Contents

Preface

Acknowledgements

About the Author

Part 1 Working in Product Control

CHAPTER 1 An Introduction to Product Control
1. The Emergence of Product Control
2. The Purpose of Product Control
3. Different Types of Product Control
4. Skills, Qualifications and Experience
5. Organizational Structure
6. The Desk
CHAPTER 2 Changing Landscape of Product Control
1. Offshoring
2. XVA
3. Greater Levels of Capital
4. Greater Focus on Liquidity
5. Notes
CHAPTER 3 Key Stakeholders
1. Front Office: Sales and Trading Desk
2. Chief Operating Officers (COOs)
3. Operations
4. Middle Office
5. Market Risk
6. Financial Reporting
7. Management Reporting
8. Finance Change
9. IT
10. Operational Risk
11. Regulatory Reporting
12. Accounting Policy
13. Tax
14. Audit
15. Finance Shared Service
16. Summary
17. Notes

Part 2 Technical Skills

CHAPTER 4 Accounting Standards: Recognition and Measurement
1. IAS 39 Financial Instruments: Recognition and Measurement
2. IFRS 9: Financial Instruments
3. IFRS 13: Fair Value Measurement
4. Notes
CHAPTER 5 Market Risk
1. What Is Market Risk and How Is It Generated?
2. How Is Market Risk Measured by a Bank?
3. Notes
CHAPTER 6 Pricing Financial Instruments
1. How to Approach the Pricing of a Financial Instrument
2. Pricing examples
3. Notes
CHAPTER 7 Internal Control
1. What is Internal Control?
2. Establishing an Internal Control Framework
3. Example of Front to Back Internal Controls
4. Notes

Part 3 Profit and Loss Controls

CHAPTER 8 System Feeds, End of Day Rates and Profit and Loss Estimates
1. System Feeds
2. End of Day
3. End of Day Rates
4. P&L Estimate
5. Notes
CHAPTER 9 Review of New and Amended Trades
1. New Trades
2. Amended Trades
3. Notes
CHAPTER 10 Review of Mark-to-Market P&L
1. Defining Mark-to-Market P&L
2. Attributing MTM P&L
3. Risk-Based P&L estimates
4. Changes in the End of Day Prices
5. When to Validate the MTM P&L
CHAPTER 11 Funding, Fees and Charges
1. Funding
2. Fees and Charges
3. Notes
CHAPTER 12 Profit and Loss Adjustments
1. The Need for P&L Adjustments
2. Controlling P&L Adjustments
3. Notes
CHAPTER 13 Profit and Loss Commentary
1. Who Is the Reader?
2. When Is P&L Commentary Required?
CHAPTER 14 Profit and Loss Reconciliations and Sign-Offs
1. Flash vs. Actual
2. Desk P&L Sign-off
3. P&L Reconciliation

Part 4 Valuations

CHAPTER 15 Independent Price Verification
1. Components to IPV Process
2. Notes
CHAPTER 16 Valuation Adjustments
1. Why Valuation Adjustments Are Required
2. Bid–Offer
3. Day 1 Reserves
4. Model Valuation Adjustment
5. XVA and Collateral Agreements
6. Recording and Reporting of VAs
7. Notes

Part 5 Balance Sheet Controls

CHAPTER 17 Balance Sheet Substantiation and Analysis
1. Substantiating the Balance Sheet
2. Frequency of the Balance Sheet Substantiation
3. Evidencing the Balance Sheet Substantiation
4. Unsupported Balances
5. Lines of Responsibility
CHAPTER 18 Dividending of Profit and Loss and FX Selldown
CHAPTER 19 Controlling Nostros
1. Introduction to Nostros
2. Controlling Nostros – Cash Breaks
3. Risk-Weighting Cash and AVE breaks
4. Provisioning for Nostro and AVE Breaks
5. Notes

