Financial Markets Operations Management (51 page)
Read Financial Markets Operations Management Online
Authors: Keith Dickinson
| DBV Class List | ||
| DBV Class List | Description | Security Categories |
| F10 | FTSE 100 | FTSE 100 |
| F25 | FTSE250 | FTSE 250 |
| OTH | Other Equities | Other UK and Irish |
| F35 | FTSE350 | FTSE 350 |
| UKE | All UK Equity | ALL UK and Irish Equities |
| UBG | Unstripped BGS | Unstripped British Government Debt |
| BGS | All BGS | All British Government Securities |
| UBN | Unstructured BGS & NBG | Unstripped British Government and Non-British Government Securities |
| GIL | All Gilts | All gilts |
| E30 | Eurotop 300 | Eurotop 300 |
| EGS | EGS | Eurotop Tier 1 Collateral (includes securities of unrated issuers |
| OIS | Other International | Other International securities |
| INT | All International | All international securities |
| USS | U.S. Security | U.S. Securities |
| TSY | Treasury Bill | Treasury bills |
| ELG | OMO Eligible Sec's | OMO eligible bills |
| BB1 | Eligible Bank Bills | Eligible bank bills |
| OMM | Other Bills | Other (including LA bills and ineligible bank bills) |
| CD1 | CDs Band1 | CDs rated Aaa-Aa3 |
| CD2 | CDs Band2 | CDs rated A1-A3 |
| CD3 | CDs Band3 | CDs rated Baa1-Baa3 |
| CD4 | CDs Band4 | CDs rated below Baa3 |
| CP1 | CP Band1 | CP rated Aaa-Aa3 |
| CP2 | CP Band2 | CP rated A1-A3 |
| CP3 | CP Band3 | CP rated Baa1-Baa3 |
| CP4 | CP Band4 | CP rated below Baa3 |
| ACD | All CDs | All CDs (specified in conjunction with Issuer ID) |
| ACP | All CP | All CP (specified in conjunction on with Issuer ID) |
| ISS | All CDs and all CP | All CDs and all CP (specified in conjunction with Issuer ID) |
| Company | URL |
| 4Sight | www.4sight.com |
| Anetics | www.anetics.com |
| BondLend | www.bondlend.com |
| Broadridge Financial Solutions | www.broadridge.com |
| EquiLend | www.equilend.com |
| eSecLending | www.eseclending.com |
| Helix Financial Systems | www.helixfs.com |
| ION Trading | www.iontrading.com |
| Lombard Risk | www.lombardrisk.com |
| OnlineStockLoan | www.OnlineStockLoan.com |
| Pirum Systems | www.pirum.com |
| PrimeOne Solutions | www.primeonesolutions.com |
| Quadriserv & Automated Equity Finance Markets, Inc. (AQS) | www.tradeaqs.com |
| Stonewain Systems | www.stonewain.com |
| Sungard | www.sungard.com/securitiesfinance |
Accounting for Securities
Part IV of the book will take you through two elements of monitoring and control: accounting and reconciliation.
Let me ask you a very simple question: how much are you worth? Make a list of the sort of things that you own and estimate what these are worth. This will be your net worth.
Of course there will be no definitive answer to this question, as every person is unique and every person's net worth will differ. But why do you need to know how much you are worth? Perhaps the most obvious answer would be that you are interested in knowing. However, you are not the only person who either needs to know or has to know your worth.
For example, your government has an interest as your salary will be taxed; whilst this income tax is typically deducted at source, the government, through its revenue agency, will be keen to ensure that you have paid sufficient tax.
Another example would include an application to borrow money from your bank; it needs to be assured that you have the ability to service that loan. To do this, it might require documentary evidence of your salary and other assets that you might own. The list goes on!
To summarise the above, there are certain entities that need to know certain information about our wealth.
The source of much of the information required by these interested parties will be financial information of one form or another. Those working in the business (e.g. the business managers) will need management accounting for their internal reporting purposes. By contrast, financial accounting is concerned with reporting to external parties outside the company.
It is not the purpose of this chapter to go into any great depth on the topic of accountancy and accounting, but to concentrate on the financial information that is generated by the day-to-day securities transactions and the corporate action events that flow from this. By the end of this chapter, you should be able to:
- Define assets and liabilities and understand the concept of the accounting equation;
- Understand how the Profit & Loss Statement and the Balance Sheet are affected by securities transactions;
- Distinguish between the main Front Office “books” such as the Trading Book, the Available-For-Sale and the Hold-To Maturity Book;
- Understand the accounting lifecycle for transactions and its impact on the Profit & Loss Statement and the Balance Sheet.
