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Capital-Markets Activities Manual
Activities: Operations and System Risk (Back-Office Operations)
Source: Federal Reserve System
(The complete Activities
Manual (pdf format) can be downloaded from the Federal Reserve's web
to Operations and System Risk
1. Obtain copies of all policies and procedures
governing back-office operations. Policies and procedures should at a
minimum include the following.
a. the mission statement
b. organizational structure and responsibilities
c permissible activities and off-premises dealing rules
d. limits approved by the board of directors for the full range of activities
and risks, including intraday and overnight net open positions, instrument
types, contracts, individual traders, settlement, price movement, market
liquidity, counterparty, and commodity or product types, if applicable
(For more details on limits, see sections 2010.1, 2020.1, and 2030.1,
''Market Risk,'' ''Counterparty Credit and Pre-settlement Risk,'' and
''Liquidity Risk,'' respectively.)
e. the limit-monitoring process used by back office or risk-management
staff independent of the front office, and limit-excess approval procedures
f. a detailed description of transaction processing procedures and flow
g. procedures for confirming trades
h. procedures for settlement of trades
i. required reconciliations
j. an approved list of brokers, counterparties, and an explicit dispute-resolution
methodology (that is, brokers' points policy)
k. the procedure for addressing disputed trades and discrepancies in financial
l. revaluation procedures
m. accounting procedures, including a chart of accounts and booking policies
for internal transactions and transactions with affiliates
n. guidelines for management information reporting
o. requirements for documentation and recordkeeping
p. guidelines for the quality control and storage of taped conversations
of dealer transactions
q. guidelines for brokers' commissions and fees and their appropriate
r. a code of ethics for traders and other personnel with insider information,
and ''know-your-customer'' guidelines
s. personal-trading guidelines and monitoring procedures
t. a list of authorized signatures
u. the policy for off-market rates which includes the following:
• A letter from someone in senior customer management (treasurer
or above) should be kept on file explaining (1) that the customer will
occasionally request off-market rates, (2) the reasons such requests will
be made, and (3) that such requests are consistent with the customer firm's
internal policies. This letter should be kept current.
• The dealer should solicit an explanation from the customer for
each request for an off-market-rate deal at the time the request is made.
• Senior management and appropriate credit officers at the dealer
institution should be informed of and approve each transaction and any
effective extension of credit.
• A letter should be sent to senior customer management immediately
after each off-market transaction is executed explaining the particulars
of the trade and explicitly stating the implied loan or borrowing amount.
• Normally, existing forward contracts should not be extended for
more than three months nor extended more than once; however, any extension
of a rollover should itself meet the requirements above.
2. Review the financial institution's policies to determine whether they
are adequate and effective. Does top management have clear directives
regarding the responsibilities of management personnel in charge of overseeing
and controlling risk? See sections 2010.1, 2020.1, 2030.1, and 2070.1,
''Market Risk,'' ''Counterparty Credit and Pre-settlement Risk,'' ''Liquidity
Risk,'' and ''Legal Risk,'' respectively.
3. Conduct interviews with senior and middle management to determine their
familiarity with policy directives in day-to-day situations. Develop conclusions
as to the adequacy of these policies in defining responsibilities at lower
levels of management in addressing the nature of the business and the
business risks being undertaken, and in defining specific limitations
on all types of transactional risks and operational failures intended
to protect the organization from unsustainable losses. Are these policies
reviewed periodically to ensure that all risk-bearing businesses of the
financial institutions come under directives approved by top management
and in light of the financial institution's profit experience? Develop
an understanding of the degree of commitment of middle and lower-level
management to the institution's policy directives.
a. Evaluate whether management is informed about pertinent laws, regulations,
and accounting conventions. Evaluate whether training of back-office staff
is adequate for the institution's volume and business mix.
b. Evaluate the management-succession plan for back-office and control
c. Evaluate the impact of staff turnover on back-office operations.
4. Determine the extent to which the financial institution adheres to
its established limits, policies, and procedures.
5. Determine the adherence of key personnel to established policies, procedures,
SEGREGATION OF DUTIES
1. Ensure that the process of executing
trades is separate from that of confirming, reconciling, revaluing, or
clearing these transactions or controlling the disbursement of funds,
securities, or other payments, such as margins, commissions, and fees.