Part 6 Financial Accounting and Reporting

CHAPTER 20 Financial Accounting Entries
1. Financial Accounting Entries
2. Chart of Accounts
3. Accounting Rules Engine
4. Notes
CHAPTER 21 Financial Reporting and Note Disclosures
1. Context of Financial Reporting
2. Profit and Loss
3. Balance Sheet
4. Netting
5. Fair Value Hierarchy
6. Notes

Part 7 Supplementary Controls

CHAPTER 22 New Product Proposals
1. Starting Line
2. The Review
3. The Sign-Off
CHAPTER 23 Rogue Trading
1. The Forefathers of Rogue Trading
2. The Fallout from Rogue Trading – The Bank
3. The Fallout from Rogue Trading – The Industry
4. Going Rogue
5. UBS Rogue Trading Incident, 2011
6. Notes

Index

EULA

List of Tables

Chapter 1

Table 1.1

Chapter 3

Table 3.1
Table 3.2

Chapter 4

Table 4.1
Table 4.2
Table 4.3
Table 4.4
Table 4.5
Table 4.6
Table 4.7
Table 4.8
Table 4.9
Table 4.10
Table 4.11
Table 4.12
Table 4.13
Table 4.14

Chapter 5

Table 5.1
Table 5.2
Table 5.3
Table 5.4
Table 5.5
Table 5.6
Table 5.7
Table 5.8

Chapter 6

Table 6.1
Table 6.2
Table 6.3
Table 6.4
Table 6.5
Table 6.6
Table 6.7
Table 6.8
Table 6.9
Table 6.10
Table 6.11

Chapter 7

Table 7.1
Table 7.2
Table 7.3
Table 7.4

Chapter 8

Table 8.1
Table 8.2

Chapter 9

Table 9.1
Table 9.2
Table 9.3
Table 9.4
Table 9.5
Table 9.6
Table 9.7
Table 9.8
Table 9.9
Table 9.10
Table 9.11
Table 9.12
Table 9.13
Table 9.14
Table 9.15
Table 9.16
Table 9.17
Table 9.18

Chapter 10

Table 10.1
Table 10.2
Table 10.3
Table 10.4

Chapter 11

Table 11.1
Table 11.2
Table 11.3
Table 11.4
Table 11.5
Table 11.6

Chapter 12

Table 12.1
Table 12.2
Table 12.3

Chapter 13

Table 13.1
Table 13.2
Table 13.3
Table 13.4

Chapter 14

Table 14.1
Table 14.2
Table 14.3
Table 14.4

Chapter 15

Table 15.1
Table 15.2
Table 15.3
Table 15.4
Table 15.5
Table 15.6
Table 15.7
Table 15.8

Chapter 16

Table 16.1
Table 16.2
Table 16.3
Table 16.4
Table 16.5
Table 16.6
Table 16.7
Table 16.8
Table 16.9
Table 16.10

Chapter 17

Table 17.1
Table 17.2
Table 17.3
Table 17.4
Table 17.5
Table 17.6
Table 17.7
Table 17.8
Table 17.9

Chapter 18

Table 18.1
Table 18.2

Chapter 19

Table 19.1
Table 19.2
Table 19.3
Table 19.4

Chapter 20

Table 20.1
Table 20.2
Table 20.3
Table 20.4
Table 20.5
Table 20.6
Table 20.7
Table 20.8
Table 20.9
Table 20.10
Table 20.11
Table 20.12
Table 20.13
Table 20.14
Table 20.15
Table 20.16
Table 20.17
Table 20.18
Table 20.19
Table 20.20
Table 20.21
Table 20.22
Table 20.23
Table 20.24

Chapter 21

Table 21.1
Table 21.2
Table 21.3
Table 21.4
Table 21.5
Table 21.6
Table 21.7
Table 21.8
Table 21.9
Table 21.10
Table 21.11
Table 21.12
Table 21.13
Table 21.14
Table 21.15
Table 21.16
Table 21.17
Table 21.18
Table 21.19

