Foreign Exchange Operations E-Book

David F. DeRosa

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 367

Veröffentlichungsjahr: 2013

Beschreibung

The ultimate nuts-and-bolts guide to foreign exchange operations The foreign exchange landscape is particularly risky since so much of the world is unregulated and takes place over the counter (off exchange). Brilliant traders and money managers who are profitable may find themselves underperforming, or worse, losing, simply because they failed to establish strong operations. In this book, David DeRosa provides industry players with everything they need for strong operational functions from all the types of trades to execution, master trading agreements, documentation, settlement, margin and collateral, and prime brokerage services. * Contains vital work flow solutions for trading in the volatile foreign exchange marketplace * Offers information for mastering the operational aspect of foreign exchange trading to help determine best partners such as prime brokers and others * Written by David DeRosa a leading foreign exchange expert who has consulted to hundreds of financial institutions Foreign Exchange Operations helps traders mitigate risks and offers a guide to all aspects of trading operations from mastering trading agreements to margin documentation.

Leseprobe

Contents

Cover

Series

Title Page

Copyright

Dedication

Preface

Acknowledgments

Chapter 1: Introduction to Foreign Exchange

DEFINING MONEY

PARTICIPANTS IN THE FOREIGN EXCHANGE MARKET

IDENTIFYING CURRENCIES AND EXCHANGE RATES

QUOTATION CONVENTIONS

THE FOREIGN EXCHANGE MARKET

FOREIGN EXCHANGE REGIMES

EXCHANGE RATE CONTROLS

THE STRUCTURE OF THE FOREIGN EXCHANGE MARKET

BANKS' IDENTIFICATION CODES

THE AUTHORITIES

SPOT FOREIGN EXCHANGE DEALS

PROFIT AND LOSS ON A SIMPLE TRADE

VALUE DATES

FORWARD FOREIGN EXCHANGE AND COVERED INTEREST PARITY

FORWARD SWAPS

NON-DELIVERABLE FORWARDS

SUMMARY

APPENDIX 1.1: ISO CURRENCY CODES

REFERENCES

Chapter 2: Options on Foreign Exchange

OPTION BASICS

PUT–CALL PARITY

THE IMPORTANCE OF OPTION MODELS

RISK PARAMETERS

THE MINOR GREEKS

MORE ON DELTA

PORTFOLIOS OF OPTIONS

AMERICAN EXERCISE MODELS

VOLATILITY

IMPORTANT OPTION STRATEGIES

OPTION MARKET MAKING

NON-DELIVERABLE OPTIONS

BARRIER OPTIONS

BINARY OPTIONS

BARRIER DETERMINATION AGENCY

OTHER EXOTIC OPTIONS

MORE ON OPTION-RELATED RISKS

SUMMARY

APPENDIX 2.1: FURTHER COMMENTS ON PUT–CALL PARITY

APPENDIX 2.2: BLACK-SCHOLES-MERTON MODEL

APPENDIX 2.3: BARRIER AND BINARY OPTIONS

REFERENCES

Chapter 3: How Trades Are Executed and Confirmed

SPOT FOREIGN EXCHANGE DEALS

FORWARD OUTRIGHT DEALS

FORWARD SWAP DEALS

OPTION TRADES

HOW FOREIGN EXCHANGE TRADES ARE EXECUTED

CONCENTRATION IN MARKET MAKING

EXAMPLE OF AN ELECTRONIC TRADING PLATFORM: FXALL

TRADE DOCUMENTATION CYCLE

INTERNAL OPERATIONS AND REPORTS FOR DEALERS

SUMMARY

APPENDIX 3.1: TRANSACTIONS AT DAILY FIXINGS

REFERENCES

Chapter 4: Foreign Exchange Settlement

SETTLEMENT INSTRUCTIONS FOR AN INDIVIDUAL SPOT FOREIGN EXCHANGE DEAL

OVERVIEW OF THE SETTLEMENT PROCESS

THE BRETTON WOODS–SMITHSONIAN PERIOD

THE HERSTATT LEGACY

SETTLEMENT RISK

NETTING

HOW THE MODERN SETTLEMENT SYSTEMS DEVELOPED

LARGE-VALUE TRANSFERS

CENTRAL BANK INVOLVEMENT

CORRESPONDENT BANKING

PAYMENT SYSTEMS

DESIGNATED-TIME NET SETTLEMENT (DTNS)

REAL-TIME GROSS SETTLEMENT (RTGS)