2. Ensure that individuals initiating transactions do not confirm trades,
revalue positions, approve or make general-ledger entries, or resolve
disputed trades. Additionally, within the back office, segregation must
occur between reconciling and confirming positions. Accounting entry and
payment receipt and disbursement must also be performed by distinct individuals
with separate reporting lines.
3. Determine whether access to trading products, trading records, critical
forms, and both the dealing room and processing areas is permitted only
in accordance with stated policies and procedures.
4. Determine whether a unit independent of the trading room is responsible
for reviewing daily reports to detect excesses of approved trading limits.
5. Review the job descriptions and reporting lines of all trading and
supervisory personnel to ensure that they support the segregation of duties
outlined in the financial institution's policies. In addition, during
the course of the examination, observe the performance of personnel to
determine whether certain duties that are supposed to be segregated are
1. Confirm that the trading tickets or automated
transactions used to record purchases, sales, and trading contracts are
well controlled. Sequential ticketing may be appropriate to permit reconstruction
of trading history, if required.
2. Verify that trading tickets are verified and time coded by the front-office
3. If risk management is monitored by the back office, determine that
traders are adhering to stated limits. If limit excesses exist, ensure
that management approval has been obtained and documented before the occurrence
of the limit violation. Determine whether the institution maintains adequate
records of limit violations.
4. Review transactions for any unusual pattern or activity, such as an
increase in volume, new trading counterparties, or a pattern of top-price
or bottom-price trades relative to the day's trading range or with the
5. Determine whether the institution holds collateral for margin trading.
Determine whether adequate procedures are in place to monitor positions
against collateral. Ensure that the margin-monitoring process is wholly
independent of the front office. Review the adequacy of procedures for
verifying reports of margin deposits and contract-position valuations
(based on outside pricing sources) submitted by brokers and futures commission
merchants. Review procedures for reconciling these reports to the financial
6. Review the financial institution's system for ensuring that deals are
transacted at market rates.
7. Determine whether the institution can identify off-market rates for
the range of instruments transacted. Determine whether appropriate justification
for these transactions is on file and acknowledged by senior management.
8. Review the holdover-trade policy and the holdover register's record
of trades made but not posted to the ledgers at the end of the day, the
identification of such contracts as ''holdover'' items, and their inclusion
in trader or trading-office position reports to management.
9. Determine whether all holdover trades are properly recorded and monitored.
In addition, review the financial institution's holdover register and
evaluate the reasons for any unusually high incidence of held-over deals.
10. Identify transactions undertaken with affiliated counterparties to
determine whether such dealings have been transacted at prices comparable
to those employed in deals with non-affiliated counterparties.
1. Determine whether the confirmation process
is controlled by the back-office area. Different types of transactions
sometimes have varying legal or regulatory standards for the medium of
communication that can be used (such as telex).
2. Review the confirmation process and follow-up procedures. Determine
that personnel check all incoming confirmations to internal records and
immediately record, investigate, and correct any discrepancies. In addition,
a. outgoing confirmations are sent not later than one business day after
the transaction date;
b. outgoing confirmations contain all relevant contract details, and incoming
confirmations are delivered directly to the back office for review;
c. all discrepancies between an incoming confirmation and the financial
institution's own records are recorded in a confirmation discrepancy register,
regardless of disposition, and open items are reviewed regularly and resolved
in a timely manner;
d. discrepancies are directed and reviewed for resolution by an officer
independent of the trading function;
e. all discrepancies requiring corrective action are promptly identified
and followed up on; and
f. any unusual concentrations of discrepancies exist for traders or counterparties.
3. Review confirmation-aging reports to identify trades without confirmations
that have been outstanding more than 15 days. (Significantly less than
15 days in some markets may be a cause for concern.)
4. Determine whether the information on confirmations received is verified
with the trader's ticket or the contract.
5. Determine whether the institution has an effective confirmation-matching
and confirmation-chasing process.
1. In all instances, particularly those
in which the settlement of trades occurs outside an established clearing
system, review the financial institution's settlement controls to determine
whether they adequately limit settlement risk.
