CHAPTER ICHAPTER I

An OverviewAn Overview

Back officeBack office

Is usually located behind the trading Is usually located behind the trading room, but the work that is performed room, but the work that is performed there has changed considerably, there has changed considerably, evolving far beyond just processing evolving far beyond just processing into a total support role for the into a total support role for the dealing functions. dealing functions.

Need to make back office Need to make back office efficiencyefficiency

Increasing regulation and compliance Increasing regulation and compliance requirements, risk management requirements, risk management needs and interactive system needs and interactive system development.development.

Treasury operations has grown into Treasury operations has grown into one of the key administrative areas of one of the key administrative areas of financial institution, responsible for the financial institution, responsible for the processing of all financial market processing of all financial market transactions and usually much more, transactions and usually much more, including a crucial role in the control of including a crucial role in the control of risk.risk.

Modern international banks have a Modern international banks have a large daily turnover in numerous large daily turnover in numerous currencies from treasury transactions currencies from treasury transactions which result in high value payment which result in high value payment and receiptsin many centers.and receiptsin many centers.

An important development in the An important development in the back office has been the advent of back office has been the advent of straight through processing (STP) straight through processing (STP) also called hands- off or exception also called hands- off or exception processing. This has been mad processing. This has been mad possible through system advances of possible through system advances of real time on line input in the trading real time on line input in the trading room, which in turn has mean that room, which in turn has mean that the back office can recall deals input the back office can recall deals input in the trading room to verify from an in the trading room to verify from an external source. external source.

Flexible ControlFlexible Control

A key concept for the head of a A key concept for the head of a treasury operations unit.treasury operations unit.

Two perspectivesTwo perspectives

First is summed up First is summed up saying, the bottom saying, the bottom line is that the line is that the bank has to do bank has to do business otherwise business otherwise it is out of businessit is out of business

Second perspective Second perspective on flexible control on flexible control is making sure that is making sure that the right amount of the right amount of attention and attention and response is given response is given in proportion to in proportion to what is really what is really required.required.

Two Obvious PrioritiesTwo Obvious Priorities

Good on- going control of Good on- going control of payments authorization, payments authorization, ensuring prompt follow up ensuring prompt follow up to confirmation and to confirmation and reconciliation exceptions.reconciliation exceptions.

Efficient housekeeping for Efficient housekeeping for the standing data tables in the standing data tables in the database of the various the database of the various systems, which may be in systems, which may be in use in any given bank. An use in any given bank. An important accounting important accounting related priority is the related priority is the protection of the integrity of protection of the integrity of the systems in use by the systems in use by making sure that staff making sure that staff report systems problems report systems problems through a normal procedure through a normal procedure to the support unit via to the support unit via treasury operations line treasury operations line management.management.

Cash Reconciliation Cash Reconciliation

Is another function where the head of Is another function where the head of the back office just keep the tightest the back office just keep the tightest control.control.

Modern Technology may have removed Modern Technology may have removed the input and routine checking of the input and routine checking of service and reduction in costs, but this service and reduction in costs, but this has been more than offset by increased has been more than offset by increased complexity in day-to-day operation.complexity in day-to-day operation.

Introducing the Core Introducing the Core FunctionsFunctions

The mainstream role of the back office The mainstream role of the back office is in direct support of the trading room is in direct support of the trading room or front office. Traditionally this or front office. Traditionally this included the input of deals written and included the input of deals written and authorized by traders, checking of authorized by traders, checking of input, verification by confirmation, input, verification by confirmation, settlement and reconciliation of nostro settlement and reconciliation of nostro accounts as soon as possible. accounts as soon as possible.

Input and CompletionInput and Completion

The first core function for the back The first core function for the back office is to recall the deal through the office is to recall the deal through the input system and decide what has to input system and decide what has to be done to complete the details of be done to complete the details of the deal.the deal.

Verification by ConfirmationVerification by Confirmation

Provided the input is accurate , the Provided the input is accurate , the traders immediately benefit from traders immediately benefit from online positions and maturity online positions and maturity ladders. This is further enhanced by ladders. This is further enhanced by the facility to manipulate/interpolate the facility to manipulate/interpolate the outstanding book with many the outstanding book with many charting an analytical tools.charting an analytical tools.

The second core function for the The second core function for the processing support unit is to verify the processing support unit is to verify the ideal from an external source as soon as ideal from an external source as soon as possible after the transaction has been possible after the transaction has been done. For bank-to-bank trading, the done. For bank-to-bank trading, the verification can take the form of a verification can take the form of a confirmation of a deal done through the confirmation of a deal done through the Reuters 2000 or EBS trading systems, or a Reuters 2000 or EBS trading systems, or a broker’s confirmation via Barts 3if the deal broker’s confirmation via Barts 3if the deal has been done through a broker. It can also has been done through a broker. It can also be a confirmation from the counterparty, be a confirmation from the counterparty, normally via SWIFT, which will be matched normally via SWIFT, which will be matched automatically using Accord or a similar automatically using Accord or a similar inhouse3 matching system such as TRAM inhouse3 matching system such as TRAM (transaction matching system).(transaction matching system).

SettlementSettlement

The third core function in the processing The third core function in the processing chain is that of settlement. This can take the chain is that of settlement. This can take the form of a clean currency payment/receipt at form of a clean currency payment/receipt at the banks agency accounts.the banks agency accounts.