Chapter 22

Table 22.1
Table 22.2
Table 22.3

Chapter 23

Table 23.1
Table 23.2

List of Illustrations

Chapter 1

Figure 1.1 The purpose of product control
Figure 1.2 The P&L
Figure 1.3 Finance and product control organizational structure
Figure 1.4 Remit of valuation control
Figure 1.5 The foreign exchange market operating hours
Figure 1.6 World stock market operating hours
Figure 1.7 Sir Alex Ferguson brokering trades for charity in London

Chapter 2

Figure 2.1 Changes in product control
Figure 2.2 Offshoring models
Figure 2.3 The impact of increased capital

Chapter 3

Figure 3.1 Stakeholder interaction with product control
Figure 3.2 The role of operations
Figure 3.3 Sparta Bank FX One Name Trading (Single book)

Chapter 4

Figure 4.1 Overview of IAS 39
Figure 4.2 Derecognizing an asset
Figure 4.3 Repurchase agreement
Figure 4.4 Aspects of control within a transfer
Figure 4.5 IAS 39's classification and measurement of financial assets
Figure 4.6 Classification and measurement of financial liabilities under IAS 39
Figure 4.7 U.S. GAAP classification and measurement
Figure 4.8 U.S. GAAP classification and measurement
Figure 4.9 Recording the impairment of AFS and held to maturity assets
Figure 4.10 IFRS 9: classification and measurement for financial assets
Figure 4.11 Establishing the type of business model
Figure 4.12 IFRS 9: interest components
Figure 4.13 IFRS 9 – Fair value through P&L
Figure 4.14 IFRS 9: Impairment
Figure 4.15 Bid and Ask quotes for spot FX rates
Figure 4.16 IFRS 13: Determining fair value

Chapter 5

Figure 5.1 Generating and laying off market risk
Figure 5.2 Pricing, market risk and P&L
Figure 5.3 Consolidating interest rate risk
Figure 5.4 Market risk arising from a FRA
Figure 5.5 Interest rate risk for an interest rate swap
Figure 5.6 The standard deviation of P&L scores

Chapter 6

Figure 6.1 Approach to pricing a financial instrument
Figure 6.2 Spot FX trade
Figure 6.3 Spot FX quotes in the market
Figure 6.4 FX forward trade
Figure 6.5 GBP/USD FX forward rate
Figure 6.6 Bond cash flows
Figure 6.7 Interest rate swap
Figure 6.8 U.S. swaps curve
Figure 6.9 AUD/USD FX volatility
Figure 6.10 The payoff for a long AUD/USD call option

Chapter 7

Figure 7.1 COSO Integrated Control Framework
Figure 7.2 Objectives and internal control
Figure 7.3 Establishing a risk culture and risk management framework
Figure 7.4 Lines of defence
Figure 7.5 Four lines of defence
Figure 7.6 Front to back controls

Chapter 8

Figure 8.1 Optimal controls over the P&L
Figure 8.2 Decomposing or attributing the P&L
Figure 8.3 Alternative P&L reporting feeds
Figure 8.4 Supply of data and checks to product control
Figure 8.5 Sourcing end of day rates
Figure 8.6 SuperDerivatives pricing service
Figure 8.7 External rate checks
Figure 8.8 Checking trader marks

Chapter 9

Figure 9.1 Drivers of new trades
Figure 9.2 Drivers of new trades
Figure 9.3 Steps in the new trade process
Figure 9.4 New trade threshold criteria
Figure 9.5 New trade threshold criteria
Figure 9.6 Intraday GBP/USD Spot FX prices
Figure 9.7 Considerations in a new trade review
Figure 9.8 Client transaction
Figure 9.9 Crossing the bid–offer to hedge risk
Figure 9.10 Transaction price now incorporates the cost of crossing the bid–offer
Figure 9.11 Transaction price now incorporates bid–offer, margin and CVA
Figure 9.12 Transaction price now incorporates bid–offer, margin, CVA and FVA
Figure 9.13 Selling CDS protection to a client
Figure 9.14 P&L from amended trades
Figure 9.15 HSBC Share price
Figure 9.16 P&L reporting of a close out
Figure 9.17 Novation of an interest rate swap
Figure 9.18 CME Group acting as a central clearing counterparty
Figure 9.19 Overview of MarkitServ's process
Figure 9.20 Avoidable amendments