2. Determine whether the financial institution uses standardized settlement
instructions. (Their use can significantly reduce both the incidence and
size of differences arising from the mistaken settlement of funds.)
3. Review the nostro accounts to determine if there are old or numerous
outstanding items which could indicate settlement errors or poor procedures.
4. Determine if the institution prepares adequate aging schedules and
if they are appropriately monitored.
5. Determine whether disbursements and receipts have been recalculated
to reflect the net amounts for legally binding netting arrangements.
1. Obtain copies of reconciliations (for
trade, revaluation confirmation, positions) for capital-markets products.
Verify that balances reconcile between appropriate subsidiary controls
and the general ledger. Review the reconciliation process used by the
back office for its adequacy.
a. Determine the adequacy of the frequency of the reconciliations in light
of the trading operation.
b. Investigate unusual items and any items outstanding for an inordinately
long period of time.
c. Assess the adequacy of the audit trail to ensure that balances and
accounts have been properly reconciled.
d. Determine that reconciliations are maintained for an appropriate period
of time before their destruction.
2. Determine that timely reconciliations are prepared in conformity with
applicable policies and procedures of the reporting institution and with
regulatory accounting principles.
3. Determine that the reconcilement of frontoffice positions is performed
by an individual without initial transaction responsibility. Determine
that timely reconciliations are performed given capital-markets and trading
PROCEDURES FOR DISCREPANCIES AND DISPUTED
1. Assess the process and procedures for
the resolution of disputed trades.
2. Confirm that customer complaints are resolved by someone other than
the person who executed the contract.
3. Ensure that the institution's policy prohibits the use of brokers'
points in the foreign exchange market and properly controls any brokers'
switch transactions that are permitted.
4. Review the trade-investigations log to determine the size and amount
of outstanding disputes, the number resolved and not paid, the amount
paid out in the most recent period, and the trend of dispute resolutions
(the institution's fault versus counterparties' fault).
5. Review the volume of confirmation and settlement discrepancies noted
and the corresponding levels of overdraft interest or compensation expenses
paid to counterparties to determine-
a. the adequacy of operations staffing (number and skill level),
b. the adequacy of current operating policies and procedures, and
c. the overall standard of internal controls.
BROKERS' COMMISSIONS AND FEES PROCEDURES
1. Evaluate the volume of trading deals
transacted through brokers.
2. Review brokerage expenses. Determine that at least monthly brokerage
a. commensurate with the level of trading activity and profits,
b. spread over a fair number of brokers with no evidence of favoring particular
c. reconciled by personnel independent of traders for accuracy and distribution
3. Scrutinize transactions for which the broker has not assessed the usual
4. Does the financial institution retain information on and authorizations
for all overdraft charges and brokerage bills within the last 12 months
and retain all telex tapes or copies and recorded conversation tapes for
at least 90 days? (This retention period may need to be considerably longer
for some markets.)
5. Review the retention policy for brokers' commission and fee reports.
6. Assess that adequate information is obtained to substantiate compensated
contracts, liquidation of contracts, and cancelled contracts.
7. Review a sample of brokered transactions and their documentation.
1. Determine whether revaluation procedures
address the full range of capital-markets and trading instruments at the
2. Determine the frequency of revaluation by product and application (use).
3. Determine the source of market rates and whether the selection process
is subject to manipulation or override by traders. Determine if trader
override is justified and well documented.
4. Evaluate the methodology of revaluing illiquid or structured products
when prices are not readily available. If the institution establishes
reserves for these products, review the adequacy of those reserves.
5. Determine whether investment portfolios are adequately monitored on
a reasonable frequency.
DOCUMENTATION AND RECORDKEEPING PROCEDURES
1. Determine the adequacy of control on
documentation. Review written documentation for the following:
a. the types of contracts eligible for purchase or sale by the financial
b. individuals eligible to purchase and sell contracts
c. individuals eligible to sign contracts or confirmations
d. the names of firms or institutions with whom employees are authorized
to conduct business (counterparties)
2. Determine whether the institution has a formal record-retention policy
and whether it results in an adequate audit trail for internal and external
1. Determine whether the audit program includes
a risk assessment of all front- and back-office activities.
