Chapter 8 Flashcards

Question

OTFs

Answer 1

An OTF is a multilateral system which is not a RIE or MTF. OTFs allow trading of bonds, structured products, emissions and derivatives. There is no equity trading. OTFs filled the gap for many off-venue transactions to now be seen within the trading environment. Increasing transparency and liquidity. OTFs, unlike MTFs, allow discretion of matching buying and selling interests in line with fair and orderly trading and best execution obligations. Helping to promote liquidity and price transparency to historically less liquid and transparent asset classes. It is hoped this will facilitate greater market competition. OTFs must subscribe themselves to RIE and MTF transparency. OTFs must also monitor member compliance and member transactions.

Answer 2

A qualifying investment firm which deals on its own account on a regular systematic basis. It executes client orders outside and MTF, OTF or RIE. Trading is only between clients of the firm. The SI acts as a mini exchange and a firm can become a SI on an opt-in basis if it does not fit criteria.

Answer 3

Challenger to dark pools which have a counterparty (single-dealer platforms). Other differences include: * Brokers can ask questions about client orders and know the parties involved. Broker could fill the order at a tailored price. * Ping Pools have fewer controls on offering transparency. Some regulators demand dark pools must publish their users and the operation method of the pool. Neither required by ping pools. This causes concern for some market participants.

Answer 4

Market and Regulatory Environment * High income economy * Formal stock market regulatory authority * Fair and non-prejudicial treatment of minority shareholders * Selective or non-selective incidence of foreign ownership restriction * No objections or significant restriction or penalty applied to repatriation of capital * Well-developed and free equity and FX markets * Simple registration process for foreign investors Custody & settlement * Settlement – rare incidence of failed trades * Custody – Sufficient competition to ensure high quality custodian services * Clearing & Settlement – T+2 or less * Settlement – Free delivery available * Custody – Omnibus facilities available to international investors Dealing Landscape * Brokerage – Sufficient competition to ensure high-quality brokerage service * Liquidity versus sufficient broad market to support high level of global investment * Transaction costs – Implicit and explicit costs are reasonable and competitive * Short selling permitted * Stock lending permitted * Efficient trading mechanism * Transparency – Market depth information/visibility and timely trade reporting Derivatives * Developed derivatives markets

Answer 5

Emerging markets can be defined in various ways. They could be * Countries with markets of low or middle income or * Markets with less than 2% of global market cap FTSE Russell divides emerging markets into two categories * Advanced emerging countries – Rapidly growing economy, significant industrialisation and advanced technological capability. Sophisticated financial markets, strong infrastructure and high standard of living. Ex – Brazil, Mexico & SA * Secondary emerging countries – Developing economically but less developed financial markets and infrastructure. Earlier stage of industrialisation but high potential for growth. Ex – China, Saudi Arabia & UAE

Answer 6

US Monetary policy is set by the Fed and has an objective of promoting maximum employment, stable prices and moderate long-term interest rates. The inflation target is an average of 2% over time. This is achieved using the discount rate, reserve requirements, open market operations and interest on reserves. 15% of global GDP accounted for by US. Two largest stock exchanges in the world NYSE and NASDAQ by market cap. NYSE Continuous auction format. Member firms act as auctioneers in an open-outcry auction market environment in order to bring together buyers and sellers. However 50% of order flow is now delivered electronically, proposals to adopt hybrid structure of open outcry & electronic markets. NASDAQ Electronic stock exchange. High tech and many listings include telecoms, media and tech companies. High growth and volatile. Trades are undertaken via market makers who make a book in specific stocks. Purchases are done directly through market makers. Settlement Main settlement depository is the Depository Trust Company, central securities depository subsidiary of the Depository Trust and Clearing Corporation providing clearing and settlement services to financial markets in the US. DTC is responsible for corporate stocks and bonds, municipal bonds and money market instruments. Federal Reserve Bank is the depository for US gov bonds and securities. Book entry, shareholders can request certificate. US aims to eliminate physical certificates at state level. Equities & government bonds settle T+1 and corporate / municipals settle T+2

Answer 7

Tokyo Stock Exchange one of five in Japan and one of the most important in the world. More than 3,800 listed companies it is third largest in the world. Includes Toyota, Sony and Mitsubishi. Three market segments – Prime Market, Standard Market and Growth Market. Electronic continuous auction system. Brokers place orders online and trades are automatically executed when buy and sells match. No market maker. TSE uses price controls ensuring that prices cannot rise / fall above a certain point each day. Prevent dramatic swings in price. Settlement cycle is T+2. JASDEC acts as CSD for equity. Settlement is book entry transfer with cash transfer. JGBs are T+1 settlement. Bank of Japan central clearing and depository.

