After a trade is made, the front office enters its terms in the system, and the back office exchanges a confirmation with the counterparty and matches it against the firm's records. This entry and matching step is meant to find and correct booking errors and confirmation mismatches.

Types of booking errors and how they lead to losses

A booking error can occur in any of the trade terms. If the wrong record is used to manage positions, collateral, and settlement, the error can lead to losses. The table gives examples of errors in the main terms.

Term Example of a booking error What happens if the error remains
Direction A sale is entered as a purchase The position is recorded in the opposite direction
Amount USD 1 million is entered as USD 10 million (a digit error) Positions and settlement amounts are recorded at 10 times the actual size
Dates The settlement date is entered as six months ahead instead of three Payment is not ready on the actual settlement date
Currency Dollars are entered as euros The position is managed as one in a different currency
Counterparty Company K is entered as a different company Credit limits and collateral are managed as if they belonged to the other counterparty
Terms swapped between trades The rates of two trades are entered the wrong way around The market value and profit and loss of both trades are wrong

Consider a hypothetical example in which Y Bank enters into an FX forward with Company K to sell USD 1 million in three months at JPY 150 per dollar. In three months, Y Bank will deliver USD 1 million and receive JPY 150 million. Suppose a staff member enters the trade the other way around, as "Y Bank buys USD 1 million." The records then show a long position of USD 1 million. The actual position is a short position of USD 1 million, so the records and the actual position differ by USD 2 million.

Now suppose Y Bank tries to offset the long position shown in its records. On the same day, it enters into another FX forward in the market to sell USD 1 million in three months at JPY 150 per dollar. The records now show a position of zero, but in reality Y Bank is left with a short position of USD 2 million. If the dollar is at JPY 152 on the settlement date, Y Bank loses JPY 4 million on this position; if it is at JPY 148, Y Bank gains JPY 4 million. Which one happens depends on market moves, and until the error is found, the position sits outside risk management.

The terms in the table are the basic items in a trade record. The US Federal Reserve's examination manual (February 1998) states that the record of an executed trade includes the trade date, settlement date, counterparty, instrument, amount, price or rate, and settlement instructions1. The items that firms in Japan report to the authorities as trade data for OTC derivatives also include the parties to the trade, the direction (buyer or seller, payer or receiver), the effective date, the maturity date, the settlement currency, the price, and the notional amount2.

A firm also calculates its exposure to each counterparty (the amount it could lose if that counterparty defaulted) and its collateral calls from its own records. So an error left in the records can make the exposure and collateral amounts wrong as well3. Errors in payments and receipts can cause large losses4. Losses from booking errors fall under "execution, delivery and process management," one of the types of operational risk loss events listed in Japan's capital adequacy notice5. The broader picture of operational risk is covered in Operational Risk in Derivatives.

The role of trade confirmations and the matching process

A trade confirmation is a record of the trade terms that each party sends to the other after the trade is agreed and before it settles. Because it sets out the terms in detail, a confirmation serves as legal evidence and is also used for operational checks and to prevent fraud6. US swap rules define a confirmation as legally binding documentation that records the parties' agreement to all the terms of the trade. A confirmation is created when the receiving party signs the record of terms sent by the other party7.

Trade execution and confirmation are handled by different people8. Confirmations are sent by the back office (operations and settlement), not the front office (sales and trading), and the back office follows up on and controls the counterparty's responses. The basic approach is to compare the confirmation received from the counterparty with the firm's copy of the confirmation it sent. In trades with nonfinancial companies, the firm may instead send the confirmation in duplicate and ask the counterparty to sign and return one copy6. Comparing two records in this way to find and correct differences is called reconciliation.

Y Bank front officeY Bank back officeCompany KMismatchMatchExecute an FXforward withCompany KEnter thetrade terms inthe systemCheck theentered termsSend theconfirmationto Company KCompare theconfirmation withits own recordsFind the causeand resolve themismatchCheck the signedcopy, then markas confirmed
Figure 1How a confirmation for an FX forward is exchanged
Figure description

The flow shows Y Bank and Company K exchanging a confirmation for an FX forward. If the records match, Company K returns a signed copy; if not, the cause is investigated. If the error is Y Bank's, it corrects the entry and obtains a new confirmation with the corrected terms. If the error is Company K's, it notifies Company K, which corrects its records and returns a signed copy. In either case, the returned confirmation is checked in the same way and, if it matches, the trade is marked as confirmed. Errors that the back office missed in its own check are also found at the stage of comparing with the counterparty's records.

Confirmations are addressed to a department at the counterparty that is independent of its trading unit. Reconciliation is kept fully independent of the trading unit, and confirmations and other documents are completed and exchanged as soon as possible after the trade9.

What to do when a mismatch is found

When a mismatch is found, the firm records every one, investigates the cause, and resolves it. When the parties agree to correct the terms, a new confirmation is exchanged with the corrected terms. Significant mismatches are investigated by staff independent of the trading unit. In the earlier example, if Y Bank sends a confirmation stating "Y Bank buys USD 1 million," Company K, whose records show it as the buyer of dollars, replies that the direction does not match. Y Bank's back office checks the front office's order records and confirms that the error lies in its own entry. Once the entry is corrected, the recorded position becomes the actual short position of USD 2 million and comes back under risk management.