2. Determine whether the audits performed are comprehensive and address
areas of concern with appropriate frequency.
3. Determine whether audit findings are complete.
4. Determine whether audit findings are relayed to the appropriate level
of management and that there is appropriate follow-up and response.
5. Determine whether the audit staff is adequately trained to analyze
the range of capital markets activities at the financial institution.
1. Recommend corrective action when policies,
procedures, practices, internal controls, or management information systems
are found to be deficient, or when violations of laws, rulings, or regulations
have been noted.
Operations and Systems Risk
Internal Control Questionnaire
POLICIES AND PROCEDURES
The following questions are appropriate
for policies and operating procedures for capital markets and trading
1. Do the policies and procedures have the approval of the board of directors?
2. Do they give sufficiently precise guidance to officers and employees?
3. Do they have clear directives regarding the responsibilities of management
personnel in charge of overseeing and controlling risk? (See sections
2010.1, 2020.1, 2030.1, and 2070.1, ''Market Risk,'' ''Counterparty Credit
and Pre-settlement Risk,'' ''Liquidity Risk,'' and ''Legal Risk,'' respectively.
4. Do they appear to be appropriate to management's objectives and the
needs of the institution's customers?
5. Do they cover all of the financial institution's back-office operations
and adequately describe the objectives of these activities?
6. Are they updated on a timely basis when new products are introduced
or when existing products are modified?
7. Do they fully describe all the documentation requirements relating
to trading products?
8. Do they establish parameters which prevent conflicts of interest within
the financial institution's overall trading operations (that is, do safeguards
prevent insider abuses)?
9. Do procedures manuals cover all the securities activities that the
financial institution conducts, and do they prescribe appropriate internal
controls relevant to those functions (such as revaluation procedures,
accounting and accrual procedures, settlement procedures, confirmation
procedures, accounting/auditing trails, and procedures for establishing
the sequential order and time of transactions)?
10. Do procedures include a code of ethics? Is there a ''know-your-customer''
guideline at the institution? How does the institution ensure compliance?
11. Are there written procedures to control after-hours trades and trades
originating outside the trading room (for example, at the trader's home)?
Is there an approved list of all traders authorized to trade off premises?
SEGREGATION OF DUTIES
1. Does the back office have a current organization
chart? If so, obtain a copy.
2. Is the organization chart supplemented by position descriptions and
summaries of major functions? If so, obtain copies of them.
3. Is there a management-succession plan for back-office and control staff,
and is it adequate? Is the experience level of personnel commensurate
with the institution's activity? Is the turnover rate high?
4. Compare organizational charts between exams. If the turnover rate has
been high, determine the reasons for the turnover and evaluate what effect
the turnover has had on the financial institution's trading operations.
Determine the reasons for each trader's termination or resignation.
5. Are all employees required to take two consecutive weeks of vacation
annually? Is this policy followed?
6. Does the institution perform background checks on employees?
7. Review the financial institution's compensation program for these activities
to determine whether remuneration is based on volume and profitability
criteria. If so, determine whether controls are in place to prevent personnel
from taking excessive risks to meet the criteria.
8. Is there a list of locations where trading activities are carried out,
supplemented by a description of the activities at each location and an
explanation of each location's responsibilities with regard to risk management
and control? If so, obtain copies of the list and arrange for access to
the supplemental information.
9. Are dealers and position clerks that report to them excluded from the
a. preparing, validating (officially signing), and mailing trading contracts?
b. recording trading transactions, maintaining position ledgers and maturity
files, and preparing daily activity and position reports (except for memorandum
records used to inform dealers of position information)?
c. periodically revaluing positions and determining gains or losses for
official accounting records?
d. settling transactions and other paying or receiving functions, such
as issuing or receiving, and processing cable or mail transactions, drafts,
or bills of exchange? e. receiving counterparty confirmations and reconciling
them to contracts or broker statements, following up on outstanding confirmations,
and correcting related errors and similar processing functions?
f. operating and reconciling nostro and other due-to or due-from accounts
related to trading activities?
g. preparing, approving, and posting any other accounting entries?