Any corporate entity is a collection of assets and the corresponding claims against those assets. We refer to these claims as liabilities and these are made up of creditors' claims and the owners' claims:
- Assets:
These are the economic resources owned by the company and utilised for future economic benefits for the owner. These assets include tangible assets (e.g. cash, accounts receivable, inventories, buildings and equipment) and intangible assets (e.g. patents and legal rights). - Liabilities:
These are the resources used to finance the assets. These are amounts that the company owes to other entities and represent an obligation to pay these entities. Liabilities include borrowed funds (e.g. amounts due to banks), issued debt securities (bonds) and other financial liabilities. - Owners' equity:
This is the “interest” that an owner or investor has in the company. This interest is represented in terms of shares originally issued by the company (in exchange for cash through an IPO). The shares are negotiable and transferable and can be issued on a stock exchange, providing a platform from which investors can buy and sell the shares.
Two of the principal financial statements that companies prepare are the Profit & Loss Statement and the Balance Sheet. You will find examples of these two statements below, as prepared by a fictitious company ABC.
This statement, shown in
Figure 13.1
, captures the income and expenses borne by ABC for a particular period; in this case, for the 12 months that ended 31Â December 2013. In ABC's Annual Report, there would be explanatory notes accompanying this statement to highlight the constituent elements to each line of the statement. For our purposes, only explanations for securities- and derivatives-related items will be included.
| for the year ended 31 December 2013 | Notes | Â | 2013 |
| amounts in millions of euros | Â | Â | Â |
| Income | Â | Â | Â |
| Interest income banking operation | Â | EUR 60,000 | Â |
| Interest expense banking operations | Â | EUR (48,000) | Â |
| Interest from banking operations | 8 | Â | EUR 12,000 |
| Investment income | 9 | Â | EUR 7,500 |
| Gross commission income | Â | EUR 3,000 | Â |
| Commission expense | Â | EUR (1,000) | Â |
| Commission income | 10 | Â | EUR 2,000 |
| Valuation results on non-trading derivatives | 11 | Â | EUR (3,000) |
| Net trading income | 12 | Â | EUR Â 2,000 |
| Total income | Â | Â | EUR 20,500 |
| Expenses | Â | Â | Â |
| Addition to loan loss provisions | Â | Â | EUR 2,000 |
| Intangible amortisation and other impairments | Â | Â | EUR 300 |
| Staff expenses | Â | Â | EUR 7,300 |
| Other operating expenses | Â | Â | EUR 6,000 |
| Total expenses | Â | Â | EUR 15,600 |
| Profit before tax | Â | Â | EUR 4,900 |
| Taxation | Â | Â | EUR 700 |
| Net Profit after Tax | Â | Â | EUR 4,200 |
Notes: Interest from banking operations (8): Interest income from loans and securities less interest paid on loans, deposits and securities.
Investment income (9): Includes dividends, coupons, and realised profits/losses from selling investments (e.g. equities and bonds).
Commission income (10): Includes brokerage fees, advisory fees, fund management fees, transfer fees, custody fees, etc.
Valuation results on non-trading derivatives (11): Included here are the fair value movements on derivatives used to economically hedge exposures, but for which no hedge accounting is applied. The fair value movements on the derivatives are influenced by changes in the market conditions, such as stock prices, interest rates and currency exchange rates.
Net trading income (12): Includes the results of making markets in securities (e.g. government bonds, equities and money-market instruments) and interest rate derivatives (e.g. swaps, options, futures and forward contracts). Foreign exchange transaction results include gains and losses from spot and forward contracts, options, futures and translated foreign currency assets and liabilities.
FIGURE 13.1
ABC â Profit & Loss Statement
In contrast to the Profit & Loss Statement which covers a particular period in time, the Balance Sheet is a snapshot on one particular date. The Balance Sheet shows the resources owned by the company and the claims against those resources. What the Balance Sheet does not do is indicate the situation one day before or one day after the particular date.
