Effective Product Control: Controlling for Trading Desks

Preface xiii

Acknowledgements xv

About the Author xvii

PART ONE Working in Product Control

CHAPTER 1 An Introduction to Product Control 3

The Emergence of Product Control 3

The Purpose of Product Control 3

Different Types of Product Control 5

Skills, Qualifications and Experience 6

Organizational Structure 8

The Desk 10

CHAPTER 2 Changing Landscape of Product Control 15

Offshoring 15

XVA 19

Greater Levels of Capital 19

Greater Focus on Liquidity 20

Notes 21

CHAPTER 3 Key Stakeholders 23

Front Office: Sales and Trading Desk 23

Chief Operating Officers (COOs) 25

Operations 26

Middle Office 27

Market Risk 28

Financial Reporting 29

Management Reporting 29

Finance Change 30

IT 30

Operational Risk 32

Regulatory Reporting 32

Accounting Policy 34

Tax 34

Audit 36

Finance Shared Service 37

Summary 37

Notes 37

PART TWO Technical Skills

CHAPTER 4 Accounting Standards: Recognition and Measurement 41

IAS 39 Financial Instruments: Recognition and Measurement 42

IFRS 9: Financial Instruments 60

IFRS 13: Fair Value Measurement 66

Notes 71

CHAPTER 5 Market Risk 75

What Is Market Risk and How Is It Generated? 75

How Is Market Risk Measured by a Bank? 77

Note 85

CHAPTER 6 Pricing Financial Instruments 87

How to Approach the Pricing of a Financial Instrument 87

Pricing Examples 89

Notes 105

CHAPTER 7 Internal Control 107

What Is Internal Control? 107

Establishing an Internal Control Framework 110

Example of Front to Back Internal Controls 117

Notes 122

PART THREE Profit and Loss Controls

CHAPTER 8 System Feeds, End of Day Rates and Profit and Loss Estimates 127

System Feeds 127

End of Day 129

End of Day Rates 130

P&L Estimate 135

Note 136

CHAPTER 9 Review of New and Amended Trades 137

New Trades 137

Amended Trades 152

Notes 164

CHAPTER 10 Review of Mark-to-Market P&L 165

Defining Mark-to-Market P&L 165

Attributing MTM P&L 166

Risk-Based P&L Estimates 170

Changes in the End of Day Prices 173

When to Validate the MTM P&L 176

CHAPTER 11 Funding, Fees and Charges 177

Funding 177

Fees and Charges 185

Note 187

CHAPTER 12 Profit and Loss Adjustments 189

The Need for P&L Adjustments 189

Controlling P&L Adjustments 190

Notes 194

CHAPTER 13 Profit and Loss Commentary 195

Who Is the Reader? 198

When Is P&L Commentary Required? 198

CHAPTER 14 Profit and Loss Reconciliations and Sign-Offs 201

Flash vs. Actual 201

Desk P&L Sign-off 203

P&L Reconciliation 205

PART FOUR

Valuations

CHAPTER 15 Independent Price Verification 209

Components to IPV Process 210

Note 224

CHAPTER 16 Valuation Adjustments 225

Why Valuation Adjustments Are Required 225

Bid–Offer 225

Day 1 Reserves 234

Model Valuation Adjustment 234

XVA and Collateral Agreements 235

Recording and Reporting of VAs 239

Notes 239

PART FIVE Balance Sheet Controls

CHAPTER 17 Balance Sheet Substantiation and Analysis 243

Substantiating the Balance Sheet 243

Frequency of the Balance Sheet Substantiation 248

Evidencing the Balance Sheet Substantiation 249

Unsupported Balances 249

Lines of Responsibility 255

CHAPTER 18 Dividending of Profit and Loss and FX Selldown 257

CHAPTER 19 Controlling Nostros 261

Introduction to Nostros 261

Controlling Nostros – Cash Breaks 262

Risk-Weighting Cash and AVE breaks 266

Provisioning for Nostro and AVE Breaks 267

Notes 268

PART SIX Financial Accounting and Reporting

CHAPTER 20 Financial Accounting Entries 271

Financial Accounting Entries 271

Chart of Accounts 284

Accounting Rules Engine 286

Notes 289

CHAPTER 21 Financial Reporting and Note Disclosures 291

Context of Financial Reporting 291

Profit and Loss 293

Balance Sheet 295

Netting 297

Fair Value Hierarchy 304

Notes 309

PART SEVEN Supplementary Controls

CHAPTER 22 New Product Proposals 313

Starting Line 313

The Review 314

The Sign-Off 319

CHAPTER 23 Rogue Trading 321

The Forefathers of Rogue Trading 321

The Fallout from Rogue Trading – The Bank 323

The Fallout from Rogue Trading – The Industry 325

Going Rogue 325

UBS Rogue Trading Incident, 2011 327

Notes 343

Index 347