10. Is management informed about pertinent laws, regulations, and accounting
conventions? Is training of back-office staff adequate for the institution's
volume and business mix?
11. Does management have a strategy for the back office that parallels
that for the organization?
12. Is the process of executing trades separate from that of confirming,
reconciling, revaluing, or clearing these transactions or from controlling
the disbursement of funds, securities, or other payments, such as margins,
commissions, or fees?
13. Are front-office functions segregated from those individuals who confirm
trades, revalue positions, approve or make general-ledger entries, or
resolve disputed trades? Additionally, within the back office, are reconciling
and confirming positions segregated? Is accounting entry and payment receipt
or disbursement performed by distinct individuals with separate reporting
14. Is access to trading products, trading records, critical forms, and
both the dealing room and processing areas permitted only in accordance
with stated policies and procedures?
15. Is a unit independent of the trading room responsible for reviewing
daily reports to detect excesses of approved trading limits?
16. From observation, are back-office tasks truly segregated from front-office
1. Are tickets pre-numbered? If not, are
trading tickets assigned a computer-generated number? Does control over
tickets appear reasonable and adequate?
2. Do tickets clearly define the type of product (for example, interest-rate
swap, OTC bond option, or gold bullion)?
3. Do tickets contain all other pertinent information to prepare the related
contract without recourse to the dealing room?
4. Are trading tickets time and date stamped in the front office? Are
dual signatures on the tickets for the trader and back-office personnel?
5. Are there any unusual patterns of activity (for example, an increase
in volume, new trading counterparties, a pattern of top-price or bottom-price
trades relative to the day's trading range or with the same counterparties)?
6. Are reviews of outstanding contracts performed on a frequency commensurate
with trading activity?
7. Are trader positions reviewed and approved by management on a timely
8. Can the institution identify off-market transactions?
9. Does the institution ensure that senior customer management is aware
of off-market transactions and the special risks involved? Is appropriate
justification for these transactions on file and acknowledged by senior
10. Are holdover trades adequately controlled?
11. Are all holdover trades properly recorded and monitored? Can the institution
justify the reasons for any unusually high incidence of held-over deals?
12. Does the institution transact trades with affiliated counterparties?
Are such dealings transacted at prices comparable to those employed in
deals with non-affiliated counterparties?
13. Does the financial institution have specific policies for margin lending,
and are customer requests adequately reviewed and authorized? Does it
enforce all margin requirements and sell securities if customers do not
meet margin calls?
14. Does the back office monitor collateral against open positions for
margin customers? Is the supervision adequate?
15. Are margin requirements on all outstanding contracts for a customer
monitored daily? In the case of actively trading customers, are margin
requirements checked after cash trades?
Review the confirmation process and follow-up
1. Are all data on incoming and outgoing confirmations compared to file
copies of contracts? Verify that confirmations contain the following information:
b. instrument purchased or sold
c. trade date
d. value date
e. maturity or expiry date
f. financial terms
g. delivery and payment instructions
h. definition of any applicable market conventions (for example, the interest-determination
i. date of preparation, if different from the transaction date
j amount traded
k. reference number
2. Are signatures on confirmations verified?
3. Are outgoing confirmations sent not later than one business day after
the transaction date?
4. Do outgoing confirmations contain all relevant contract details? Are
incoming confirmations delivered directly to the back office for review?
5. Does the institution adequately monitor discrepancies between an incoming
confirmation and the financial institution's own records?
6. Are discrepancies directed to and reviewed for resolution by an officer
independent of the trading function?
7. Are all discrepancies requiring corrective action promptly identified
and followed up on?
8. Are there any unusual concentrations of discrepancies for traders or
9. Has the institution conducted adequate research to determine the standing
of legal or regulatory standards for the medium of communication that
can be used (for example, telex)?
10. Does the institution have an effective confirmation-matching and confirmation-chasing
11. Are there procedures to uncover unusually heavy trading by a single
1. Do the financial institution's controls
adequately limit settlement risk?
2. Are nostro accounts reconciled frequently? Are there old or numerous
outstanding items which could indicate settlement errors or poor procedures?