Answer 8

EU Monetary Policy is set by the ECB. Objective is to maintain price stability by keeping the HICP close to (but below) 2%. The inflation target is a medium term 2%. This is achieved using interest rates (long-term loans at favourable rates and negative rates). Deutsche Börse main exchange offers securities and derivatives trading, offers settlement and provision of market information. Cash market provides floor trading and a full electronic system each are efficient and optimise liquidity. Xetra is the electronic trading system matches buy and sell orders in a fully electronic book. System fixes prices and specialists supervise it. Investors benefit from faster processing. Deutsche Börse owns the ICSD ClearStream which provides banking, custody and settlement of fixed-interest securities and shares. ClearStream provides settlement and clearing for the German market. Eurex Clearing AG is the CCP for German stocks traded on Xetra and Börse Frankfurt. Equities and bonds are T+2 settlement. Transfer by book entry through Cascade in domestic business and ClearStream for international. DAX has changed rules to improve index quality, Increased constituents to 40 from 30. Must have two consecutive years positive EBITDA. Failure to audit accounts and quarterlies results in immediate ban

Answer 9

The key safeguard in futures contracts is the clearing margin which must be maintained with the clearing house. Set by the margin committee and directors. The clearing margin is in relation to net long or short positions in each commodity. Clearing margins are posted in different forms. An example in the US might be * Cash as evidence by margin certificates * Short-term government securities * Stock in the clearing corporation * Letter of credit issued by an approved bank Margin cannot be touched until it is released by the clearing corporation. Margin requirements are updated daily. A clearing corporation may call on a member to deposit additional margin to cover adverse price movements. This is called the ‘variation margin call’ which must be deposited within one hour. This ensures a tight control over margin in price fluctuations. Clearing corporation settles each account on its books each day and adjusts the gain or loss daily. Settlement price is a simple average of high and low prices in the closing range monthly. Clearing houses roles include: * Transparent transaction processing * Post-trade management functions * Financial management of member’s collateral deposits * Final settlement of outstanding obligations through financial payment or physical delivery * Risk management of market participants * Financial guarantee of performance of its contracts Clearing House Risks How far does the performance guarantee extend? Under net margin the clearing house only collects margins from members based on net exposure. Clearing house goal is not to guarantee futures contracts but only to protect members from default of other members.

Answer 10

Immobilization Holding of the paper certificates by depositories. This is historic practice and transition is being made to dematerialisation which is the replacement of certificates with electronic equivalents. Corporate Action Processing CSDs perform admin tasks regarding dividend processing, interest and principal processing and also corporate actions through proxy voting. Safekeeping Dematerialised securities are held in book-entry only form or in physical form immobilised within the CSD. Deposit & Withdrawal CSDs allow support for deposit and withdrawal i.e., the relationship between transfer agents and/or issuers with the CSD. Covers the CSD’s role in underwriting and listing. Pledging CSDs provide pledging of shares and securities. Jurisdictions set their framework for protecting the interests of those parties. Other Services Include securities lending and borrowing, matching and repo settlement.