Chapter 10

Figure 10.1 Defining MTM P&L
Figure 10.2 Validating MTM P&L
Figure 10.3 Driver of MTM P&L
Figure 10.4 Using the waterfall method to sub-attribute an FX option's MTM P&L
Figure 10.5 Using the restored method to attribute an FX option's MTM P&L
Figure 10.6 Quantifying a risk-based P&L estimate
Figure 10.7 Fixings vs risk based P&L estimate
Figure 10.8 U.S. markets in Bloomberg
Figure 10.9 AUD/USD price changes

Chapter 11

Figure 11.1 Drivers of funding
Figure 11.2 Sourcing funding
Figure 11.3 Funding a bond purchase
Figure 11.4 Funding P&L
Figure 11.5 Above and below the line expenses

Chapter 13

Figure 13.1 P&L commentary segments
Figure 13.2 Intraday MTM P&L

Chapter 14

Figure 14.1 P&L sign off
Figure 14.2 Approaches to P&L reporting and the impact on reconciliations
Figure 14.3 Establishing P&L variance thresholds

Chapter 15

Figure 15.1 P&L smoothing
Figure 15.2 IPV process
Figure 15.3 Price discovery hierarchy
Figure 15.4 Cross currency basis
Figure 15.5 Stock prices
Figure 15.6 World corporate bond prices
Figure 15.7 Outright GBP volatilities by delta
Figure 15.8 Spot FX rates
Figure 15.9 GBPUSD FX forward points
Figure 15.10 Transocean 5-yr Senior CDS quote

Chapter 16

Figure 16.1 Aligning valuations to their exit price
Figure 16.2 Crossing the bid–offer spread
Figure 16.3 Differences in bid–offer spreads by tenor
Figure 16.4 Volatile market
Figure 16.5 Stable market
Figure 16.6 Rates desk risk aggregation
Figure 16.7 Back-to-back interest rate swap
Figure 16.8 FCA on a back-to-back interest rate swap

Chapter 17

Figure 17.1 Substantiating the GL

Chapter 18

Figure 18.1 Overview of dividending, FX selldown and repatriation of P&L
Figure 18.2 In non-selldown centres, foreign currency P&L is transferred to the FX position accounts

Chapter 19

Figure 19.1 Nostro record keeping
Figure 19.2 Ledger and statement entries
Figure 19.3 TLM reconciliation workflow
Figure 19.4 TLM cash reconciliation dashboard
Figure 19.5 Cash break identification
Figure 19.6 Cash break transfer to the credit desk

Chapter 20

Figure 20.1 A trial balance report
Figure 20.2 Loan agreement
Figure 20.3 Cash flows for $1m Muster Inc. 10% S/A bond
Figure 20.4 Accounting for an interest rate swap
Figure 20.5 Accounting for an FX forward
Figure 20.6 Accounting rules engine flows

Chapter 21

Figure 21.1 Different paradigms
Figure 21.2 Netting – a summary of IAS 32’s criteria
Figure 21.3 Fair value hierarchy
Figure 21.4 FVH decision tree

Chapter 23

Figure 23.1 Rogue trading events
Figure 23.2 Repercussions of rogue trading
Figure 23.3 NAB capital increase post rogue trading
Figure 23.4 Control weakness at UBS not remediated post rogue trading review in 2008
Figure 23.5 UBS Organizational structure
Figure 23.6 EURO STOXX 50 and S&P 500 price history
Figure 23.7 Concealment mechanisms used by the rogue trader
Figure 23.8 SCP alerts
Figure 23.9 Late trades
Figure 23.10 Deferred settlements
Figure 23.11 P&L smoothing using fee tickets
Figure 23.12 Summary of control weaknesses
Figure 23.13 Consolidated lens

CHAPTER 1
An Introduction to Product Control

The Emergence of Product Control

Finance within banking is unlike finance in most other types of industries. In most non-banking companies, the finance team is separate from the producer. For example, in a manufacturing company the finance department is not on the shop floor, and in a retail company it is not in the stores. Most likely, finance is housed in the head office.