EXAMPLES OF MODERN PAYMENT SYSTEMS

CLS BANK

INTERNAL CONTROLS

SUMMARY

REFERENCES

Chapter 5: Master Agreements

MOTIVATION

THE ARCHITECTURE

THE FXC MASTER AGREEMENT FORMS

THE ISDA MASTER AGREEMENT FORMS

SINGLE AGREEMENT

NON-RELIANCE: PARTIES TO RELY ON THEIR OWN EXPERTISE

NETTING: PAYMENT OR SETTLEMENT NETTING AND NOVATION NETTING

EVENTS OF DEFAULT

TERMINATION EVENTS

ADDITIONAL TERMINATION EVENTS

CLOSE-OUT NETTING

SAFE HARBORS

EARLY TERMINATION

PAYMENTS UPON TERMINATION AND CLOSE-OUT AMOUNTS

CLOSE-OUT AMOUNT: 2002 ISDA

SET-OFF PROVISIONS

SPECIAL FEATURES FOR OPTIONS: ICOM AND FEOMA

SPECIAL FEATURES FOR NON-DELIVERABLE FORWARDS

MISCELLANEOUS ISSUES

MORE ON DEEDS OF ADHERENCE AND SCHEDULES

SUMMARY

APPENDIX 5.1: IFXCO TERMS

ANNEX 1

ANNEX 2A

ANNEX 2B

ANNEX 3

APPENDIX 5.2: IFXCO ADHERENCE AGREEMENT

REFERENCES

Chapter 6: Margin and Collateral

CREDIT AGREEMENTS

FRAMEWORK FOR THE ISDA CREDIT SUPPORT DEED AND THE FXC COLLATERAL ANNEX

FRAMEWORK FOR THE ISDA CREDIT SUPPORT ANNEXES

ENFORCEMENT RIGHTS OF THE SECURED PARTY

SOME ADDITIONAL FEATURES COMMONLY FOUND IN CREDIT SUPPORT DOCUMENTS

THE VALUE-AT-RISK CONCEPT

VaR FOR SPOT, FORWARD, AND VANILLA OPTIONS

PORTFOLIO VALUE-AT-RISK

SAMPLE CUSTOMER CREDIT SNAPSHOT

LIMITATIONS OF VaR

LIMITATIONS OF COLLATERALIZED AGREEMENTS

SUMMARY

APPENDIX 6.1: THE 1999 COLLATERAL ANNEX TO FEOMA, IFEMA, OR ICOM MASTER AGREEMENT

REFERENCES

Chapter 7: Foreign Exchange Prime Brokerage

OVERVIEW OF FX PRIME BROKERAGE

PROS AND CONS OF FX PRIME BROKERAGE

EXECUTION AND CONFIRMATION IN AN FX PRIME BROKERAGE ENVIRONMENT

THE LEGAL ARCHITECTURE OF FX PRIME BROKERAGE

THE FX PRIME BROKER AND THE EXECUTING DEALER

THE MASTER FX GIVE-UP AGREEMENT

OTHER ELEMENTS OF THE MASTER FX GIVE-UP AGREEMENT

THE FX PRIME BROKER AND THE DESIGNATED PARTY

THE EXECUTING DEALER AND THE DESIGNATED PARTY

REVERSE GIVE-UP RELATIONSHIPS

SUMMARY

APPENDIX 7.1: MASTER FX GIVE-UP AGREEMENT

REFERENCES

About the Author

Index

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Copyright © 2014 by David F. DeRosa. All rights reserved.

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Library of Congress Cataloging-in-Publication Data:DeRosa, David F. Foreign exchange operations : master trading agreements, settlement, and collateral/David F. DeRosa, PhD. 1 online resource. – (Wiley finance series) Includes bibliographical references and index. Description based on print version record and CIP data provided by publisher; resource not viewed. ISBN 978-0-470-93291-9 (cloth); ISBN 978-1-118-41839-0 (ePDF); ISBN 978-1-118-41555-9 (epub) 1. Foreign exchange. 2. Commercial treaties. 3. International trade. I. Title. HG3851 332.4′5–dc23

2013017690

For Francesca

Preface

The topic of this book is foreign exchange operations. At the outset, there is the question of why to study operations. The answer comes in three parts.

First, there are the practical reasons. The sums of money that are traded in the foreign exchange market are utterly massive. This makes for an enormous incentive to improve the functioning and accuracy of not just the dealing room but also the operations facility. Specifically, learning about operations can help to reduce costly mistakes. Mistakes can be expensive because they cause positions to be incorrectly hedged and create inadvertent exposure to risk. Additionally, there is always the possibility for fraud. Realistically, financial markets are natural breeding grounds for fraud, not just in sales and trading but also in operations. One objective in learning about operations should be to make fraud close to impossible to carry out, and, if it does occur, easy to discover.

The second reason for being interested in this subject is that digging into operations leads to encounters with financial history. One can learn how financial infrastructure developed as the product of changes in the foreign exchange market, legal practices, technology, and institutional arrangements.

The largest spur to the development of modern operations was the collapse of the Bretton Woods agreement in the early 1970s. This led to the creation of floating, or nearly floating, exchange rates among major currencies. During the next four decades, trading in foreign exchange and its related derivatives exploded in volume. This caused foreign-exchange-dealing banks, central banks, and industry groups to embark on a remarkable journey with the objective of creating efficient and safe operations and, in particular, a secure settlements environment.

