Foreign Exchange Transaction Processing: Execution-to ...

1 Foreign Exchange Transaction processing : Execution-to -Settlement Recommendations for Nondealer Participants 11. Table of Contents Introduction ..13 Netting and Settlement ..25. The Foreign Exchange market ..13 Process Description ..25. The Changing Marketplace ..13 Recommendation No. 13: Net Payments What Is the Foreign Exchange Committee and Confirm Bilateral Amounts ..25. and What Are the Best Practices? ..14 Recommendation No. 14: Provide Accurate How to Use This Document ..14 and Complete Settlement Recommendation No.

2 15: Use Standing Pre-Trade Preparation Settlement and Documentation ..15 Recommendation No. 16: Understand Risks Process Description ..15 Associated with Third-Party Payments ..27. Recommendation No. 1: Determine Foreign Exchange Needs and Develop Account Appropriate Infrastructure ..15 Process Description ..28. Recommendation No. 2: Ensure Recommendation No. 17: Perform Timely Segregation of Account Recommendation No. 3: Determine Recommendation No. 18: Identify Appropriate Nonreceipt of Payments and Submit Compensation Claims in a Timely Trade execution and Capture.

3 18. Process Accounting and Recommendation No. 4: Establish Process Description ..29. Appropriate Trading Policies Recommendation No. 19: Conduct Daily and Procedures ..18 General Ledger, Position, and P&L. Recommendation No. 5: Clearly Identify Recommendation No. 20: Conduct Daily Recommendation No. 6: Establish Position and Control System Recommendation No. 7: Enter Trades Other ..31. in a Timely Recommendation No. 21: Develop and Test Contingency Plans ..31. Confirmation ..21 Recommendation No. 22: Ensure Service Outsourcing Conforms to Best Process Recommendation No.

4 8: Confirm Trades Acknowledgments ..33. in a Timely Recommendation No. 9: Block Trades Recommended Readings ..34. Should Be Confirmed in a Timely Manner ..22. Recommendation No. 10: Resolve Confirmation Discrepancies in a Timely Manner ..22. Recommendation No. 11: Unique Features of Foreign Exchange Options ..23. Recommendation No. 12: Unique Features of Non-deliverable Forwards ..24. 12 Foreign Exchange COMMITTEE 2004 ANNUAL REPORT. Foreign Exchange Transaction processing : Execution-to -Settlement Recommendations for Nondealer Participants Introduction The Foreign Exchange market The Foreign Exchange (FX) market is the largest and most liquid sector of the global financial system.

5 According to the Bank for International Settlements' Triennial Central Bank Survey of Foreign Exchange and Derivatives market Activity 2004, FX. turnover averages USD trillion per day in the cash Exchange market and an addi- tional USD trillion per day in the over-the-counter (OTC) FX and interest rate derivatives The FX market serves as the primary mechanism for making payments across borders, transferring funds, and determining Exchange rates between different national currencies. The Changing Marketplace Over the past decade, the FX market has grown in terms of both volume and diversity of participants and products.

6 Although commercial banks have historically domi- nated the market , today's participants also include investment banks, brokerage companies, multinational corporations, money managers, commodity trading advisors, insurance companies, governments, central banks, and pension and hedge funds. In addition, the size of the FX market has grown as the economy has continued to globalize. The value of transactions that are settled globally each day has risen exponentially from USD 1 billion in 1974 to USD trillion in 2004. 13. What Is the Foreign Exchange FX market on a more occasional basis.

7 The Committee and What Are the Best twenty-two issues highlighted are meant to Practices? promote risk awareness and provide best The Foreign Exchange Committee is an industry practice recommendations for nondealers. group sponsored by the Federal Reserve Bank Participants in prime brokerage or similar of New York that has been providing guid- arrangements should also be familiar with ance and leadership to the global FX market these recommendations. The implementation since its founding in 1978. In all its work, the of these practices may mitigate some of the Committee seeks to improve the efficiencies trading and operational risks that are specific to of the FX market , to encourage steps to the FX industry.

8 It may also help limit potential reduce settlement risk, and to support financial losses and reduce operational costs. actions that enhance the legal certainty of FX. contracts. This document is primarily oriented toward nondealer participants with moderate FX. In 1998, the Committee recognized the activities. However, those nondealer parti- need for a checklist of best practices that cipants that are particularly active in the FX. could help nondealer participants entering market are encouraged to review the the FX market to develop internal guidelines Committee's guidance to other market and procedures for managing risk.

9 The participants, specifically the Guidelines for original version of Foreign Exchange Foreign Exchange Trading Activities and the Transaction processing : Execution-to -Settlement Management of Operational Risk in Foreign Recommendations for Nondealer Participants Exchange . These documents provide a more was published in 1999 by the Committee's detailed discussion of the business practices Operations Managers Working Group to and operational guidelines appropriate to serve as a resource for market participants as institutions with larger or more complex FX.

10 They evaluate their policies and procedures activities. Copies of these papers are regarding FX transactions . This 2004 update available on the Committee's website at takes into account market practices that have < >. evolved since the paper's original publication and supersedes previous recommendations by the Committee regarding nondealer How to Use This Document participants. This document is divided into sections based on the five steps of the FX trade process flow: The purpose of this paper is to share the 1) pre-trade preparation, 2) trade execution experiences of financial institutions that are and capture, 3) confirmation, 4) netting and active in the growing FX market with non- settlement, and 5) account reconciliation and dealer participants that may participate in the accounting/financial control processes.