In these industries, the value of the product is not often in dispute. Usually the cost of sales and production, or margin per unit, is known and the revenues are the function of a simple calculation. There is also often a team of management accountants providing information to the product line managers on the results of their business and assisting in analytics on those results.

In banking, it is not that simple. Finance is more integral to the production because the products banks deliver are financial. In the 1990s, with increasing volumes of trading, a greater pool of financial instruments and higher levels of complexity, it was necessary for banks to establish a dedicated function within finance to control evolving sales and trading desks. With that, management accountants within finance morphed and grew into a function called product control, which came to dominate large swathes of finance, establishing footprints all over the developed world and later on, the developing world.

Over the past decade, these large swathes have been migrating from the more expensive financial centres such as London, New York, Tokyo, Hong Kong and Singapore, to cheaper locations such as India, Poland and the Philippines. This change has presented opportunities for aspiring workers in the developing nations and presented uncertain career paths for those remaining in the shrinking financial centres.

We will look at this trend in more detail in Chapter 2.

The Purpose of Product Control

Product control is the face of finance to the sales and trading desks in a bank. They provide financial control and transparency through (Figure Figure 1.1):

Providing a profit and loss statement and balance sheet which is accurate and timely;
Providing meaningful insight into the desk's financial results;
Supporting the desk in the execution of their business strategy; and
Evaluating and integrating new products into the financial environment.

Product control's purpose is executed through a series of controls across the P&L and balance sheet, many of which are performed daily. On top of these controls, product control's financial acumen and understanding of the bank's systems can be used to support the execution of the desk's business strategy. This includes providing insight into drivers of financial performance, reviewing the desk's use of legal entities within the banking group and assessing the efficiency of process workflows.

**Figure 1.1** The purpose of product control

The centrepiece of the product control role is the daily P&L (Figure 1.2). If you aren't familiar with this term, it measures the income and expenses for the sales and trading desks. If the sum of the income from trading activities, client sales and trading expenses is greater than zero, a profit is reported, otherwise a loss is reported.

We will explore the controls that product control normally execute in greater detail throughout Parts III through VII of the book.

Different Types of Product Control

Before we can explore the role of product control further we need to be aware that not every organization will share the same mandate for their product control function. Although there will be exceptions to this, we can broadly categorize the function into one of two types:

P&L only
P&L, balance sheet and financial reporting.

P&L Only

The P&L-focused role is, as its name suggests, focused purely on the P&L. In firms across the industry this function may also be labelled as middle office. The review and substantiation of the balance sheet and financial reports are performed by a separate team(s) within finance.

There are benefits and drawbacks for any organizational structure. There are two main benefits to this model. First, it relies on a team with a narrower skill set, which can improve the control framework as the product controller does not have to be an expert in an excessive number of disciplines (accounting, risk management, financial reporting, etc.). Second, as the skill set is narrower it should be easier for the firm to hire and develop their talent.

The primary but manageable drawback to this structure is that a single team is not controlling all the financial aspects of the desk and weakness in the control framework arises when the roles and responsibilities of the different finance teams are not clearly defined and understood by all staff.

For example, the product controllers for the credit trading desk are aware of a late trade booking for 31 December (financial year end) that has missed the end of day report batches that are used to populate the P&L reporting system and general ledger (GL) for financial reporting. The product controller determines the trade has an immaterial impact on the P&L so decides not to adjust the P&L.

Although the trade had an immaterial impact on the P&L, it had a material impact on balance sheet usage, which the financial controllers will not be aware of. Consequently, the firm's year-end reporting misstates not only the balance sheet size and shape, but also the capital ratios, as the risk-weighted assets (RWAs) did not take this late trade into consideration.