Along the way:

The legal community, with the help of industry groups and central banks, designed the modern master agreements, confirmations, collateral agreements, and master give-up agreements. Particularly important was the development of closeout netting and bankruptcy-remote safe harbors for trading accounts.Specialized institutions came into prominence, including SWIFT (Society for Worldwide Interbank Financial Telecommunication, a communications network for secure messaging) and CLS Bank (for escrow-style bilateral settlements).Foreign-exchange-dealing banks acquired sophistication in the management of margin and collateral practices.Central banks established Real-Time Gross Settlements systems for large-scale money transfers.Trading desks have been automated in increasingly sophisticated ways. In Chapter 3, we look at an example of an electronic platform, FXall. Many of these platforms have direct linkages to operations departments.Foreign exchange dealers have capitalized on their existing operations technology to create new services for their trading customers. One example is foreign exchange prime brokerage, a subject to which I devote the whole of Chapter 7.

The third reason for being interested in operations is that it reveals how the development of the foreign exchange market has evolved around sponsored transactional patterns.1 By this I mean transactional patterns that are facilitated by central banks and affiliated institutions. One normally thinks of a central bank as a creator of money, a regulator of commercial banks, and an authority in conducting monetary policy. There is another role that they play. Central banks have broad powers over the format of trading and the actual settlement of transactions simply by their affording the market efficient funds transfer systems. Prime examples are the real-time gross settlement systems that are operated by dozens of central banks. These systems are used in practically every foreign exchange settlement because they are an efficient and economical means of effecting large value transfers.

My primary intention is to convey the practical details of how foreign exchange operations work. For this reason I have prepared more than a hundred examples of trading conversations, SWIFT messages, confirmations, statements, and other types of reports.

I have adopted a somewhat broad definition of operations that includes many related topics, including:

Execution, documentation, and confirmation of trades.Trade settlement and funds transfers.Master agreements and other contractual arrangements that support trading and settlement.Margin and collateral practices.Foreign exchange prime brokerage.

Before I can begin these topics I present two introductory chapters. Chapter 1 is about the size and nature of the foreign exchange market. Chapter 2 introduces the essential concepts of currency options.

David F. DeRosa June 2013

1 DeRosa, David F. 2013. Sponsored transactional patterns: Comments on Mehrling's “Essential hybridity: A money view of FX.” Journal of Comparative Economics, 41 (2) 364–366.

Acknowledgments

The Foreign Exchange Committee (FXC) has graciously given me permission to reprint several of its template agreements. The views expressed in this book are those of the author, and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. It should not be assumed that the Federal Reserve Bank of New York or the Federal Reserve System endorse this book or any of the views expressed in this book.

I gratefully acknowledge permission from SWIFT to reprint information extracted from publicly available sources that may be subject to SWIFT copyrights and trademarks. Names and transaction details are fictitious. SWIFT is the trade name of S.W.I.F.T. SCRL. SWIFT Standards are licensed subject to the terms and conditions of the SWIFT Standards IPR Policy—End-User License Agreement (www.swift.com/about_swift/legal/swiftstandards_ipr_policy). The content of this material has not been reviewed by SWIFT for accuracy, nor is it endorsed by SWIFT.

I express gratitude to FXall for allowing me to reprint several of their transactions screens.

I give thanks to Mr. Bob Pepitone of The Clearing House for assistance in understanding payment systems.

Several persons have been of great assistance to me in the preparation of this book. I wish to give special thanks to John Goh. I also thank Catherine McGuinness, Jason Stemmler, Anu Khambete, Devin Brosseau, Inge Ivchenko, Michael F. Guarino, and Francesca DeRosa.

The author is solely responsible for any errors.

DFD

CHAPTER 1

Introduction to Foreign Exchange

The foreign exchange market is the market where currencies are traded. A currency is the money of a country. It serves as the country's legal tender, the medium with which debts can be discharged and taxes can be paid.

As a general rule, every country has its own currency, though there are some prominent exceptions. By extension, practically every country has a central bank (DeRosa 2009).

Large money-center banks are the primary dealers in foreign exchange, trading in spot, forward, forward swaps, and options. Central banks are also instrumental to the foreign exchange market, acting as policy agents for their respective governments and as operators of the primary settlements systems. This chapter will introduce the key players, the varieties of transactions, and the important conventions of the marketplace.

DEFINING MONEY

In an international context, we say currency, but in a local environment the term is money.

Currency, or money, is curious in at least one regard. At its core, it is a creation of a central bank. Monetary economists describe central bank money, or high-powered money, as the sum of currency outstanding and in the hands of the public plus commercial bank deposits (or reserves) held at the central bank. This part of the money supply is state created. Add to this the money that is created privately in the banking system through expansion because of fractional reserve requirements. The implication is that money is a hybrid concept, part state and part private in origin. Mehrling (2013) and DeRosa (2013) recognize this hybridity and call attention to the role of the central bank in establishing pricing parity between state money and private money.