The Federal Reserve's examination manual sets out the following steps for handling mismatches10.

  • Every mismatch between a received confirmation and the firm's records is entered in a discrepancy log, however it was resolved, and open items are reviewed regularly.
  • Significant mismatches are investigated independently of the trading unit. For small ones, the trader who deals with the counterparty day to day may be asked to check with the counterparty.
  • A manager independent of the trading unit follows mismatches through to resolution.
  • When the parties agree to change the terms, they exchange a new confirmation.

For foreign exchange trades, a firm that receives a confirmation that does not match its records checks internally and then promptly notifies the counterparty. If the counterparty says a trade was done but the firm has no record of it, the firm also tells the counterparty. The firm has escalation procedures that report unconfirmed or disputed trades to more senior staff so they are resolved sooner11. Procedures for amending or canceling trades keep the operations (back office), sales, and trading functions separate, and the status of amendments and cancellations is reported regularly to management12.

Confirmation delays and deadlines

When trades without an exchanged confirmation (unconfirmed trades) pile up, booking errors stay hidden. According to 2008 testimony to the US Congress, post-trade processing of OTC derivatives had long been largely paper-based. Dealers had large backlogs of unconfirmed trades, and a significant portion had been outstanding for 30 days or more. Delayed confirmation can lead a firm to underestimate its exposure to counterparties or to fail to call collateral. It can also delay the close-out and replacement of trades with a counterparty that defaults3.

In 2005, unconfirmed trades were especially numerous in credit default swaps. From September 2005, the authorities, led by the Federal Reserve Bank of New York, worked with the dealers, and the dealers made much greater use of platforms for exchanging confirmations electronically. By September 2006, the dealers had reduced trades unconfirmed for more than 30 days by 85% in aggregate. However, unconfirmed trades grew almost fivefold from June to August 2007, showing that the reductions could not be sustained when trading volume suddenly jumped13.

There are also rules on deadlines. Under the rules of the U.S. Commodity Futures Trading Commission (CFTC), swaps between swap dealers must be confirmed by the end of the first business day after execution. Trades between a swap dealer and a financial entity must also be confirmed by the end of the next business day. Financial entities are the counterparties the rule lists: funds, employee benefit plans, and persons mainly engaged in financial business such as banking. Trades with other counterparties must be confirmed by the end of the second business day. Swap dealers must set out and follow written procedures for meeting these deadlines14.

In Japan's trade reporting, a firm reporting an OTC derivatives trade indicates whether a confirmation has been exchanged: the trade is reported as unconfirmed, confirmed electronically, or confirmed by non-electronic means15.

For foreign exchange trades, firms use automated confirmation matching where it is available. Confirmations are sent, as far as possible, using industry-agreed templates and standardized message formats8. Senior management regularly receives the number of unconfirmed trades and the time taken to confirm them. It then assesses the operational risk of continuing to trade with the counterparties concerned11.

Controls that prevent booking errors and mismatches

Booking errors and mismatches are found early by layering checks on input, segregation of duties, and regular reconciliation. When the front office enters trades in the trading system, the back office checks the entries before the trades are accepted16. For foreign exchange trades, the recommended approach is to transmit trade data directly and automatically from front-office systems to back-office systems. Where this is not possible, the firm has controls to make sure the data is captured completely and accurately17.

Under segregation of duties, the people who make trades are not given responsibility for signing confirmations, reconciling records, settling trades, or controlling collateral payments18. In Japan, the FSA's supervisory guidelines for major banks call for the rules for managing market risk to make clear the roles and authority of the managers of the front office, the back office, and the middle office (risk management and similar functions)19.

In reconciliation between departments, the records in front-office, middle-office, and back-office systems are compared regularly, and staff independent of the business unit identify differences and follow them through to resolution20. Traders compare their daily positions with records prepared separately by the back office. The person who reconciles the records is not the person who enters the trade data21. Reconciling expected cash flows with actual movements in accounts is another way to find missing or wrong entries early22.

With counterparties, portfolio reconciliation is used in addition to matching confirmations. Portfolio reconciliation is the process of exchanging the material terms and valuations of all swaps with a counterparty and resolving any differences. Under US rules, swap dealers reconcile with each other every business day if they have 500 or more swaps, every week if they have more than 50 but fewer than 500, and every quarter if they have 50 or fewer. If reconciliation reveals a discrepancy in a material term, it is resolved immediately23.

Having an independent department receive confirmations also helps prevent fraud. A trader could send out a confirmation, destroy the copies, and arrange for the counterparty's confirmation to be delivered to the trader directly, building up positions the firm does not know about. If an independent department receives and checks the counterparty's confirmations, this kind of fraud is found quickly24. Cases of rogue trading involving falsified confirmations are covered in Rogue Trading Cases: Barings, Societe Generale and Others.

