without terminating the trade. There are different types of novation
Offset: Offset is the process of terminating a derivatives contract through an opposite trade position with the same attributes (known as offset trade). Sometimes parties use this offset trade to terminate an existing contract before its maturity date.
Unwind: Unwind happens when an existing derivatives contract is terminated after agreed with the original counterparty before its maturity. This is also known as early termination in OTC derivatives world. This is same as Full termination. Partial Unwind (also partial termination) refers to partial unwind or termination of an existing derivatives contract.
Compression: Sometimes derivatives contracts are netted or compressed to reduce the overall risk exposure. In Compression multiple trades between same parties and similar trade attributes are compressed to generate only one trade with combined exposure. Original trades are terminated a new trade is created in this process, this helps in risk exposure and other trade related activities due to decreased number of trades. In netting process, multiple exposures are netted against each other to create one single trade with reduced exposure. It also helps to reduce overall exposure and helps in other activities like settlement and P&L maintenance for trades.
Allocation: This is opposite to Compression where an existing trade is allocated to different parties with reduced notional amount. This process is used to book a trade with parent party and then allocated the same trade to different child parties in different proportions. In this process, original trade is terminated and multiple new trades are created.