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Derivatives Compass

PractitionerAdvanced

Back Office (Settlement, Collateral and Accounting)

Who this is for
For people who handle confirmations, settlement, collateral, reporting and accounting.
How to read it
Newcomers read the foundations first. Practitioners start at stage 1. If you already run collateral and reporting, start at stage 4.

  1. Stage 1The life of a tradePractitioner

    From trade capture and confirmations through lifecycle events, settlement, daily valuation and P&L to early termination: the path a single trade follows.

    1. IntroductoryTrade Capture and ApprovalA unit other than the one that did the trade checks the entry, errors are corrected, and checked trades are passed on for reconciliation with the counterparty.Internal Operations
    2. IntroductoryTrade ConfirmationsA confirmation puts the terms agreed by phone or other means in writing, such as the parties, direction, amount, rate, and delivery date, so errors and fraud can be caught before settlement.Client-Facing Business
    3. PractitionerLifecycle Event ProcessingA lifecycle event determines whether a trade continues, ends, or is replaced by another trade.Internal Operations
    4. IntroductorySettlementIf settlement does not happen as planned, a financial institution can lose funds it expected to receive or have to raise replacement funds in a hurry.Internal Operations
    5. PractitionerDaily Valuation and P&L Sign-OffErrors and fraud could hide in P&L that traders set themselves, so a unit that does not trade checks the front office's figures.Internal Operations
    6. PractitionerEarly TerminationA client may cancel a trade mid-term for its own reasons, but some trades cannot, in principle, be cancelled mid-term.Client-Facing Business

  2. Stage 2Collateral and clearingPractitioner

    The CSA and collateral operations, sourcing collateral, futures margin, how clearing houses work, and the clearing and margin mandates.

    1. PractitionerThe Credit Support Annex (CSA)A CSA fixes in advance who delivers how much collateral, when the market value of the trades under the master agreement moves.Documentation and Law
    2. PractitionerCollateral OperationsThresholds, minimum transfer amounts, eligible collateral and haircuts, and the interest rate on cash collateral differ from agreement to agreement, so the daily calculation uses the terms agreed with each counterparty.Internal Operations
    3. PractitionerSourcing and Substituting CollateralCollateral can be sourced from assets a firm holds, by reusing collateral it has received, or through collateral transformation.Liquidity and Funding Risk
    4. IntroductoryFutures Margin and Daily SettlementFor futures cleared by JSCC, the central counterparty, customers deposit margin by the day after the trade.Listed and OTC Trading
    5. IntroductoryCentral Counterparties: JSCC, LCH, CME and OthersWhen a CCP becomes the counterparty to trades, the effects of a counterparty default are concentrated in the CCP, so it covers its credit risk to participants with pre-funded resources.Market Infrastructure
    6. PractitionerMandatory ClearingThe obligation arises when a designated transaction is entered into, unless it falls under an exception set by Cabinet Office Order.Regulation: Japan
    7. PractitionerMargin Requirements for Uncleared DerivativesThe margin requirements call for variation margin and initial margin to be exchanged on OTC derivative transactions that are not cleared.Regulation: Japan

  3. Stage 3Reporting and reconciliationPractitioner

    Regulatory reporting and trade repositories, identifiers, portfolio reconciliation, compression and post-trade confirmation services.

    1. PractitionerRegulatory ReportingTrade information is sent to a trade repository trade by trade, while capital ratios and the state of risks are sent to the authorities at set times.Internal Operations
    2. PractitionerTrade ReportingThe legal basis is Articles 156-63 to 156-66 of the Financial Instruments and Exchange Act and a Cabinet Office Order.Regulation: Japan
    3. PractitionerTrade RepositoriesTrade repositories exist so that authorities can see the whole over-the-counter derivatives market.Market Infrastructure
    4. PractitionerIdentifiers: LEI, UTI, and UPIThe LEI identifies the legal entity, the UTI the trade, and the UPI the product, and an ISO standard sets the form of each.Data and Systems
    5. PractitionerPortfolio ReconciliationReconciliation exchanges the material terms of trades and their valuations as of the close of business on the previous business day, and resolves any discrepancies.Market Infrastructure
    6. PractitionerPortfolio CompressionIf you hold two trades whose positions offset each other, the total notional amount is larger than the net position.Market Infrastructure
    7. PractitionerPost-Trade Confirmation and Matching ServicesIn electronic confirmation, the confirmation is established when the terms agree or the parties accept them.Market Infrastructure

  4. Stage 4Accounting and taxPractitioner

    Accounting operations, fair value standards, hedge accounting and Japan's deferral hedge, disclosures, taxation of gains and withholding tax.