Notes

  1. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2050.1 "Operations and Systems Risk (Front-Office Operations)" (February 1998), "Transaction Flow," page 3. ↩

  2. Financial Services Agency, "店頭デリバティブ取引等の規制に関する内閣府令第４条第１項で定める作成・保存・報告事項 ガイドライン" (Guidelines on the items to be prepared, retained, and reported under Article 4, paragraph 1 of the Cabinet Office Order on the regulation of OTC derivatives transactions, our translation) (December 2022), "報告事項 一覧" (List of reporting items): parties to the trade, items 7 and 8; direction, items 10 and 11; effective date, item 1; maturity date, item 2; settlement currency, item 21; price, item 64; notional amount, item 87 (in Japanese). ↩

  3. Board of Governors of the Federal Reserve System, "Over-the-counter derivatives" (testimony of Patrick M. Parkinson before a subcommittee of the US Senate, July 9, 2008), "Supervisory Efforts to Strengthen the Infrastructure of the OTC Credit Derivatives Market," first paragraph. ↩ ↩2

  4. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1 "Operations and Systems Risk (Back-Office Operations)" (February 1998), "Settlement Process," page 4. ↩

  5. Financial Services Agency, "銀行法第十四条の二の規定に基づき、銀行がその保有する資産等に照らし自己資本の充実の状況が適当であるかどうかを判断するための基準" (Standards for determining whether a bank's capital adequacy is appropriate in light of the assets it holds, under Article 14-2 of the Banking Act, our translation; FSA Notice No. 19 of 2006, consolidated version updated on August 24, 2026), Appended Table 2 (別表第二; relating to Article 310, item 1, sub-item ハ), "損失事象の種類" (Types of loss events) (pages 614–615) (in Japanese). ↩

  6. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1 (February 1998), "Confirmations," page 3. ↩ ↩2

  7. 17 CFR 23.500(a) (Acknowledgment) and 23.500(c) (Confirmation). ↩

  8. Global Foreign Exchange Committee, "グローバル外為行動規範" (FX Global Code, December 2024 version, provisional Japanese translation by the Tokyo Foreign Exchange Market Committee), Principle 46 (pages 46–47) (in Japanese). The English original is Global Foreign Exchange Committee, "FX Global Code" (December 2024), https://www.globalfxc.org/uploads/fx_global.pdf; the principle numbers are the same, and the page numbers are those of the translation. ↩ ↩2 ↩3

  9. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1 (February 1998), page 4 (continuation of "Confirmations") and page 7. ↩

  10. The same manual, Section 2060.1 (February 1998), page 4, and Section 2060.3 "Examination Procedures" (February 1998), "CONFIRMATION PROCEDURES," step 2, page 3. ↩ ↩2

  11. Global Foreign Exchange Committee, "グローバル外為行動規範" (FX Global Code, provisional Japanese translation), Principle 48 (pages 47–48) (in Japanese). ↩ ↩2 ↩3

  12. The same code, Principle 45 (page 46) (in Japanese). ↩

  13. Board of Governors of the Federal Reserve System, "Over-the-counter derivatives" (Parkinson testimony, July 9, 2008), "Supervisory Efforts to Strengthen the Infrastructure of the OTC Credit Derivatives Market," first to fourth paragraphs. ↩

  14. 17 CFR 23.501(a)(1)–(3). Financial entities are defined in 23.500(e). The treatment of trades submitted to and accepted by a clearing organization is in 23.501(a)(4). ↩

  15. Financial Services Agency, "店頭デリバティブ取引等の規制に関する内閣府令第４条第１項で定める作成・保存・報告事項 ガイドライン" (Guidelines on the items to be prepared, retained, and reported under the Cabinet Office Order on OTC derivatives, our translation) (December 2022), item 19, "Confirmed（コンファメーションの有無）" (Confirmed (whether a confirmation exists)), in the table of reporting items, allowed values and notes (in Japanese). ↩ ↩2

  16. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2050.1 (February 1998), "Transaction Flow," page 2. ↩

  17. Global Foreign Exchange Committee, "グローバル外為行動規範" (FX Global Code, provisional Japanese translation), Principle 44 (page 46) (in Japanese). ↩

  18. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1 (April 2003), "INTERNAL CONTROLS," page 2. ↩

  19. Financial Services Agency, "主要行等向けの総合的な監督指針" (Comprehensive Guidelines for Supervision of Major Banks, etc.), III-2-3-3-2(1)② (in Japanese). ↩

  20. Global Foreign Exchange Committee, "グローバル外為行動規範" (FX Global Code, provisional Japanese translation), Principle 27 (page 35) (in Japanese). ↩

  21. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1, page 2 (April 2003, "TICKET FLOW") and page 5 (February 1998, "Reconciliations"). ↩

  22. Global Foreign Exchange Committee, "グローバル外為行動規範" (FX Global Code, provisional Japanese translation), Principle 54 (page 51) (in Japanese). ↩

  23. 17 CFR 23.500(i) (Portfolio reconciliation) and 23.502(a)(3)(i)–(iii) and (a)(4). For counterparties that are not swap dealers, see 23.502(b)(3). ↩

  24. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1 (February 1998), page 4 (continuation of "Confirmations"). ↩