This drawback can be compensated for by having clear roles and responsibilities and up-to-date standard operating procedures (SOPs) for each function. These documents make clear the control framework which the firm has in place for each desk.

Each task and responsibility should be documented extensively and refer to what is a control exception and when that exception should be escalated. In this example, the SOPs could require product control to adjust the month-end financials (both P&L and balance sheet) for every late trade.

P&L: Balance Sheet and Financial Reporting Focus

A broader version of product control includes responsibilities which cover the P&L, balance sheet and some financial reporting for the bank.

This product controller is aware that changes in the balance sheet are the driver of P&L performance and as such it is critical that the balance sheet is reviewed, substantiated and understood.

This product controller will perform the same functions as the P&L-only controller in addition to the following tasks:

Review and substantiation of the balance sheet
Advising the desk on the accounting treatment for their transactions (if further expertise is not required from accounting policy)
Assisting financial reporting in their review of the financial reports, including note disclosures
Populating the GL with any necessary financial accounting entries.

As product control cover a substantial portion of the control framework assigned to finance, the bank benefits from a single team monitoring all aspects of the desk's financial performance (i.e., the P&L, balance sheet and financial reporting). This set-up should ensure both the P&L and balance sheet are aligned and that by seeing the full financial picture, issues are more readily identifiable.

The main drawbacks of this structure relate to the breadth of responsibilities being undertaken. As the product controller needs to be skilled in many more disciplines than the P&L-only function, it can be more difficult to recruit and develop talent. Additionally, so many responsibilities may cause some to be neglected.

As before, these drawbacks can also be compensated for by having clear roles and responsibilities and complete standard operating procedures.

For the purposes of this book we will focus on this type of product control function.

Skills, Qualifications and Experience

Product control has historically employed candidates with varying levels of experience but one of the most common recruitment styles of banks has been to employ candidates who, after completing three years of work experience in an accounting firm and passing their accounting exams, have qualified as chartered accountants. These chartered accountants would then be brought into the product control function and be trained up to control the sales and trading desks.

Over time, these candidates would gain the necessary experience to move through the product control ranks by becoming senior product controllers and then product control managers.

Accountants who, for various reasons, have decided not to train in accounting firms are also very prevalent in the product control ranks. These candidates commonly spend their qualifying period working within the financial services sector at banks, fund managers, credit rating agencies and so on. This means they have different, but equally valuable, experiences to bring to product control.

Once in product control both sets of candidates can further their qualifications and skills by taking postgraduate courses.

Table 1.1 lists the product control hierarchy and the typical experience, qualifications and skill sets that you could expect to see in any bank.

Table 1.1 Qualifications, experience and technical skills

Title and Position		Qualifications and experience			Technical skills
Corporate Title	Position	Product Control Experience (Avg Years)	Bachelor's Degree	Qualified Accountant	Accounting	Market Risk	Pricing	Control Framework
Managing Director (MD)	Global head of product control	20	X	X	VH	VH	VH	VH
Managing Director (MD) or Director (D)	Global head of business line product control (e.g. Credit)	15	X	X	VH	VH	VH	VH
Director (D) or Vice President (VP)	Regional head of business line product control	10	X	X	H	H	H	H
Vice President (VP)	Senior product controller	6	X	X	M	M	M	H
Assistant Vice President (AVP)	Product controller	3	X	X	M	M	M	M
Analyst	Junior product controller	1	X	Newly or part qualified	L	L	L	L

Note: Corporate titles will vary across the industry

VH = very high, H = high, M = medium, L = low.

The depth and breadth of experience and skills, which product control provides, can open many opportunities within banking. Prior to the Jérôme Kerviel and Kweku Adoboli rogue trading events, these opportunities included transfers onto the trading desk. These transfers are now very rare due to the risks they pose to the bank. More commonly, many product controllers transition into chief operating officers (COOs), chief financial officers (CFOs) and operational risk executives.