    1. PractitionerAccounting OperationsTransactions are entered in the ledger, supported by copies of the trade agreement, and updated on each settlement date and each revaluation.Internal Operations
    2. PractitionerFair Value Measurement: IFRS 13, ASC 820 and the Fair Value HierarchyFair value is the price received to sell an asset or paid to transfer a liability (an exit price). The entity's intention to hold or settle is not relevant.Accounting
    3. PractitionerJapan's Fair Value Measurement StandardThe standard applies from the beginning of a fiscal year, and early application was also permitted.Accounting
    4. PractitionerHedge Accounting BasicsA hedging instrument is measured at fair value but a hedged item is not always, so the two gains or losses appear in different periods.Accounting
    5. PractitionerDeferral Hedge Accounting under Japanese GAAPUnder Japanese GAAP, deferral hedge accounting is the basic method, and the fair value hedging method is an exception.Accounting
    6. PractitionerDisclosures in the NotesJapanese GAAP requires contract amounts and fair values by type of underlying, and adds valuation gains and losses for transactions to which hedge accounting is not applied.Accounting
    7. PractitionerTaxation of Derivative Gains and LossesEven for the same derivative trade, a company calculates income under the Corporation Tax Act and an individual under a special provision of the Act on Special Measures Concerning Taxation, so the methods differ.Tax
    8. PractitionerWithholding TaxIn Japan, a payer of certain Japan-source income to a nonresident or foreign corporation deducts tax and remits it by the 10th of the next month.Tax

  5. Stage 5Preventing failuresPractitioner

    How input errors, settlement failures and reporting mistakes happen, how audits work, and the events of default and close-out netting.

    1. IntroductoryOperational Risk in DerivativesThe regulatory definition includes legal risk and excludes strategic risk and reputational risk.Operational Risk
    2. IntroductoryBooking Errors and Confirmation MismatchesIf the direction is reversed or an amount is entered with the wrong number of digits, positions, collateral, and settlement amounts go forward on the wrong basis.Operational Risk
    3. PractitionerSettlement Failures and Reporting ErrorsA settlement failure leads to costs, compensation, and losses when a counterparty does not deliver. A reporting error leads to correction effort and penalties.Operational Risk
    4. PractitionerResponding to Audits and ExaminationsA financial institution undergoes internal audit, external audit by an audit firm, the Financial Services Agency's inspections, and the Bank of Japan's examinations as separate audits, each with a different party and basis.Internal Operations
    5. PractitionerEvents of Default and Termination EventsThe master agreement sets out insolvency, failure to pay, and deterioration in credit standing as events that allow the trades to be ended early.Documentation and Law
    6. PractitionerClose-Out NettingIn close-out netting, when the counterparty fails, the net of the values of all transactions becomes a single claim or obligation.Documentation and Law

  6. Stage 6Defaults and advanced accountingAdvanced

    Hedge accounting under IFRS and US GAAP, clearing house default management, netting opinions and stay protocols.

    1. AdvancedHedge Accounting under IFRS 9 and ASC 815The three types are treated similarly, but IFRS 9 recognizes ineffectiveness in profit or loss, while ASC 815 does not measure it separately.Accounting
    2. AdvancedCCP Default ManagementJSCC processes a defaulting clearing member's positions through hedging and auctions, among other methods, to fix the loss.Market Infrastructure
    3. AdvancedNetting Enforceability and Legal OpinionsA legal opinion states in writing that close-out netting is expected to be recognized in the relevant jurisdictions.Documentation and Law
    4. AdvancedResolution stay protocolsWhen a large financial institution enters resolution, counterparties' simultaneous terminations can unsettle the market and obstruct the resolution measures.Booking Models

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