Answer 11

Custodians primary responsibilities are to ensure client assets are fully protected at all times. They must provide robust safekeeping for all valuables and documentation. Client assets must be properly segregated from those of the custodian and legal arrangements made to ensure any shocks to the custodian do not expose the client’s assets to claims from creditors. Custodian Services * Provide safekeeping of assets in the local market * Make arrangements for delivery and receipt of cash and securities to support settlement * Provide market information to the investor on developments and reforms in the market * Collect dividend income, interest on debt and other income * Monitor and manage entitlements through corporate actions and voting rights * Manage tax reclaims and tax services * Manage client cash flow * Ensure securities are registered and that transfer of legal title proceeds effectively * Ensure reporting obligations to regulators are effectively discharged Investors can choose their type of custodian for global assets * Global Custodian – Manages their custody arrangements across full range of foreign markets where it holds invested assets * Local Custodian – An individual custodian manages their investments in each market they invest * Regional Custodian – Provides agent bank services across multiple markets in the same region * Alternatively, can make arrangements to settle trades and hold securities and cash with a CSD within each market, or use an ICSD

Answer 12

Provide investment admin and cross-border processing of securities trades. Keeps financial assets secure (safe custody) outside of the country where investor is located. Tasks include settlement, safekeeping, cash management, record-keeping and asset servicing. Some investors may also use for investment accounting, treasury and FX, securities lending and borrowing, collateral management and performance/risk analysis. Global custodians have an extensive network of branches worldwide allowing them to provide comprehensive local custody services rather than relying on third-party providers. Where global custodians do not have presence, they may appoint an external agent bank to provide local custody service. If there is no economic rationale for having their own branch.

Answer 13

Appointed by global custodian as local agent to provide settlement and custody services for assets it holds on behalf of investor clients. Sub custodian is the eyes and ears of the global custodian in a local market. It provides market specific information and lobbies for reforms to make the market more appealing for foreign investment It may take the form of: * One of the branches of the global custodian * A local agent bank which specialises in sub-custody * A regional provider that offers sub-custody to the global custodian across a range of markets

Answer 14

Provide sub-custody in their home market. Known as single-market providers. They are dying out due to regional and global competitors. They offer service alongside global custody and master custody to institutional investors in home markets. They are local specialists and focus on local business. This can be attractive when local practice is unusual compared to global norms or if there is strong capacity for lobbying for reforms for cross-border clients. * They are country specialists * Eyes and Ears of global custodian * Have regular dealings with financial authorities and local politicians – well placed to lobby for efficiency reforms * Expert knowledge of local market practice * Offer opportunity for reciprocal business Downsides * Credit rating will be lower than global custodians * Cannot leverage developed technology across multiple markets. Products may lag regional custodians competitively * Cannot offer the price discounts

Answer 15

Works across a region through multiple markets. Advantages * Higher credit-rating than single-market * Can cross-fertilise good practice across multiple markets * Standardised reporting, management information systems * Leveraging innovation in technology, product development and client service * Economies of scale may support delivery of some/all product lines – cost savings and efficiency * Size and regional importance means leverage on local regulators * Global clients can receive price discounts Disadvantages * Less focused product offering * Wider range of clients means less attention to any individual and less individualised service * May lack long track record and goodwill of local custodians

Answer 16

* Custody agreements outline legal conditions for holding the assets and are protected and segregated from the custodians’ assets * Responsibilities of the custodian under the custody relationship * Authority for custodian to accept fund manager instructions when institutional investor employs Ims to manage assets on its behalf Custody agreements include * Method of receipt of client assets * Reporting obligations and deadlines * Guidelines for use of CSDs * Business contingency plans to cope with malfunction or disaster * Liability in contract and damage claims * Service standards and care required * List of persons authorise to give instruction * Actions to be taken in response to instruction or without instruction

Answer 17

This includes: * Recordkeeping, maintenance of documentation * Settlement on both RIEs and OTCs * Communication and reporting * Processing Corp. Actions * Income Processing * Tax Services * Cash Management * Stock Lending and Borrowing * Market Information and Market Knowledge * Standards of service expected from account officers and relationship managers as points of contact

Answer 18

Trustees must uphold the following standards: * Demonstrate familiarity with structure and aims of the pension scheme and have appropriate training and skill to carry out responsibilities. * Fiduciaries must monitor and review tasks delegated to third parties to ensure they are discharged effectively * Duty of loyalty demands that trustees administer their scheme based on the best interests of members * Trustees must avoid undue risk in managing scheme assets. Appoint intermediaries to manage or administer scheme assets on the scheme’s behalf.

Chapter 8 Flashcards

(42 cards)