Phase 1: Pre-trade
All steps before trading activities are categorized into the pre-trade phase. The below processes are part of Pre-Trade phase
1. On boarding – On boarding is the process of adding a new customer or a trading partner for trading purposes. On boarding exercise includes preparation of service agreements, relationship agreements and finalization trading limits, trading margins, credit lines and other legal parameters etc. Here all the documentations are completed all the customer related data is collected.
2. Order Origination – Orders originate from financial institutions and other market participants where the trading decisions are made. Once trading decision is made, trading orders are forwarded to front office for execution.
3. Pre-Trade Compliance – Before execution at front desk level, orders are verified to ensure details are adhering both internal and external compliance rules including margin requirements, counterparty check, valid trade parameters etc.
Phase 2: Trading
Once trading orders are finalized, these are sent to front desk traders for execution. They are the professional traders who has all the knowledge of price and other information. The typical processes involved here are:
1. Pricing – Pricing is the method of identifying the proper market value of an instrument. For exchange traded products which have good liquidity, pricing can be easily determined. For OTC derivatives products which do not have good liquidity, pricing requires proper modelling. Also it requires lots of real time market data to determine price of the OTC derivatives product like swaps.
2. Dealing and Execution – Execution is the agreement when two parties formally enters into a contract through some trading venue or off-facility. In electronic matching system, both buy and sell orders are matched online and executed directly.
3. Allocation – Once trade is executed, the trades are allocated to the participant parties or legal entities. Once the trade is allocated, other post trading processes can start including P&L statement, Cash flow etc.
Phase 3: Post-Trade Processing
The duration of post-trade processing varies by the market. For exchange traded case, trades are processed within seconds or minutes while trades processed in OTC derivatives space take few hours to few days to complete the entire processing. Below are the different important aspects of Post Trade processing.
1. Trade Booking – After the execution, trades are booked in some front office application and details are captured in a post-trade processing system. Trade booking can be done in both manual and electronic system.
2. Trade Validation – After trade capture in front office trade capture system, the trade details are verified which includes counterparty data validation, trade duration, maturity and other trade attributes.
3. Trade Enrichment – Trades executed in front office system only contains some basic and key information. During post trade processing system, trade records are enriched with various other static data including instrument information, party information, currency information, calendar data etc.
4. Matching and Confirmation – matching and confirmation refer to final official agreement process where the trade details are matched and confirmed by both the parties. This is required to eliminate any manual error which could have happened during trade booking process.
5. Clearing – Clearing is a process of registering a trade at a clearing house to eliminate the counterparty risk completely. Clearing houses or Central Clearing Counterparties can clear a trade on behalf of its members after securing necessary collateral or margin amount.
6. Different lifecycle events of trades are discussed in another Post.