On the flip side, given the broad set of technical skills required to advance through the ranks in product control, it is more difficult to enter the field later in your career if you do not already have these skills.

Organizational Structure

Product control sits within the finance department and is aligned to support the business. Product control's most senior appointment is the global head who, in addition to setting the agenda for the work performed by their team, will interact directly with the bank's markets CEO, who is the head of the trading floor.

In addition to the overall global head of product control, the division has global heads responsible for each line of business and it is their responsibility to represent product control to the respective heads of those businesses.

Using Figure 1.3 as an example, there are heads of product control for credit, foreign exchange, rates, commodities and equities. These heads are responsible for supporting and controlling the business they are aligned to.

**Figure 1.3** Finance and product control organizational structure

The teams of product controllers supporting and controlling the sales and trading desks for their business are usually consolidated into regional hubs where the traders are located. Sales staff, however, will be dotted all around the world as they are not limited to the regional hubs that exist for traders. The sales trades will be booked from the local offices and then risk managed in the regional hub by the trading desk.

In Figure 1.3 the regional hubs are Europe, the Middle East and Africa (EMEA), the Americas (both North and South America) and Asia.

The regional product control hubs will typically have managers for each line of business (e.g. credit, rates, etc.) in addition to a manager for the country (e.g. head of product control Singapore). The product control country manager will typically report directly into the country CFO (e.g. Singapore CFO) and will have an indirect reporting line to the global head of product control. They can also have indirect reporting lines to the heads of product control for each line of business.

There are exceptions to every rule and, in some cases, product control will not be based in the same location as their traders. For example, a small rates desk operating out of Sydney could be controlled by a regional product control team located in Singapore.

In addition to these teams, there is usually a separate product control team that is responsible for valuations. In rare cases, this team sits within market risk or alternatively may still sit within finance but report directly to the CFO or financial controller.

Valuations, or valuations control as they are also known, are responsible for a range of activities related to the valuation of financial instruments. Some of the common responsibilities for this team are illustrated in Figure 1.4 and they are outlined here:

Rate capture: Rate capture is the sourcing of end of day rates which are used to revalue the desk's open positions. This doesn't always sit with valuations and can reside within the business, operations or in market risk.
Bid offer and XVA (comprehensive valuation adjustments): Bid offer and XVA are the valuation adjustments required to bring the desk's portfolio to its fair value. We will look at valuation adjustments in more detail in Chapter 16.
Independent price verification (IPV): IPV checks that the end of day prices align to fair value. We will look at IPV in Chapter 15.
Prudential valuation: Prudential valuation is relatively new and isn't applicable in all jurisdictions. This work requires the valuations team to quantify additional valuation adjustments stipulated by the prudential supervisor, such as illiquidity and concentration risk.
Fair value hierarchy (FVH): FVH allocates the bank's financial assets and liabilities into three levels depending upon price observability and market activity.

**Figure 1.4** Remit of valuation control

In addition to these activities, valuations will work with the line product controllers to review and validate the day 1 P&L for significant or exotic new trades. And when a new product is proposed by the business, valuations will assess the product from a valuations perspective.

The Desk

A bank maintains separate desks to cover each line of business (FX, rates, credit, etc.). This structure allows the bank to tailor skill sets and focus on the specific markets and financial instruments for each line of business, which benefits the clients and the bank.

For example, the FX desk will only be responsible for pricing client trades and taking discretionary positions in the FX market. These desks will likely be further segregated into sub-desks to facilitate further specialization, such as linear (vanilla) and non-linear (exotic), and time-zone requirements.

Although the financial markets are global in nature, within each of the underlying markets there will be trading start and finish times which the desk's working hours align to. Two of those markets are foreign exchange and the stock markets, which are illustrated in Figures 1.5 and 1.6.