The initiating bank, accounting entries and The initiating bank, accounting entries and reporting are created from the one common reporting are created from the one common events file. An important corollary to the events file. An important corollary to the payment process is that the deal may be payment process is that the deal may be one included in a netting arrangement with one included in a netting arrangement with the counterparty.the counterparty.

ReconciliationReconciliation

Operations areas are typically involved in a Operations areas are typically involved in a number of reconciliation processes including number of reconciliation processes including the agreement of trader’s overnight the agreement of trader’s overnight positions, nostro accounts and brokerage.positions, nostro accounts and brokerage.

The basic reconciliation function is to agree or The basic reconciliation function is to agree or reconcile the entries that have passed over reconcile the entries that have passed over an account with an agent bank against those an account with an agent bank against those that have been passed internally in the books that have been passed internally in the books of the bank to a nostro account. (The word of the bank to a nostro account. (The word ‘nostro’ simply means’ our account with ‘nostro’ simply means’ our account with them’) them’)

In summary, the core functions In summary, the core functions of the back office are:of the back office are: Input (where necessary) and completion of Input (where necessary) and completion of

details of deal;details of deal; Verification of deal by both inward and Verification of deal by both inward and

outward confirmations;outward confirmations; Settlement of the deal depending on the Settlement of the deal depending on the

event which may also include netting;event which may also include netting; Reconciliation of nostros, positions, books.Reconciliation of nostros, positions, books.

These functions are vital to the ongoing These functions are vital to the ongoing viability of the bank.viability of the bank.

The Back Office can also The Back Office can also includeinclude

Risk ManagementRisk Management

This function can sit well in the back This function can sit well in the back office if staffed by officers specifically office if staffed by officers specifically ex-market practitioners.ex-market practitioners.

It can range from agreeing overnight It can range from agreeing overnight cash positions for the trading room cash positions for the trading room through to full-risk modeling through to full-risk modeling associated with derivatives trading associated with derivatives trading and hedging.and hedging.

Treasury accountingTreasury accounting

This unit acts as an intermediary This unit acts as an intermediary between the treasury business unit between the treasury business unit and the finance department to and the finance department to ensure that the accounting of ensure that the accounting of treasury products is accurate and treasury products is accurate and correct.correct.

DocumentationDocumentation

This can range from simple customer This can range from simple customer mandates through to full legal mandates through to full legal documentation with both banks and documentation with both banks and customers.customers.

Originally this area can be viewed in similar Originally this area can be viewed in similar way to the accounting function. If way to the accounting function. If documentation forms part of the back office documentation forms part of the back office then the business will be more understood then the business will be more understood by management and better controlled as a by management and better controlled as a result.result.

Financials, analysis, budgets, Financials, analysis, budgets, regulatory reportingregulatory reporting Depending on the size of the business Depending on the size of the business

unit, a small financial section allows the unit, a small financial section allows the treasury business head to have a hands-on treasury business head to have a hands-on role for all financial aspects of the role for all financial aspects of the business.business.

In an ideal world, the suite of reports In an ideal world, the suite of reports required by the regulators would be required by the regulators would be entirely system generated and require no entirely system generated and require no intervention.intervention.

Systems and Systems and TelecommunicationsTelecommunications This is possibly the most problematical area This is possibly the most problematical area

for the treasury back office.for the treasury back office. Although rapid technological change and Although rapid technological change and

straight-through processing have cut straight-through processing have cut through traditional boundaries of through traditional boundaries of responsibility, it is still necessary for one responsibility, it is still necessary for one area to be accountable for the total system area to be accountable for the total system requirements for a treasury unit to function requirements for a treasury unit to function efficiently and indeed to avoid chaos on the efficiently and indeed to avoid chaos on the network or switching system supporting network or switching system supporting traderstraders

Systems and telecommunications

Regulatory reporting

Financials,analysis, budgets

Documentation

Treasury accounting

Risk management

1. Input and completion2. Verification by confirmation

3. Settlement4. Reconciliation

The Treasury back officeThe Treasury back office

ResourcesResources

Traditionally, traders were regarded Traditionally, traders were regarded as highly specialized staff, supported as highly specialized staff, supported by competent personnel in the back by competent personnel in the back office.office.

Nowadays, as complexity increased, Nowadays, as complexity increased, high quality, specialized people are high quality, specialized people are needed in both the dealing room and needed in both the dealing room and the back office.the back office.

DateDateNameNameCauseCauseLessonLesson

19741974Bankhaus Bankhaus Herstaff, Herstaff, CologneCologne

Losses in Losses in foreign foreign exchangeexchange

Delivery or Delivery or settlement settlement time zone time zone riskrisk

19661966

HammersmHammersmith and ith and Fulham Fulham locallocal

Interest Interest rate swaps rate swaps losseslosses

Dealing Dealing ultra vires/ ultra vires/ documentadocumentationtion

19951995Barings Barings Bank, Bank, singaporesingapore

Futures and Futures and options options index index trading trading losseslosses

SegregatioSegregation of duties/ n of duties/ managememanagement controlnt control

The treasury back office: what can go The treasury back office: what can go wrong?wrong?