FX Dealing Room FX Dealing Room OperationsOperations• Service Branch – customers buy or sell FX, fund nostro A/c Service Branch – customers buy or sell FX, fund nostro A/c

and also proprietary trading in currenciesand also proprietary trading in currencies• DealerDealer

Understanding of the jobUnderstanding of the jobRisk Trading capacity Risk Trading capacity Speed in decision makingSpeed in decision makingQuick reflexesQuick reflexesUnderstanding market changingUnderstanding market changingPsychological Qualities – ability to work under Psychological Qualities – ability to work under

stress, willingness to accept responsibility, stress, willingness to accept responsibility, good measure of good measure of aggressiveness, willingness to aggressiveness, willingness to recognize that one can be wrongrecognize that one can be wrong

Dealer to maintain two position - funds Dealer to maintain two position - funds and currency (no mismatches).and currency (no mismatches).

Position BookPosition Book1.1. Currency – merchant interbankCurrency – merchant interbank

2.2. Overbought / LongOverbought / Long In foreign exchange, Overbought/Long arises when In foreign exchange, Overbought/Long arises when

the amount purchased of a given currency is the amount purchased of a given currency is greater than the amount sold. greater than the amount sold.

3.3. Oversold / ShortOversold / Short In foreign exchange operations, when the amount In foreign exchange operations, when the amount

of the given currency sold is greater than the of the given currency sold is greater than the amount purchased amount purchased

4.4. Net open positionNet open position Bank is both a buyer and seller of a foreign currency. Bank is both a buyer and seller of a foreign currency.

However, it is required to maintain at the close of However, it is required to maintain at the close of business each day, square (i.e. sales matching business each day, square (i.e. sales matching purchases) or near square positions in each foreign purchases) or near square positions in each foreign currency after taking into account all the purchases currency after taking into account all the purchases and sales, (both spot and forward) to avoid any and sales, (both spot and forward) to avoid any exchange risk. exchange risk.

In order to maintain effective control over its In order to maintain effective control over its purchase and sale operations and to determine a purchase and sale operations and to determine a ready net position of its operations, for the purpose ready net position of its operations, for the purpose of squaring off cover transactions, it maintains a of squaring off cover transactions, it maintains a book known as position book.book known as position book.

The currency position is the difference between the The currency position is the difference between the days total sales and purchases of a particular days total sales and purchases of a particular currencycurrency

5.5. Cover operation / cover dealsCover operation / cover deals A long position will indicate, that the dealer has a A long position will indicate, that the dealer has a

surplus in that currency and, in order to square of surplus in that currency and, in order to square of his position, he is required to dispose of this his position, he is required to dispose of this surplus in the inter bank market or international surplus in the inter bank market or international exchange market in London or New York.exchange market in London or New York.

In case of a short position of a currency the dealer In case of a short position of a currency the dealer will be require to acquire that amount from the will be require to acquire that amount from the inter bank market or the international market.inter bank market or the international market.

These operations disposal (sales) and acquisition These operations disposal (sales) and acquisition (purchases) by the dealer are known as cover (purchases) by the dealer are known as cover deals. deals.

At the end of the day these cover deals are At the end of the day these cover deals are recorded in the position book and it is ensured recorded in the position book and it is ensured that the overbought/oversold position is that the overbought/oversold position is converted into near square position. converted into near square position.

The activity of squaring off transactions as they The activity of squaring off transactions as they occur against an already available position or occur against an already available position or by going straight to the interbank market-is by going straight to the interbank market-is termed as covering. The operation is termed as termed as covering. The operation is termed as cover operation.cover operation.

The term signifies that every transaction that a The term signifies that every transaction that a customer / merchant originates is covered customer / merchant originates is covered immediately – a ‘sale’ to a merchant by an immediately – a ‘sale’ to a merchant by an interbank ‘purchase’, or a ‘purchase’ from a interbank ‘purchase’, or a ‘purchase’ from a merchant by a interbank ‘sale’. merchant by a interbank ‘sale’.

5.5. Overnight PositionOvernight Position Overnight position is defined as total amount that the Overnight position is defined as total amount that the

dealing room can be oversold (short) or overbought dealing room can be oversold (short) or overbought (long) in different currencies.(long) in different currencies.

As exchange market conditions can be very fluid and As exchange market conditions can be very fluid and unpredictable the management of a bank keeps a close unpredictable the management of a bank keeps a close watch on the dealers position at the close of business watch on the dealers position at the close of business each day to ensure that the position is within the set each day to ensure that the position is within the set limit limit

Since the dealer are in constant touch with the market Since the dealer are in constant touch with the market developments in the course of operations during the developments in the course of operations during the day, they can cut their losses /or protect their gains by day, they can cut their losses /or protect their gains by closing out the positions during the day, if the rates closing out the positions during the day, if the rates move against them. move against them.

Whereas between the closing of one working day and Whereas between the closing of one working day and the opening of another, their position may get locked-in the opening of another, their position may get locked-in and it may turn out to be too late to cut losses. and it may turn out to be too late to cut losses.

5.5. Intraday / day light limitsIntraday / day light limits Intraday / day light limits refer to the total Intraday / day light limits refer to the total

open or uncovered positions in the various open or uncovered positions in the various currencies that may have to maintained by currencies that may have to maintained by a dealer at any time during the business a dealer at any time during the business day in customers as well as inter bank day in customers as well as inter bank business.business.