**Figure 1.5** The foreign exchange market operating hours

Source: Courtesy, Investing.com www.investing.com

**Figure 1.6** World stock market operating hours

Source: Courtesy, Investing.com www.investing.com

Although product control aren't expected to work identical hours to the desk, they need to be primarily the same so the P&L and other deliverables are completed.

The Trading Floor

The desk is located on a trading floor, which is a secure area of the bank and is strictly off limits to anyone who does not need to be there. In some firms, the trading floor seats a few dozen people and in others it seats hundreds of people.

As product control is the face of finance to the front office, to foster a closer working relationship it is important they are within close proximity to the desk. As trading floor space is priced at a premium, product control will be located on a different floor to the traders or in some cases a different building altogether.

The trading floor is a temperately warm area due to the numerous high-spec computers, multiple monitors and large number of data cables connecting the traders to the world. One of the most striking visual features of a trading floor is the proliferation of computer monitors. These screens enable the desk to view all the data it needs to make speedy and sound pricing and risk management decisions. These monitors contain:

Live market data from suppliers such as Bloomberg and Reuters
Live risk data from their risk management systems
Client orders waiting to be filled
Messaging services which contain information from key stakeholders and external clients – for example:
- Product controllers provide the P&L report which requires approval.
- Market risk provide market risk usage and limit reports which also require approval.
- Middle office provide the day's trade blotter and trade amendments.

Those on the trading floor are connected to each other via dealer boards and turrets (called squawk boxes). These telecommunications devices also connect the traders with their external brokers. To adhere to regulatory requirements and provide evidence in the case of trade disputes, all telecommunication traffic on the trading floor is recorded.

In Figure 1.7 Sir Alex Ferguson is brokering a trade for charity. This desk configuration is similar to what you can expect to see for a trader on a bank's trading floor.

**Figure 1.7** Sir Alex Ferguson brokering trades for charity in London

Source: ©PA Images

More recently, the trading floor environment has received a great deal of attention from regulators in multiple jurisdictions around the world. These regulators, for example, the Fed, FCA and APRA/ASIC, commenced reviews of all trader communications, including internal communications with colleagues and external communications with brokers and trading peers, in search of evidence to prove wrongdoing on the part of the trader.

This wrongdoing related mainly to the manipulation of key industry benchmarks such as LIBOR and BBSW, whose consensus yields were purported and in some cases proved, to be set at a level which illegally brought financial gain to the trader (at the expense of others).

These regulatory reviews prompted banks to conduct their own internal reviews of trader conduct, which not only focused on illegalities but also on other aspects of conduct such as trader language, client confidentiality and social activities related to work. The consequences now for traders exhibiting contrary behaviour can be severe and include financial penalties and termination of employment.

The effect of these reviews has been seen by some as bringing the trading floor into the 21st century by creating a more professional working environment, but it has also been viewed as creating a more sterile environment where traders are far more reluctant to “shoot from the hip”. Gordon Gekko and Jordan Belfort need not apply to work in the City these days.

Pressures of Supporting the Desk

The trading floor is a high-pressure environment, which raises the stress levels of traders and has a knock-on effect for product control. This pressure stems from the speedy and significant decisions traders need to make and the significant financial implications of these decisions.

As traders' pay is primarily based upon how much P&L they generate, traders can react badly when they incur trading losses, especially when they are behind budget. As product controllers, we need to be mindful of this, especially when you are the person reporting that loss. It's important not to take a trader's reaction personally.

As trading desks have great expectations placed on them, it is important that product control respond with appropriate urgency to their requests and to potential control issues. Financial markets have a way of inflicting damage on banks, so it's important that control issues and requests are dealt with in a timely manner.

This completes our introduction to product control. The remaining part of this book will examine the changes occurring within product control and introduce the role of product control's primary stakeholders.

ISBN 978-1-118-93981-9 (hardback)	ISBN 978-1-118-93979-6 (ePDF)
ISBN 978-1-118-93980-2 (ePub)	ISBN 978-1-118-93978-9 (obk)

Effective Product Control

Controlling for Trading Desks