Figure 13.2
shows the Balance Sheet for ABC.
| As at 31 December 2013 | Notes | 2013 |
| amounts in millions of euros | Â | Â |
| ASSETS | Â | Â |
| Cash and balances with central banks | Â | EUR Â Â 50,000 |
| Amounts due from banks | Â | EUR Â Â 40,000 |
| Financial assets at fair value through profit and loss | 1 | Â |
| â trading assets | Â | EUR 110,000 |
| â non-trading derivatives | Â | EUR Â Â 14,000 |
| â designated as at fair value through profit and loss | Â | EUR Â Â Â Â 5,000 |
| Investments | 2 | Â |
| â available-for-sale | Â | EUR 200,000 |
| â held-to-maturity | Â | EUR Â Â Â Â 8,000 |
| Loans and advances to customers | Â | EUR 500,000 |
| Assets Held for Sale | 3 | EUR Â Â Â Â 3,000 |
| Total assets | Â | EUR 930,000 |
| EQUITY | Â | Â |
| Shareholders' equity | 4 | EUR Â Â 60,000 |
| Retained earnings | Â | EUR Â Â 30,000 |
| Total equity | Â | EUR Â Â 90,000 |
| LIABILITIES | Â | Â |
| Subordinated loans | 5 | EUR Â Â 10,000 |
| Debt securities in issue | 6 | EUR 160,000 |
| Other borrowed funds | Â | EUR Â Â 30,000 |
| Amounts due to banks | Â | EUR Â Â 40,000 |
| Customer deposits and other funds on deposit | Â | EUR 460,000 |
| Financial liabilities at fair value through profit & loss | 7 | Â |
| â trading liabilities | Â | EUR Â Â 85,000 |
| â non-trading derivatives | Â | EUR Â Â 20,000 |
| â designated as at fair value through profit and loss | Â | EUR Â Â 15,000 |
| Liabilities held for sale | 3 | EUR Â Â 20,000 |
| Total liabilities | Â | EUR 840,000 |
| Total equity and liabilities | Â | EUR 930,000 |
Notes: Financial assets at fair value through profit and loss (1): These include assets used for trading purposes and non-trading derivatives.
Investments (2): These are investments that are either “available-for-sale (AFS)” or “held-to-maturity (HTM)”. AFS investments can be either equities or debt securities; HTM investments can only be debt securities.
Assets and liabilities held for sale (3): Disposal through a stand-alone sale transaction rather than a sale from normal day-to-day (continuing) operations. This could include
   (a) a sale that is highly probable but not yet agreed or
   (b) an agreed sale that has not yet closed.
Shareholders' equity (4): This includes share capital (authorised share capital minus unissued share capital) made up of ordinary shares and, where appropriate, preference shares (common and preferred stock in US parlance) and the various reserves that are either distributable or non-distributable.
Subordinated loans (5): Loans that have a lower priority than other bonds of an issuer in case of bankruptcy.
Debt securities in issue (6): This includes fixed-interest and floating-rate debt securities, usually analysed by maturity of the debt.
Financial liabilities at fair value through profit & loss (7): See (1) above.
FIGURE 13.2
ABC â Balance Sheet
Some of the terms mentioned in the notes to
Figure 13.2
are defined in
Table 13.2
.
TABLE 13.2
Terminology
| Term | Definition |
| Trading assets | A financial asset acquired principally for the purpose of selling in the short term or if designated by management as such. |
| Non-trading derivatives | Derivative instruments that are used by the company as part of its risk management strategies, but which do not qualify for hedge accounting are presented as non-trading derivatives. Non-trading derivatives are measured at fair value, with changes in the fair value taken to the Profit & Loss account. |
| Held to maturity | Non-derivative financial assets with fixed or determinable payments and fixed maturity for which the company has the positive intent and ability to hold to maturity and which are designated by management as HTM assets are initially recognised at fair value plus transaction costs. Subsequently, they are carried at amortised cost using the effective interest method less any impairment losses. Interest income from HTM debt securities is recognised in interest income in the Profit & Loss account using the effective interest method. HTM investments include only debt securities. |
| Available for sale | These are non-strategic investments; neither held for trading nor HTM. An AFS investment must have a readily available market price. |
| Fair value (aka mark-to-market) | The fair values of financial instruments are based on quoted market prices at the Balance Sheet date where available. The quoted market price used for financial assets held by the Group is the current bid price; the quoted market price used for financial liabilities is the current ask price. The fair value of financial instruments that are not traded in an active market is determined using valuation techniques. A variety of methods is used and assumptions made that are based on market conditions existing at each Balance Sheet date. |