The management of a bank lays down the The management of a bank lays down the limits on the maximum position in all limits on the maximum position in all major currencies that may remain major currencies that may remain uncovered at any time during the day. uncovered at any time during the day.

5.5. Gap limits Gap limits In foreign exchange transaction, the gap refers to In foreign exchange transaction, the gap refers to

the period between the maturities/deliveries for the period between the maturities/deliveries for purchases and the maturities/deliveries for sales of purchases and the maturities/deliveries for sales of each foreign currencies (exchange gap)each foreign currencies (exchange gap)

Individuals gap limits (IGL)Individuals gap limits (IGL) It is essential that the management in each bank It is essential that the management in each bank

should lay down an individual gap limit (IGL) in should lay down an individual gap limit (IGL) in absolute terms for each currency which will apply to absolute terms for each currency which will apply to the net position in each forward month weather the net position in each forward month weather overbought (plus position) or oversold (minus overbought (plus position) or oversold (minus position), excesses over which will need the approval position), excesses over which will need the approval of the top management. of the top management.

Aggregate gap limits (AGL)Aggregate gap limits (AGL) The management also lay down an aggregate gap The management also lay down an aggregate gap

limit (AGL) which applied to the sum total of the limit (AGL) which applied to the sum total of the gaps in each currencies which should be arrived gaps in each currencies which should be arrived at by adding (not netting), the plus and minus at by adding (not netting), the plus and minus position of each monthposition of each month

The aggregate gap limit should normally be The aggregate gap limit should normally be related to the owned funds of the banks (i.e. related to the owned funds of the banks (i.e. capital +reserve) in order to reflect the capacity capital +reserve) in order to reflect the capacity of the bank to absorb losses arising from of the bank to absorb losses arising from existence of gap existence of gap

Back Office – the back office consists Back Office – the back office consists broadly of the settlement section. The broadly of the settlement section. The settlement section is attached to the settlement section is attached to the dealing room (though not controlled by it) dealing room (though not controlled by it) and acts as the latter’s immediate support and acts as the latter’s immediate support structure. Responsibilities and functions of structure. Responsibilities and functions of the back office include the followingthe back office include the following

• Processing of deals generated by dealers.Processing of deals generated by dealers.

• Issuing and receipt of contract notes and deal Issuing and receipt of contract notes and deal confirmations.confirmations.

• Keeping track of payables and receivables resulting from Keeping track of payables and receivables resulting from inter bank contracts entered into by the dealers.inter bank contracts entered into by the dealers.

• Ensure that timely deliveries and receipts are indeed Ensure that timely deliveries and receipts are indeed effected; settling compensation claims for delays.effected; settling compensation claims for delays.

• Fund management, maintaining required balances in the Fund management, maintaining required balances in the Nostro accounts. Nostro accounts.

• Maintaining position book, gap records, assist the chief Maintaining position book, gap records, assist the chief dealer with required information and data to enable him dealer with required information and data to enable him take an informed decision.take an informed decision.

• Implement the guidelines, rules and norms prescribed by Implement the guidelines, rules and norms prescribed by the Exchange Control Department of the central bank as the Exchange Control Department of the central bank as well as the bank authority themselves. well as the bank authority themselves.

• The merchant desk acts as the bridge The merchant desk acts as the bridge between the branches (and their between the branches (and their customers) and the dealing room. customers) and the dealing room.

Mid Office – Risk Management, check Mid Office – Risk Management, check over the risk taken by the dealers, over the risk taken by the dealers, market informationmarket information

Foreign currency position, Mirror Foreign currency position, Mirror Accounts Import Suspense a/c – Accounts Import Suspense a/c – valuation FIDAIE Rate valuation FIDAIE Rate

Major Risk (Dealing Room)Major Risk (Dealing Room)

Operation risk – arises human error, Operation risk – arises human error, technical faults, infra technical faults, infra breakdown, faulty system breakdown, faulty system procedure and internal procedure and internal control control

Exchange risk – fluctuations in exchange Exchange risk – fluctuations in exchange rate rate

Credit risk – Inability of the counter party Credit risk – Inability of the counter party to meet the obligation to meet the obligation

Pre settlement risk – failure of the counter Pre settlement risk – failure of the counter party before maturity of the dealparty before maturity of the deal

Settlement risk – failure of the counter Settlement risk – failure of the counter party during the course of settlement due party during the course of settlement due to the time zone differenceto the time zone difference

Liquidity risk – unable to meet its funding Liquidity risk – unable to meet its funding requirementrequirement

Gap risk/ interest rate risk - gaps are to be Gap risk/ interest rate risk - gaps are to be filled by the bank by paying / receiving filled by the bank by paying / receiving appropriate forward differentials. The appropriate forward differentials. The forward differentials are in turn a function forward differentials are in turn a function of interest rates and adverse movement of of interest rates and adverse movement of interest rate would result adverse interest rate would result adverse movement of forward differential.movement of forward differential.

►Market risk – party unable to exit / cover Market risk – party unable to exit / cover offset a position quickly at a resonable offset a position quickly at a resonable priceprice

►Legal risk – risk of non enforceabilityLegal risk – risk of non enforceability►Systematic risk – risk of major bank Systematic risk – risk of major bank

failurefailure►Country risk- local govt regulations or Country risk- local govt regulations or

political or economic instability in the political or economic instability in the country.country.

►FX dealing operations are considered to FX dealing operations are considered to be profit center. Exchange profitbe profit center. Exchange profit

►Clear functional separation of dealing Clear functional separation of dealing and back office, accounting and and back office, accounting and reconciliation. reconciliation.