3. How are failed securities trades managed?
a. Do procedures promptly resolve transactions that are not settled when
and as agreed on (''fails'')?
b. Are stale items valued periodically and, if any potential loss is indicated,
is a particular effort made to clear such items or to protect the financial
institution from loss by other means?
c. Are fail accounts periodically reconciled to the general ledger, and
are any differences followed up to a conclusion?
4. Is the back office routinely able to reconcile its cash accounts against
securities accepted or delivered?
5. Is physical security of trading products adequate?
6. To ensure segregation of duties, are personnel responsible for releasing
funds specifically excluded from any confirmation responsibilities?
7. Does the institution prepare adequate aging schedules? Are they monitored?
8. Are netting arrangements correctly reflected in disbursements and receipts?
Obtain copies of reconciliations (for trade,
revaluation confirmation, and positions) for traded products. Verify that
balances reconcile to appropriate subsidiary controls and the general
ledger. Review the reconciliation process followed by the back office
1. Are timely reconciliations prepared in conformity with applicable policies
and procedures of the reporting institution and regulatory accounting
2. Are unusual items investigated? Are there any outstandings?
3. Is the audit trail adequate to ensure that balances and accounts have
been properly reconciled?
4. Are reconciliations held on file for an appropriate period of time?
5. Is the reconcilement of front-office positions performed by an individual
without initial transaction responsibility?
DISCREPANCIES AND DISPUTED TRADES
1. Is the resolution of disputed trades
and determination of compensation for the early unwinding of contractual
obligations of the financial institution controlled by the back office?
2. Are the processes and procedures for the resolution of disputed trades
3. Are customer complaints resolved by someone other than the person who
executed the contract?
4. Does the institution's policy prohibit the use of brokers' points in
the foreign-exchange market and control any brokers' switch transactions?
5. Is the volume of confirmation and settlement discrepancies excessive?
BROKERS' COMMISSIONS AND FEES PROCEDURES
1. Evaluate the volume of trading deals
transacted through brokers. Are commissions and fees-
a. commensurate with the level of trading activity and profits?
b. spread over a fair number of brokers? Is there evidence of favoring
a particular or group of brokers?
c. reconciled by personnel independent of traders to determine accuracy
and distribution of expenses?
2. Are regular statements received from these brokers?
3. Are incoming brokers' statements sent directly to the accounting or
operations department and not to trading personnel?
4. Are brokers' statements reconciled by the back office with the financial
institution's records before the payment of commissions?
5. Does the back office routinely report any significant questions or
problems in dealing with brokers? Are discrepancies on brokers' statements
directed to someone outside the trading function for resolution?
6. Can the institution justify cases in which the broker has not assessed
the usual fee?
7. Is an adequate audit trail established for all overdraft charges and
brokerage bills within the last 12 months? Does the process require retention
of all telex tapes or copies and recorded conversation tapes for at least
90 days? (This retention period may need to be considerably longer for
1. Do the revaluation procedures address
the full range of capital-markets and trading instruments at the institution?
2. Is the frequency of revaluation by product and application (use) adequate?
3. Are the source of market rates and the selection process subject to
manipulation or override by traders? Is trader override justified and
4. Are revaluation results discussed with the trading management? Is an
approval process in place to ensure agreement of positions and profit
and loss by back- and front-office staff?
See section 2120.1, ''Accounting.''
MANAGEMENT INFORMATION REPORTING
See section 2040.1, ''Management Information
DOCUMENTATION AND RECORDKEEPING
1. Is written documentation complete, approved
at the appropriate level (with authorized signatures), and enforceable?
2. Are there procedures in place to ensure compliance with the Financial
Recordkeeping and Reporting Act of 1978?
1. Does the audit program include a risk
assessment of all the front- and back-office activities?
2. Are the audits performed comprehensive, and do they address areas of
concern with appropriate frequency? Is the scope adequate and clearly
3. Do audit findings summarize all important areas of concern noted in
4. Are audit findings relayed to the appropriate level of management?
Is appropriate follow-up and response elicited?
5. Is the audit staff adequately trained to analyze the range of capital-markets
activities at the financial institution?
6. Is there the opportunity for undue influence to be imposed on audit
staff? Is audit staff sufficiently independent of control and front office
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